ESTATE PLANNING FOR THE INCAPACITATED SPOUSE · marriage offers unique challenges fo r descendan ts unless she provides differently by implementation of an estate planning program

ESTATE PLANNING FOR THE INCAPACITATEDSPOUSE

Charles E. KingGIBSON, OCHSNER & ADKINS, L.L.P.

701 South Taylor, Suite 500Amarillo, Texas 79101-2400

State Bar of TexasAdvanced Estate Planning and Probate Course

San Antonio, TexasJune 2-4, 1999

D-2 Estate Planning for the Incapacitated Spouse

D

Estate Planning for the Incapacitated Spouse D-i

TABLE OF CONTENTS

Page

I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

II. THE FACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

III. BASIC CONCEPTS AND LAWS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A. Ownership of Marital Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

1. Texas Constitution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22. Texas Family Code Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

a. Separate Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3b. Community Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

3. Agreements Changing Community Property to Separate Property . . . . . . . . . . . . 34. Transmutation of Separate Property to Community Property . . . . . . . . . . . . . . . 3

B. Management of Marital Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41. Separate Property Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42. Special Community Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43. Joint Community Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

C. Powers of Attorney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4D. Management of the Community Property Upon Incapacity of a Spouse . . . . . . . 5

1. TEX. PROB. CODE § 883 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52. 1999 Proposed Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53. Sufficient Finding of Incapacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64. TEX. PROB. CODE § 884 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65. Revocation of Power of Attorney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66. Texas Family Code Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

a. Petition to Manage Community Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7b. Appointment of Attorney Ad Litem and Notice . . . . . . . . . . . . . . . . . . . . . . 7c. District Court Order for Management, Control, and Disposition of Commu-

nity Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7d. Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8e. Continuing Jurisdiction of the District Court . . . . . . . . . . . . . . . . . . . . . . . . 8f. Practical Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

E. Judicial Supervision of Separate Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91. Court-Approved Gifting of Separate Property . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

a. Tax-Motivated Gifts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9b. Limitations Affecting Tax-Motivated Gifts . . . . . . . . . . . . . . . . . . . . . . . . . 10c. Charitable Gifts From Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

2. Business Planning -- Section 867 Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10a. Loss of Power to Make Gifts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11b. No Opportunities Upon Dissolution of Section 867 Trusts . . . . . . . . . . . . . 11

F. Release of Powers of Appointment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

IV. LIFETIME TRANSFERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11A. Inter Vivos Gifts by the Competent Spouse . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

1. Gift of the Competent Spouse's Separate Property . . . . . . . . . . . . . . . . . . . . . . 12

D-ii Estate Planning for the Incapacitated Spouse

a. The Homestead Exception . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12b. Guardianship Approval of Homestead Transfer . . . . . . . . . . . . . . . . . . . . . 12c. Gift Splitting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12d. Gift to a QTIP Trust With Reverse Bypass . . . . . . . . . . . . . . . . . . . . . . . . . 13e. IRC § 1014(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

2. Gift of Competent Spouse's Special Community Property . . . . . . . . . . . . . . . . . 133. Voidable Gifts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144. Gift of Joint Community and Incompetent Spouse's Special Community . . . . . . 155. Partition of Community Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

B. Gifts of Incompetent Spouse's Separate Property . . . . . . . . . . . . . . . . . . . . . . . . 15C. Disclaimers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16D. Release of General Powers of Appointment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16E. Revocation of Right of Survivorship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16F. Charitable Remainder Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17G. Charitable Lead Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17H. Private Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17I. Insurance Policy Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

1. Competent Spouse's Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182. Incompetent Spouse's Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183. Personal Elective Rights -- Non-Testamentary Transfers . . . . . . . . . . . . . . . . . . 18

J. Exclusion From Probate Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19K. Revocation of Revocable Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

V. ETHICAL ISSUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20A. Fiduciary Representation of Incapacitated Spouse's Estate . . . . . . . . . . . . . . . . 20B. Ethical Issues for the Attorney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

1. Duty to Seek Appointment of Guardian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 202. Client Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203. Confidential Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214. Conflicts of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215. Decline or Terminate Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

VI. WHAT CAN BE DONE FOR THE KING FAMILY? . . . . . . . . . . . . . . . . . . . . . . . . 22

VII. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Estate Planning for the Incapacitated Spouse D-1

ESTATE PLANNING FOR THE INCAPACITATEDSPOUSECharles E. King

I. INTRODUCTIONThe estate planning practitioner will face grandfather) in two trusts for Mary. One trust

during his or her career a client's declining is a generation-skipping trust over which Marycapacity to effectively participate in an estate has a testamentary limited power of appoint-planning program. This will be due to a men- ment exercisable in favor of her spouse (intal or physical event. The disabling event may trust only), her descendants, and charity. Inbe slow, arising from old age or a disease such default of the exercise of the power, theas Alzheimer's, or it may be very sudden due generation-skipping trust will pass to Mary'sto an accident or traumatic physical illness. children. The other trust will terminate on

Incapacity of one's spouse during the Mary's death and is to be distributed to Mary'smarriage offers unique challenges for descendants unless she provides differently byimplementation of an estate planning program. the exercise of a testamentary general powerThese challenges arise in large part because of of appointment.the marital property rules affecting ownership John and Mary organized a retail businessand management of the couple's collective shortly after completion of college. The busi-assets. ness is managed as a closely-held corporation,

The following discussions will address the and it has been relatively successful. Theprocedures and conflicts that the competent business provides a qualified retirement planspouse and the practitioner will face in regard program for its employees. Mary "retired"to estate planning for the incapacitated spouse. from the business five years ago. On herThe facts have been kept relatively simple. retirement, she withdrew her share from theHowever, the complications can be obviously plan and placed it in an individual retirementcompounded if the following facts involved a account.second marriage, Subchapter S stock, a revo- Their daughter works in the business withcable trust, and other estate planning hurdles. John, and she owns five percent of the stock.

