Four Big Mistakes That Executors Frequently Make

Executors have a tough and often thankless job. They have to marshal all the estate's assets, file tax returns, and distribute property according to the Will. Sometimes, they make mistakes. Here's a look at the most common ones:

Paying bills too soon. Executors often see bills arrive in the mail and decide to pay them right away to avoid any problems. But this can actually create problems.

There is an order in which bills must be paid: Items such as taxes, funeral expenses and the costs of estate administration typically take priority over credit card statements, for instance. If an estate turns out to have a lot of debts (perhaps the person who passed away had an unexpected tax bill), and the executor has paid off low-priority debts first, there might not be enough money to pay the high-priority debts, and the executor might be personally liable for them.

It's best not to pay low-priority debts until the estate administration has been completed, or at least until you know exactly what the estate's tax and administration liability will be. 

Paying heirs too soon. Often, beneficiaries are impatient to receive their inheritance and pressure the executor to start making distributions. An executor can get into trouble if he or she makes distributions quickly and it later turns out there aren't enough remaining assets to pay off the estate's debts.

A related issue is that an executor has an obligation to secure and properly value estate assets. If beneficiaries are using "self-help" to make off with personal property - vehicles, artworks, furniture, a piano - before the executor can have them appraised, the executor could be personally liable for this as well.

(It can be an even bigger problem if a family member takes an asset that the Will says should go to someone else.) 

Handling real estate. If real estate is going to be sold, deciding how quickly to do so can create a minefield for executors. Sometimes an executor can be caught in the middle between one heir who's living in a house and another who wants it liquidated quickly. And sometimes it's hard to sell a property unless certain repairs or improvements are made first - but it's not always clear whether the executor has the authority to use estate funds to make the improvements.

Another issue arises if a property sits empty for a long time. If a house isn't occupied, it may be hard to obtain insurance for it, and it may become subject to maintenance problems, burglary and vandalism.

Investing estate assets. If an estate will take a long time to settle, executors may be tempted to invest some of the estate assets. That might be okay if the investments are extremely safe, but an executor could be on the hook if an investment loses money and an heir inherits less as a result. 

It's important to remember that while executors have an obligation to conserve estate assets, they have no legal duty to try to grow them.

Of course, the opposite problem can come up if the estate assets are already invested in risky things. In that case, an executor must decide whether to leave them there or move them into safer investment vehicles.

Back-to-school and HIPAA

If you have a child who is away at college, you should be aware that the federal medical privacy rules apply to him or her. Once your child turns 18, the federal HIPAA law says that you can no longer have access to your child's medical information without his or her consent.

That's a problem, because if there's an emergency and your child isn't able to provide consent, you might not be able to access the information you need to make important medical decisions. In fact, if might not even be clear that you have the legal right to make such decisions.

This problem has a simple solution. A health care proxy signed by your child and naming you as healthcare agent and HIPAA agent, will give you the authority to access the medical information needed to make healthcare decisions for your child in an emergency situation, and the authority to make those decisions. 

New Problem for Some Executors and Heirs

Executors who have to file a federal estate tax return, and some heirs who receive assets from an estate that is subject to the federal estate tax, may be facing a significant new problem as a result of rules just issues by the IRS.

The problem only affects larger estates - generally those where the deceased person's assets, large lifetime gifts, and life insurance proceeds total more than $5.45 million. But for those estates, it's a serious issue.

The problem stems from a law passed by Congress last year. The law says that an executor who files an estate tax return must now also fill out a form - called a Form 8971 - identifying all heirs to the IRS as well as the value of the assets to be distributed to them. Each heir must also be given a related form (called Schedule A) identifying the assets they will receive and their value.

If the estate is subject to the federal estate tax, then the heirs must use the value of the assets as stated on Form 8971 as their capital gains tax basis if they eventually sell them. There's a 20% penalty for claiming a different value.

(The idea was to prevent a perceived tax abuse where an executor claims a low value to save on estate taxes, and an heir later claims a higher value for the same asset to save on capital gains taxes.)

The IRS has just released proposed regulations explaining how all this will work in practice. And while the IRS's proposed rules clarify some things, they also highlight some serious issues.

For instance, Form 8971 must be filed fairly quickly after the deceased person's death, and an executor might not yet know exactly which estate assets will be given to which heirs, or which assets will be sold to fund a particular bequest. If that happens, then the executor must send the heirs a Schedule A that includes the value of all assets that could even conceivably be used or sold to fund their bequest.

