As a family office executive, your responsibilities are vast and at times undefined, spanning birth to death across family members. The death of a family member will often be unexpected.
In that vein, the question that family offices should be asking isn’t “Have we done proper planning?” but “Is our planning cohesive, comprehensive and current?” The answer to that question can be found by performing a “death audit.”
What is a death audit, and why do I need one?
A death audit is a simulation, from an estate tax and asset transfer perspective, of the death of a patriarch or matriarch. A death audit examines the confluence of reporting, tax, ownership and valuation aspects implemented over the years to identify weak points or even breaks in the structure and estate plan, allowing advisers time to make changes before it all becomes irrevocable. Even the best-laid plans need to be revisited simply due to the passage of time.
Think of a death audit as a call to action — a proactive examination of a family’s entire estate and governance plan to determine whether it is still optimal, given current circumstances.
Whom do I need on my team, and what are the steps of a death audit?
Engage with estate planning attorneys, certified public accountants (CPAs) and valuation firms. Building your three-pronged team now — before you are faced with looming IRS deadlines, the stress of probate and the emotion of losing a family member — will allow you a more orderly selection of advisers and greater efficiency in fees.
Step one: Estate review
Creating a mock Form 706 federal estate tax return is an organized way to understand all the information you will be required to provide in a short time frame after death. The IRS gives you 15 months to complete the return. Further tax is owed — if applicable — nine months after death, so gathering information quickly is imperative.
For the statute of limitations to begin, adequate disclosure is required. Disclosure goes well beyond a listing of assets owned by the deceased, so familiarize yourself with the comprehensive information and third-party valuations needed to properly file a Form 706 estate tax return.
Read and reread the succession language in both revocable and irrevocable trusts. Does control pass as intended? You can update provisions easily in a revocable trust or possibly decant irrevocable trusts.
Additionally, this is a good time to improve outdated language from older documents. Your estate planning attorney can advise you on the needed updates not only for federal but also state law changes.
Make an honest assessment of the management of assets owned by trusts. Are the formal control and beneficiary provisions documented in the trust agreements actually being followed? Has the settlor relinquished the necessary incidents of ownership so that the trust assets will be excluded from the settlor’s estate at death? If best practices have slackened over the years, tighten them up so you have a strong track record to present in the eventual audit of the estate.
The goal of a careful review is to identify breaks in the estate plan — especially a plan that was originally put in place years ago, potentially by different counsel. A fresh look at the family’s estate plan through the simulation of a death affords advisers the opportunity to make meaningful proactive changes.
Step two: Administrative review
Administering a will and the overall estate plan demands an orderly process. Create a checklist. A checklist can help you stay organized, because every asset of a decedent must be accounted for and actions be taken to properly administer the reporting and transfer of such assets. Do not underestimate the sheer amount of data a family office needs to process due to a death.
Find the original will now. This is the one document that is required to be submitted to the Probate Court in its original form.
Review medical directives and durable powers of attorney to ensure current wishes are properly documented. The individuals or entities holding these powers should be carefully examined and periodically updated if necessary.
Step three: Entity and asset ownership review
Carefully review where assets are owned and how they will be reported on Form 706. Take advantage of valuation discounts afforded a decedent with effective structuring. Identify your valuation firm today, and be sure that they will be capable of maximizing these discounts at death. Past legislation and court cases have kept a spotlight on the risks of claiming discounts, so it is imperative that your documents are properly drafted to not jeopardize your ability to confidently assert discounts on Form 706.
Similar to your trust review, carefully review the formal management practices of assets owned by entities. Separate books and records must be maintained. Contributions and distributions must match ownership percentages. Do not commingle assets or cash across different entities. If you are going to take valuation discounts on Form 706 and ask the IRS to respect your entity structure at death, you must follow the formalities during life.
Step four: Succession planning for family office executives
A tremendous amount of institutional knowledge resides with your family office executive group. This team has been integrally involved in the development of the estate plan, the tax strategies in place for valuation discounts, the ownership structure of the family business and the governance of trust assets. Succession planning is an integral part of a comprehensive estate plan; but succession planning aimed at preserving the deep, long-term experience of the professional team can often be overlooked.
In conclusion, simulating death is not a typical responsibility of a trusted family office adviser. However, when contemplating that simulation through the lens of preparedness, the thought starts to seem more logical. Thoroughly understand the rules of engagement one must play by when not only administering an estate but also meticulously reporting ownership and a lifetime of transactions to the IRS.
During life, there exists the luxury of choice, easier access to information and the opportunity to make changes. Once a wealth owner dies, surviving family members and trusted family office employees are left with only the ability to manage a previously devised plan. Even a death audit can go stale, so be opportunistic and zealously review the ownership and administrative elements of family wealth periodically to ensure the outcome you and the decedent most want when death occurs.
This article was originally published in its entirety in the International Family Offices Journal in April.