This paper does not discuss a program of Sons of Mary and John do not own any stockimpoverishment. It will consider only the use in the company, nor do they want to. Eachof typical estate planning tools for the marital son has a very successful medical practice, andsituation. neither intends to return to the family business.

II. THE FACTSJohn and Mary King married in 1958 John's death or retirement. However, Mary

during their college days. They are each now has always been concerned about the ability ofsixty-one years old. They have three children, the daughter and son-in-law to manage theone daughter and two sons. company, and she has never been convinced

They began their marriage with little more that their marriage will last.than a hope of financial success. John's par- John and Mary have accumulated a signif-ents have died and left to John AT&T stock icant investment portfolio through a disci-worth $500,000. plined savings program. They likewise felt

Mary's mother and father were quite insurance was important, and each are insuredsuccessful, and when Mary's father died in for $500,000. Mary was designated as the1994, he left a portion of his estate (his sepa- owner of the policy insuring her life. John wasrate property that he inherited from Mary's designated as the owner of the policy insuring

It is expected that the daughter and herhusband will carry on with the business after


his life, but his life insurance agent advised him Home $ 250,000to gift the policy to Mary in order to avoid Personal effects $ 50,000estate taxes. He made this transfer in 1976. Retail business $ 750,000Mary is the designated beneficiary. John's retirement $1,000,000

John and Mary have well-prepared wills, Mary's IRA $1,100,000i.e., they were for a couple with no net worth Brokerage accountand three small children in 1964. The wills are (JTWROS) $1,500,000basic "Ma and Pa" wills, with guardian desig- Life insurance on Mary's lifenations for the children and trusts for a child's for $500,000portion.

John and Mary have focused on new willsand an overall estate plan for the past four There are several concepts and rules ofmonths. They have each told the other about law that directly affect estate planning for thevery definite plans they would like, and Mary incapacitated spouse. The ownership andhas been very specific about her jewelry to the management of property is a critical issue.daughter, and the properties of her grandfather The legal processes available for one to man-(held in the trusts created by her father) pass- age the property of another and the limitationsing to her children after her death. thereof are discussed below. Also discussed

The week before John and Mary are to go will be some "what if's." In other words, whatto their attorney's office, Mary suffers a mas- if Mary or John, or both, had planned theirsive stroke. The effects are such that Mary is estate management differently.unable to respond, and the doctors do notexpect a significant recovery. Her life expec-tancy is undetermined. John visits the lock A characterization of marital property asbox to review the status of affairs, and discov- either separate property of a spouse or com-ers an old durable general power of attorney munity property belonging to the spouses hashe had forgotten about. The general power of a significant effect on the type of estate plan-attorney does not grant gifting powers to the ning program that can be implemented.agent.

Their financial statement is as follows: 1. Texas Constitution

John's separate property: tution is the penultimate provision for the AT&T stock $ 500,000 definition of separate and community property.

Trusts for Mary: that which is owned or claimed before mar- GST Exempt trust $1,000,000 riage, and that which is acquired afterward by Non-exempt trust $ 500,000 gift, devise, or descent. The definition of

Mary's separate property: other property owned by the spouses during Life insurance on John's life the marriage that does not meet the definition for $500,000 of separate property will be presumed commu-

Community property: spouse's separate property. Likewise, by

III. BASIC CONCEPTS AND LAWS

A. Ownership of Marital Property

Article XVI, § 15 of the Texas Consti-

It defines the separate property of a spouse as

community property is by presumption, i.e., all

nity property.The Constitution allows the spouse to

partition and exchange their community prop-erty by written agreement so that the portionor interest set aside to each spouse will be that

written agreement, the spouses may agree that


community income from a spouse's separate agreement becomes that spouse's separateproperty shall be his or her separate property. property. Id. In addition, spouses may agree

2. Texas Family Code Provisions spouse shall be the separate property of theThe Texas Family Code further defines spouse owning the asset generating the in-

separate property, community property, and come. TEX. FAM. CODE § 4.103.the rights of the spouses in relation to the A partition or exchange agreement mustmarital property. In addition, the Family Code be in writing and signed by both parties. TEX.delineates the rules regarding marital agree- FAM. CODE § 4.104.ments that can affect the ownership and man- Query: Can an agreement affecting theagement of marital property as permitted by marital property of the spouses be entered intothe Constitution. on behalf of one spouse by an agent acting

a. Separate Property agreement be entered into on behalf of anA spouse's separate property consists of incompetent spouse through the guardian of