So imagine that an estate is worth $7 million, and a distant relative or friend is going to receive an inheritance equal to 1% of the estate. That beneficiary might have to be given highly detailed and personal information about the entirety of the deceased person's financial affairs - something the deceased person almost certainly never expected to happen.

What's more, a relative or friend might look at the lengthy list of assets and assume that he or she is going to get a lot more than the actual bequest. This could leave an executor with a number of very angry and frustrated beneficiaries. 

The Schedule A form itself doesn't help much. Here's what it tells the heirs:

"you have received this schedule to inform you of the value of property you received from the estate of the decedent named above."

A beneficiary could read this and easily assume that he or she is receiving all the property listed.

Nor does Schedule A clearly explain (in language a non-expert could understand) the fact that heirs face a big penalty if they sell an asset and claim a different basis.

For this reason, many executors are going to have to go to some lengths to tell beneficiaries what they need to know and keep them from getting false hopes.

Another big problem is that, under the IRS's proposed rules, if an heir later transfers an inherited asset to a family member (or even just a portion of an asset), the heir must then file a second Form 8971, and must send a Schedule A to the family member. Many heirs will be totally unaware of this requirement, and as a result many family members might have no clue what the required basis is and end up inadvertently owing a 20% tax penalty.  

Here are some other important points in the IRS's proposed rules:

• An executor who files an estate tax return has to file a Form 8971 even if no estate tax is owed, and therefor the heirs aren't legally required to use the value on the form as their basis. (This could happen, for instance, if there's a large marital or charitable deduction.)
• If an executor is filing a return solely to claim "portability" of the estate tax exemption (so a surviving spouse can later use his or her own exemption plus the spouse's exemption), a Form 8971 doesn't have to be filed.
• An executor who files a Form 8971 doesn't have to declare cash, assets in certain retirement accounts, or items of tangible personal property worth less than $3,000.
• If additional assets are discovered after an estate tax return in filed, their capital gains tax basis will be zero unless the estate files a supplemental return.
• If no estate tax return is filed, but one should have been filed, then all estate property will have a zero basis until a return is filed.

You should note that the IRS has only issued proposed regulations. Taxpayers can comment before they become final, and the IRS might tweak them later. But for now, we should assume the IRS means what it says.

Financial Advisors Have More Responsibility To Clients

Stockbrokers, financial planners, and insurance agents who provide advice regarding IRAs and other retirement accounts will have new responsibilities towards clients, and the way they bill their clients may change, under new rules announced by the U.S. Labor Department.

Under the rules, advisors must now act in their clients' best interests when they make recommendations. In the past, many advisors merely had to make recommendations that were "suitable" for a client, even if what they recommended wasn't the best possible option. 

In addition, advisors must now disclose if they have a conflict of interest (for instance, if the advisor is being paid by a third party to recommend a particular investment), and must adopt procedures to limit such conflicts.

Advisors who receive commissions must have a signed contract regarding them, and all commissions must be reasonable, under the new rules.

The Labor Department estimates that the changes will save investors some $4 billion a year, because they will get better advice and buy fewer inappropriate high-commission products.

As a result of the new rules, it's expected that many advisors will stop charging commissions altogether, and instead will manage money in return for a flat annual fee or a percentage of the amount invested. 

The Advantages of Making a List of Assets and Debts

Have you ever considered writing down a list of all your assets (with account number, passwords, and so on), as well as debts and recurring payments?

Making such a list and putting it in a secure place can be a godsend if something ever happens to you and you become incapacitated, because your family will have a much easier time looking after your affairs.

In a recent article in the Wall Street Journal, a middle-class couple described the extraordinary difficulties they faced when the wife's parents developed medical problems and could no longer handle their own finances. The couple had no idea what assets the parents owned, what insurance they had, where to find records, what bills needed to be paid, and so on. Handling the parents' affairs became a nearly full-time investigative job.

As a result of the experience, the couple resolved to maintain such a list for their own children.

The problem has only gotten worse in recent years, because of the proliferation of electronic reporting. In the past, bills and account statements would arrive regularly by mail, but now, many people access everything online. As a result, a family might never have the comfort of knowing they've located all of a person's assets.

If you make such a list, a good plan is to update it at least once a year, maybe when you do your taxes. The list has other advantages - for instance, you can always go to one spot if you forget an account number or a password. Also, reviewing and updating the list regularly can help you see what changes or improvements might be needed in your own estate planning.