(1) the property owned or claimed by the the spouse's estate?spouse before marriage; (2) the property The power of attorney held by John foracquired by the spouse during marriage by gift, the benefit of Mary creates a fiduciary relation-devise, or descent; and (3) the recovery for ship with all of the accompanying duties ofpersonal injuries sustained by the spouse loyalty and restraints on self-dealing. It isduring marriage, except any recovery for loss doubtful that John, on behalf of Mary, couldof earning capacity during marriage. TEX. enter into an agreement with himself, individu-FAM. CODE § 3.001. ally, to effect the marital property character of

b. Community Property from. If Mary appointed her daughter as theCommunity property is that property, attorney-in-fact under the power of attorney,

other than separate property, which is acquired could the daughter then enter into a maritalby either spouse during the marriage. TEX. agreement with John? Spousal rights may beFAM. CODE § 3.002. The property possessed deemed so personal that a spouse may notby either spouse during or on dissolution of delegate these powers and decisions to a thirdmarriage is presumed to be community prop- party. If so, then it would seem impossible toerty. TEX. FAM. CODE § 3.003. effect a partition of the community estate upon

3. Agreements Changing Community Prop-erty to Separate Property 4. Transmutation of Separate Property to

The spouses may enter into agreements Community Propertywhich have the effect of redefining the marital A pending amendment of Section 15,character of their properties, and amending the Article XVI, of the Texas Constitution willmanagement rights of the spouses. TEX. FAM. allow spouses to agree in writing that all orCODE §§ 4.001 et seq. (pre-marital agree- part of the separate property owned by aments) and 4.101 et seq. (post-nuptial agree- spouse shall be the spouses' community prop-ments). erty. H.J.R. No. 36. (See Appendix A.) This

At any time, spouses may partition or amendment will be submitted to the voters onexchange between themselves any part of their November 2, 1999. Defining legislation add-community property, then existing or to be ing proposed Section 4.201 et seq. to theacquired, as the spouses desire. TEX. FAM. Texas Family Code is contained in H.B. No.CODE § 4.102. The resulting property held by 734. (See Appendix B.) These amendments,a spouse following a partition or exchange

that income from separate property of either

through a power of attorney? Can such an

the community estate and the income there-

the incapacity of one spouse.


if the voters approve the constitutional amend- All other community property is subject toment, will be effective January 1, 2000. the joint management, control, and disposition

Note: At the time this paper went topress, final legislative action was not ob-tained to pass the proposed legislation intolaw. The reader must follow up to deter-mine the final disposition of the proposedlegislation discussed in this article.

B. Management of Marital PropertyThe Texas Family Code outlines the rights

of parties regarding the management of maritalproperty. The management rights depend on It is very important today that a personthe characterization of the property as separate grant a power of attorney to an appropriateproperty, joint community property, and "spe- person, which power of attorney is carefullycial" community property. drafted to include the necessary language to

1. Separate Property Management planning transactions on the principal's behalf.Each spouse has the sole right to manage, The Texas statutory durable power of

control, and dispose of that spouse's separate attorney offers little help in the estate planningproperty without the joinder of the other realm. TEX. PROB. CODE §§ 481 et seq.spouse. TEX. FAM. CODE § 3.101. There are some limited opportunities for estate

2. Special Community Property overall the statute is inadequate to permitThere is no statutory term of "special sophisticated estate planning programs by the

community property," but this phrase has been attorney-in-fact.commonly used as a short reference to com- As noted above, Mary has an old durablemunity property which is subject to the sole general power of attorney without giftingmanagement, control, and disposition of a powers. This power of attorney is a "generic"spouse. The Texas Family Code § 3.102(a) power of attorney that gives John broad au-provides that each spouse has the sole man- thority to transact general business and finan-agement, control, and disposition of the com- cial affairs for Mary, but it does not give himmunity property that the spouse would have the authority to make gifts or otherwise gratu-owned if single. This special community itously dispose of her properties in trust orproperty includes (1) personal earnings; (2) outright. Likewise, Mary's power of attorneyrevenue from separate property; (3) recoveries does not grant her agent the power to changefor personal injuries; and (4) the increase and beneficiaries of insurance policies and retire-mutations of, and the revenue from, all proper- ment accounts.ty subject to a spouse's sole management, Observation: John should also reviewcontrol, and disposition. any other agreement he and Mary may have

Gifts of special community property can signed in order to determine if certain powersbe made by the controlling spouse. However, are granted to him. For example, there may bethese transfers are subject to review because of a buy-sell agreement regarding his corpora-the fiduciary relationship between the spouses. tion, or a partnership agreement affecting hisSee IV.A.2, infra. rights to manage partnership interests.

3. Joint Community Property agreements or limited powers of attorney with

of the spouses unless they have providedotherwise by power of attorney in writing orother agreement. TEX. FAM. CODE § 3.102(c).If the special community property of eachspouse is mixed or combined, then the com-munity property becomes joint communityproperty subject to the joint managementrules. TEX. FAM. CODE § 3.102(b).

C. Powers of Attorney

permit the attorney-in-fact to engage in estate

planning techniques discussed below, but

Additionally, John and Mary may have signed

the brokerage house that may give him


management rights over the brokerage account entire community estate as providedwhich would supplement and extend the pow- in this chapter.ers under the power of attorney.

D. Management of the Community Prop-erty Upon Incapacity of a Spouse

The Texas Probate Code abdicates the terminates upon a decree of the court that themanagement of the community estate to the mental capacity of the other spouse has recov-competent spouse upon the appointment of a ered. TEX. PROB. CODE § 883A.guardian of the estate of the incompetent Query: What if John has borrowedspouse. Unless the Probate Code finds that money from Mary's separate estate? Forthe competent spouse is not eligible for ap- example, he has borrowed money through apointment as a guardian of the estate (within policy loan from the insurance policy ownedthe requirements of TEX. PROB. CODE § 681), by Mary as her separate property. Sectionthen a judicial declaration of incompetence of 681(5) of the Probate Code disqualifies aone spouse renders the competent spouse as person as guardian if he or she is indebted tothe sole agent of all of the community estate. the ward. Therefore, John might not be "qual-

1. TEX. PROB. CODE § 883 prescribed by Section 883. Who will thenThe Probate Code provides as follows: have the power to manage, control, and dis-

When a husband or wife is judi-cially declared to be incapacitated, 2. 1999 Proposed Legislationthe other spouse, in the capacity of House Bill No. 2893 before the 1999surviving partner of the marital part- Texas legislature would have amended Sectionnership, acquires full power to man- 883 of the Texas Probate Code. The amend-age, control, and dispose of the entire ment would have required the guardian of ancommunity estate, including the part incapacitated spouse to administer "the part ofof the community estate that the the community estate that the incapacitatedincapacitated spouse legally has the spouse legally has the power to manage in thepower to manage in the absence of absence of the incapacity," if the competentincapacity, without an administration. spouse is disqualified under Section 681. (SeeIf the court finds that it is in the best Appendix C.)interest of the incapacitated spouse This proposed legislation would haveand that the other spouse would not greatly extend the jurisdiction of the probatebe disqualified to serve as guardian court over the community property when theunder Section 681 of this Code, competent spouse is not disqualified underguardianship of the estate of the inca- Section 681 of the Texas Probate Code. Apacitated spouse may not be neces- new Section 883B and 883C would have (1)sary when the other spouse is not required the filing of an inventory and ap-incapacitated unless the incapacitated praisement, (2) provided a procedure forspouse owns separate property, and forcing an accounting of the community ad-the guardianship will be of the sepa- ministration, and (3) provided grounds andrate property only. The qualification procedure for removing the competent spouseof a guardian of the estate of an inca- from the administration of the communitypacitated spouse does not deprive the assets. (See Appendix C.)competent spouse of the right to It appears unlikely this proposal will pass,manage, control, and dispose of the but it may be a prediction of things to come.

TEX. PROB. CODE § 883 (emphasis added).This special power of management, control,and disposition by the competent spouse

ified" to manage the community estate as

pose of the community property?



3. Sufficient Finding of Incapacity Mary and John had executed "compre-The court's finding of incapacity must be hensive" powers of attorney in 1974. The

a final judgment, and a finding of complete powers of attorney were durable powers inincapacity. If the probate court determines that they provided for continuation of thethat there is only a partial incapacity, and limits power in the event of incapacity of the princi-the scope and power of the guardian, the order pal. The power of attorney may be totallyshould be explicit regarding the competent adequate insofar as management of the busi-spouse's management, control, and disposition ness and financial affairs of the family.of the community estate. See Bernard E. Section 485 of the Texas Probate CodeJones, Estate Planning for Incapacitated Indi- provides that upon appointment of a guardianviduals, 18th Annual Advanced Estate Plan- of the estate of the principal, the powers of thening and Probate Course, State Bar of Texas, attorney-in-fact terminate. The attorney-in-June 1-3, 1994 (Outline Y, p. Y-14). fact is required to deliver to the guardian of

4. TEX. PROB. CODE § 884 she would to the principal.Section 884 provides that an appointed Query: Would the appointment of a

guardian of the estate of an incapacitated guardian require the competent spouse tomarried person shall deliver on demand the deliver to the guardian community propertycommunity property to the spouse who is not managed under the power of attorney? If so,incapacitated. This delivery of the community wouldn't the guardian of the estate be requiredestate to the competent spouse is mandatory to re-deliver the community estate to theregardless of the status of the judgment. competent spouse as required by Section 884?Therefore, in a case involving the appointment Observation: If a guardian of the estateof a temporary guardian, the court ordered of Mary is appointed, it would terminate thethat the community estate had to be delivered power of attorney as to all property. There-to the competent spouse notwithstanding the fore, the separate property of Mary wouldfact that the judgment of incapacity was not become the corpus of the guardianship estate.final. Houston Bank & Trust Co. v. Lee, 345 The community property would be subject toS.W.2d 320, 324 (Tex. Civ. App.--Houston John's sole management, control, and disposi-1961, writ dism'd). tion.

Observation: It would seem that if thejudicial finding of incapacity is not a final 6. Texas Family Code Provisionsjudgment, or is a finding of partial incapacity, There are no provisions under the Texasthe joint community property and the special Family Code which would permit the compe-community property of the incapacitated tent spouse to manage the separate property ofspouse could be trapped in a situation where the incapacitated spouse. Therefore, a guard-no one has the authority to manage the prop- ianship of the estate is the appropriate proce-erty. The competent spouse would not have dure for the management of separate property.the statutory authority of Section 883 to

manage the entire community estate. Theappointed guardian of the estate would like-wise not have the authority to manage thecommunity estate under the provisions ofSections 883 and 884.

5. Revocation of Power of Attorney

the estate all assets of the ward in the attor-ney's possession. The attorney-in-fact shallaccount to the guardian of the estate as he or

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The Family Code does have provisions c. District Court Order for Management,which address the management of the joint Control, and Disposition of Community Prop-community and the special community of the ertyincapacitated spouse. The discretion of the court in determining

a. Petition to Manage Community Estate order seems to be very broad. The court isTexas Family Code § 3.301(a)(1) provides directed by the statutes to render an order

that a spouse may file a sworn petition stating describing or defining the community propertyfacts which make it desirable for the petition- at issue that will be subject to the manage-ing spouse to manage, control, and dispose of ment, control, and disposition of each spousecommunity property described or defined in during the marriage. TEX. FAM. CODE

the petition that would otherwise be subject to § 3.306(a). The terms of the court's orderthe sole or joint management, control, and shall be on such basis as the court "considersdisposition of the other spouse. This request just and equitable." Id.for authority can be based on the physical or The court may, in its order (1) impose anymental incapacity of the other spouse which conditions and restrictions it deems necessaryrenders him or her unable to manage, control, to protect the rights of the incapacitated s-or dispose of the community property. The pouse; (2) require bond; and (3) require deliv-petition is to be filed in the district court of the ery to the registry of the court of any portioncounty in which the petitioner resided at the of the proceeds of the sale of property to betime the incapacity began, and cannot be filed managed in accordance with the court's furtherearlier than the sixtieth day after the date of directions. TEX. FAM. CODE § 3.306(b).the occurrence of the event. TEX. FAM. CODE

§ 3.301(b). d. Comments

b. Appointment of Attorney Ad Litem and Section 3.306 regarding the extent to whichNotice the court may grant authority, the lack thereof

It is within the discretion of the court and broad language would indicate that thewhether an attorney ad litem will be appointed court's order could be very comprehensive.for the incapacitated spouse. TEX. FAM. CODE For example, the court could possibly§ 3.303(a). However, it might be most pru- waive bond and grant that the powers over thedent to have an ad litem appointed if the re- community estate would include "all powersquested control over the community estate will contained in Chapter XII of the Texas Probateextend beyond normal day-to-day financial and Code (Durable Power of Attorney Act)." Thebusiness management affairs. Not only would court's order finding incapacity resulted in aan ad litem protect the incapacitated spouse, revocation of Mary's 1974 power of attorney.but the appointment should reduce the prob- Through the exercise of the court's discretionlems caused by conflicts of interest. to grant John the full powers held by an

Notice of the hearing is to be served on attorney-in-fact under the statutory durablethe attorney representing the incapacitated power of attorney would effectively rewritespouse, if one is appointed. TEX. FAM. CODE Mary's power and extend its scope.§ 3.304(a). If an attorney has not been ap- Observation: It would also seem that thepointed for the incapacitated spouse, citation court could grant appropriate gifting powersmust be issued and served on the respondent. over the community estate. These giftingTEX. FAM. CODE § 3.304(b). powers could be parallel to those permitted a

the terms and authorities under this court

Although there is not much guidance in

guardian of the separate property estate. Thecourt could further designate the potential


types of gifts, amounts of gifts, and beneficiaries. itated spouse's existing estate plan are notA gifting program should be approached clearly blessed by the terms of the statute.

with some caution because Section 3.306 is If the court under the provisions of Texasnot as clearly worded as one would like in Family Code §§ 3.301 et seq. can permit aorder to eliminate an IRS challenge. This gifting program as suggested above, this couldchallenge would be based on an IRS position be a very viable and flexible program forthat the statute is not so broad as to authorize management of the incapacitated spouse'sgifting, and that a court's order in excess of interest in community property. It is verythat allowed by statute is not binding on the important that the competent spouse have theincapacitated spouse. Therefore, any gifts ability to dispose of community assets in anmade under this order would be revocable. estate planning program so that the transfersSee Priv. Ltr. Rul. 9731003. See also will not be subject to attack by the incapacitat-R. Austin and J. Benson, Guardian's Change of ed spouse or guardian of the estate. This isWard's Beneficiary Designation: A Breach of necessary to avoid attack by the InternalYour Fiduciary Duty?, Advanced Estate Plan- Revenue Service that such transactions arening and Probate Course, June 3-5, 1998. voidable.

e. Continuing Jurisdiction of the DistrictCourt

Texas Family Code § 3.307 provides that Texas Family Code § 3.101 provides thatthe court would have continuing jurisdiction each spouse has the sole management, control,over its order. Supposedly, the court could and disposition of that spouse's separate prop-modify its order regarding the extent of man- erty. Only one exception to the rule requiresagement and control the competent spouse the participation of both spouses upon the salehas. Likewise, the court might modify its of a spouse's separate property that is used asorder to require bond, accountings, and deliv- the homestead of the couple. TEX. FAM. CODE

ery of certain property or proceeds into the § 5.101. See IV.A.1.a, infra.registry of the court. However, this is notclear by reading the statute. 1. Court-Approved Gifting of Separate

The court may also vacate the original Propertyorder after notice and hearing if it finds that A guardianship may be preferable forthe incapacitated spouse's capacity is restored. estate planning purposes. A power of attorneyTEX. FAM. CODE § 3.307(b)(1). or trust agreement executed prior to incapacity

f. Practical Application into estate planning transactions. At least theThere is very little authority interpreting Texas Probate Code does have two programs

the statute and the scope of practice under its which offer some opportunities for the imple-provisions. It is difficult, if not impossible, to mentation of estate planning transactions.find forms and discussion in treatises. Like-wise, the appellate courts have not addressed a. Tax-Motivated Giftsthe statutory provisions. Appropriate orders Texas Probate Code § 865 addressesregarding management and control of the estate planning through tax-motivated gifts.community estate of the spouses would seem This section permits the guardian of the estateto clearly enhance the competent spouse's or any interested person to petition the courtability to manage the community assets. for an order that authorizes the guardian toHowever, orders regarding disposition in the apply the principal or income of the ward'sform of gifts, transfers to trusts, and other estate toward the establishment of an estateprograms which would modify the incapac- plan. The estate plan must be for the purpose

E. Judicial Supervision of Separate Prop-erty

may not permit the agent or trustee to enter


of minimizing income, estate, inheritance, orother taxes payable out of the ward's estate. b. Limitations Affecting Tax-Motivated GiftsIt must be shown that the ward will probably Section 865 of the Probate Code is rela-remain incapacitated during the ward's lifetime. tively broad in scope. However, there are

An "interested person" includes an heir, limitations that should be noted.devisee, spouse, or other person interested in ! This provision would not permit thethe welfare of an incapacitated person. TEX. court to order the exercise by thePROB. CODE § 601(14). guardian of an inter vivos special

The gifts permitted include gifts made power of appointment.outright or in trust. TEX. PROB. CODE §- ! The court's program could not autho- 865(a). rize the exercise of a testamentary

The permissible beneficiaries of gifts from special or general power of appoint-the ward's estate include the following: ment.

! Qualified charitable organizations in ! Execution of an inter vivos generalwhich it is shown the ward would power of appointment could be madereasonably have an interest. only if there was a method by which

! The ward's spouse, descendant, or the guardian of the estate could with-other person related to the ward by draw the appointed property from theblood or marriage. trust estate that is subject to the

! A devisee under the ward's last val- general power, and followingidly executed will, trust, or other withdrawal, the guardian placed thebeneficial instrument. assets in the ward's estate for disposi-

! A person serving as guardian if the tion under a Section 865 program.person is a spouse, descendant, or ! Must the estate plan reduce taxesother person related to the ward by payable by the ward's estate? Forblood or marriage, or a devisee under example, would a bypass trust pro-the ward's will, trust, or other benefi- gram be permitted when the effectivecial instrument. tax reduction occurs in the estate of

TEX. PROB. CODE § 865(a)(1)-(4). the ward's spouse?The applicant must outline the proposed

estate plan and set forth the benefits that are to c. Charitable Gifts From Incomebe derived by the ward's estate. TEX. PROB. The guardian of an estate may file a swornCODE § 865(b). The application must indicate application requesting an order from the courtthat the planned disposition is consistent with for permission to contribute from the incomethe ward's intentions if they can be ascertained, of the ward's estate a specific amount ofand if not, the ward will be presumed to favor money to qualified charitable organizations.reduction in the incidence of the various forms TEX. PROB. CODE § 866(a). The court mayof taxation and a partial distribution of the authorize contributions from income to award's estate as provided in the Code. Id. particular donee designated in the application

The court may appoint a guardian ad litem if the court finds that: (1) the contribution willfor the ward or any interested person at any not exceed 20% of the ward's net income; (2)stage of the proceedings. TEX. PROB. CODE the net income of the ward's estate probably§ 865(c). Notice of the application must be will exceed $25,000 for the current calendarmade to: (1) all devisees under a will, trust, or year; (3) the full amount of the contributionother beneficial instrument relating to the will be deductible from the ward's gross in-ward's estate; (2) the ward's spouse; (3) the come; (4) the condition of the ward's estateward's dependents; and (4) any other person as justifies a contribution in the proposeddirected by the court. amount; and (5) the proposed contribution is


reasonable in amount and for a worthy cause. The trust terminates on the date the courtTEX. PROB. CODE § 866(c). determines that continuing the trust is no

2. Business Planning -- Section 867 Trust date of the ward's death. TEX. PROB. CODE

The investments which a guardian is § 870. The management trust program furtherpermitted to make with the funds of the ward's includes requirements regarding (1) annualestate are significantly limited. TEX. PROB. accountings and (2) formalities for distributionCODE §§ 855 et seq. These investments are of the trust property upon termination of theunderstandably conservative and would ex- trust. TEX. PROB. CODE §§ 871 and 873.clude opportunities for the guardian's estate to The proposed 1999 amendments to Sec-invest in programs that might reduce the estate tion 867 are shown in Appendix D. Thesetax liability. For example, it is doubtful that a amendments allow the transfer of the ward'sguardian is permitted to invest corpus of the assets to a Section 867 Trust without firstward's estate in a limited partnership program being placed in a guardianship proceeding.or in undivided interests in real estate.

A method by which the ward's estatecould be subject to a broader business planningand estate planning program would be totransfer the estate administration to a "Section867 Trust." This provision of the Texas Pro-bate Code permits the court in which theguardianship proceeding is pending to enter an a. Loss of Power to Make Giftsorder that creates for the ward's benefit a trust The management trust provisions regard-for the management of guardianship funds if ing distributions from the Section 867 Trust dothe court finds that the creation of the trust is not include gifts to the ward's spouse andin the best interest of the ward. TEX. PROB. descendants. Distributions to these "bene-CODE § 867. The order of transfer shall in- ficiaries" are limited to health, education,clude terms, conditions, and limitations of the support, or maintenance of persons whom thetrust as specified in Texas Probate Code §- ward is legally obligated to support. TEX. 868. The trustee must be a trust company or PROB. CODE § 868(b). Therefore, transfer ofstate or national bank that has trust powers in the ward's estate to a management trust mayTexas. Id. defeat the ability of the probate court to order

Once the property is transferred to the gifts from the ward's estate, or otherwiseSection 867 trust, the guardianship is effec- authorize any estate planning transactions.tively terminated. TEX. PROB. CODE § 868A. The only alternative might be for the court toThe court retains jurisdiction over the trust so order a partial revocation of the trust and com-that it may amend, modify, or revoke the trust mit the removed assets to a tax-motivated giftat any time before the trust termination date. program in the guardianship proceeding.Once the trust is created, its administration issubject to the terms and provisions of the For further discussion of Section 867 manage-Texas Trust Code. TEX. PROB. CODE § 869B. ment trusts, see Bernard E. Jones, EstateThe court creating the trust continues to have Planning for Incapacitated Individuals, 18ththe same jurisdiction to hear matters relating Annual Advanced Estate Planning and Probateto the trust as the court has with respect to the Course, State Bar of Texas, June 1-3, 1994guardianship and other matters covered by the (Outline Y, p. Y-14).Texas Probate Code. TEX. PROB. CODE

§ 869C. b. No Opportunities Upon Dissolution of

longer in the ward's best interest, or on the


Section 867 Trusts


The trust must terminate on the ward's Numerous issues arise in the maritaldate of death. Upon termination, the trust setting, and they will obviously differ depend-principal and undistributed income shall be ing on whether the gift is of the separatedistributed to the representative of the de- property of the competent spouse, the separateceased ward's estate on the ward's death. TEX. property of the incapacitated spouse, or thePROB. CODE § 873(2)(c). Previously, this community property of the couple.section indicated that the court could directdistribution and termination otherwise. How- 1. Gift of the Competent Spouse's Separateever, this provision of the Code was amended Propertyeffective September 1, 1995, and this discre- A gift by the competent spouse of his ortionary language was deleted. her separate property appears to be free of

F. Release of Powers of AppointmentSection 181.051 et seq. of the Texas which would otherwise affect a transfer of

Property Code addresses the release of powers either spouse's separate property.of appointment, and the requisite steps to be The guardian of the incompetent spouse'staken. If a person is under a disability, the estate or attorney-in-fact should not be able toguardian of the person's estate may release a complain or attack the transfer of the separatepower on the order of the court in which the property of the competent spouse. The incom-guardian was appointed or in which the guard- petent spouse would have no claim regardingianship proceeding is pending. TEX. PROP. ownership. All rights of reimbursement recog-CODE § 181.053. nized under Texas law are equitable rights, and

IV. LIFETIME TRANSFERSThe following discussion regarding gifts tent spouse. Therefore, this type of gift should

by the competent spouse and by the incompe- be relatively free from question by personstent spouse's guardian or attorney-in-fact, will interested in the incompetent spouse's estate,deal with the mechanical and substantive issues and by the taxing authorities.surrounding a gift. Difficult issues regardingconflicts of interest, fiduciary duties, and a. The Homestead Exceptionattorney-client relationships run rampant A transfer by the competent spouse of histhroughout. The following discussions will or her separate property residence occupied bybegin to highlight the obvious ethical questions the couple as their homestead would requirefor the family and for the attorney. the participation of the incompetent spouse.

A. Inter Vivos Gifts by the CompetentSpouse

A frequently employed estate planning allows the competent spouse to apply to theprogram is the lifetime gift. These gifts may court for authority to "sell, convey, or encum-take many forms, but are most often by out- ber the homestead" which is the separateright transfer or transfer to trust. Each inter property of the competent spouse.vivos gift will be affected by the annual exclu- Query: Would the terms of the Texassions of the spouses, use of exemption equiva- Family Code proceeding allow a gratuitouslents, and possible allocation of generation- transfer of the separate property homestead toskipping tax exemptions. an estate planning program? For example, an

legal impediments. This assumes that there isno agreement entered into by the spouses

these rights would not be extinguished by atransfer of the separate property of the compe-

TEX. FAM. CODE § 5.001. The Family Codedoes address a procedure for the sale, convey-ance, or encumbrance of the homestead with-out the joinder of the incompetent spouse.TEX. FAM. CODE § 5.101. This provision

appropriate program for Mary and John might


be to (1) gift the homestead to the children or fied terminable interest property under IRCa trust for the children; (2) gift the homestead § 2523(f). Upon the death of the incompetentto charity with a retained life estate; or (3) gift spouse, the QTIP trust property will be in-the homestead to a qualified personal resi- cludable in the incompetent spouse's grossdence trust. estate under IRC § 2044. As a result, Mary's

b. Guardianship Approval of Homestead transition is made from the QTIP trust to theTransfer bypass trust, and this very effective estate

It would seem that the guardianship court planning program would be implemented bywould have authority to grant permission for John effectively creating his own deferredthe gift of the incompetent spouse's interest in bypass trust. Because Mary is treated as thethe competent spouse's separate property transferor of the property for estate tax pur-homestead. However, it would be question- poses, the property of the bypass trust will notable whether the guardianship court could be subject to inclusion in John's gross estateempower the guardian to make a conveyance under Section 2036 or 2038. Treas. Reg.of the property because there is no jurisdiction § 25.2523(f)-1(f) example 11.of the court over the competent spouse's sepa- If the donor spouse retains an interest in arate property. Likewise, a similar question QTIP trust, any subsequent transfer by thewould arise if the homestead was community donor spouse of the retained interest in theproperty. property is not treated as a transfer for gift tax

c. Gift Splitting Therefore, John may not want his retainedIf John makes a gift of his separate prop- interest to be subject to a spendthrift clause

erty to the children, the gift can be effectively during Mary's lifetime. The property wouldtreated for gift tax purposes as if the incompe- not be subject to estate tax in the event Johntent spouse made one-half of the gift. This predeceases Mary.occurs because of the rules under Internal One potential problem is that the gift toRevenue Code (IRC) § 2513, which permits the trust would generate an all-income require-the non-donor spouse to consent for gift tax ment with the resulting payment of the incomepurposes as having made one-half of the gift to Mary. This income would be Mary's sepa-made by the donor spouse. This consent is rate property. TEX. FAM. CODE § 3.005. Johnreflected on a gift tax return, and the guardian should be able to manage this income for Maryfor a legally incompetent spouse may sign the under his power of attorney (assuming it hasconsent. Treas. Reg. § 25.6019-1(g). not been revoked by guardianship proceed-

d. Gift to a QTIP Trust With Reverse By- guardian of Mary's estate. If the income ispass managed under the power of attorney, there is

Mary's will gives all of her estate to John no opportunity for gifting due to the lack ofupon her death. Therefore, anything gifted to gift powers. Payment to the guardian of theher by John will revert to his estate in the estate could create a situation that wouldevent Mary dies first. John can transfer his accommodate a gifting program.separate property to a QTIP trust for Mary, Observation: If the bypass trust termsand provide that upon her death the trust will would qualify as a QTIP trust, the executor ofcontinue in the form of a bypass trust for the Mary's estate could make an election underbenefit of John which terminates upon his Section 2056(b)(7) of the Internal Revenuedeath and is distributed to the children. The Code and cause the trust to be taxable ininitial transfer to trust by John would be fol- John's estate upon his death after Mary. Thislowed by an election to treat the gift as quali- reversal of the trust corpus to John's estate for

exemption equivalent would be used as the

purposes. Treas. Reg. § 25.2523(f)-1(d)(1).

ings), or the income could be paid to the


estate tax purposes may be appropriate in the right of recourse, first, against the property orevent John did not have an adequate estate to estate of the disposing spouse and then againstfully utilize his exemption equivalent at the the party to whom the funds were conveyed.time of his death. Id.

e. IRC § 1014(e) cannot order reimbursement of gifts of com-If appreciated property was acquired by munity property made during the marriage. Id.

gift by a decedent within one year of his or her at 17:11. However, if gifts are capricious,date of death, and the donor of the gift ac- excessive, or arbitrary, the courts have foundquires the property from the decedent, there is constructive fraud on the other spouse and setno "step-up" in basis. IRC § 1014(e)(1). The aside the gifts. The following factors havedonor's basis will be the same as the basis in been used by the courts to determine whetherthe hands of the decedent immediately before a gift of community property constitutesdeath. Id. constructive fraud:

Query: Would this basis rule apply to the ! Relationship between the donor andbasis of a bypass trust of which the donor is a donee.beneficiary? ! Whether special circumstances exist

2. Gift of Competent Spouse's Special Com- ! Whether community funds used formunity Property the gift are reasonably proportionate

The competent spouse has the sole man- to the community assets remaining.agement, control, and disposition of the com- ! Adequacy of the estate remaining tomunity property that the spouse would have support the spouse.owned if single, including personal earnings Barnett v. Barnett, 985 S.W.2d 520, 530 (Tex.and revenue from separate property. There- App.--Houston [1st Dist.] 1998, no writ). Itfore, John has the power to make a gift of his also appears clear that the donee's relationshipspecial community property without the join- to the non-donating spouse is of importance.der of Mary. The obvious exception is that Query: Is a gift of the special communityJohn would not be able to transfer a commu- by the competent spouse complete if it remainsnity property homestead without Mary's join- subject to attack or revocation by the non-der. donor spouse?

Unlike the separate property of John, a Query: Is a gift of special communitygift of the special community property is property subject to a Street attack? See Estatesubject to a potential attack by the incom- of Street v. United States, 152 F.3d 482 (5thpetent spouse or her estate. Texas recognizes Cir. 1998). The ruling of the appellate courta trust relationship between husband and wife did not follow the tax court decision. How-as to the special community property con- ever, the tax court decision should be notedtrolled by each spouse. 3 TEX. FAM. LAW for its renegade attitude toward Texas commu-SERV. Speers 6th ed., § 17:10 (1988). Con- nity property by holding that the disposition bystructive fraud is the breach of a fiduciary duty the decedent of his special community proper-which the law declares fraudulent because it ty removes the community asset from theviolates that fiduciary relationship. Id. There- regime of community property laws. Street,fore, a presumption of constructive fraud 152 F.3d at 484.arises when a spouse unfairly disposes of the The donating spouse of special commu-other spouse's one-half interest in community nity property may want to file a gift tax returnproperty. If a spouse disposes of special and make a split gift election for the incompe-community property in fraud of the other tent spouse. This would protect the gift underspouse's rights, the aggrieved spouse has the

Absent fraud on the community, a court

to justify the gift.


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the annual exclusion of both spouses notwith- that court does not have jurisdiction to ap-standing which position the IRS might take. prove and order gifts of the incompetent

3. Voidable Gifts Furthermore, it does not appear that theThe voidability doctrine is a serious prob- competent spouse can make a unilateral dispo-

lem insofar as completed gifts. For example, sition of his or her interest in the joint commu-the IRS has ruled in a number of cases that a nity property and the special community prop-gift by an agent under a power of attorney erty of the incompetent spouse. This would bewithout express authority for the making of in effect a partition which does not complygifts is revocable. Priv. Ltr. Rul. 9509034, with the requirements of the Texas Constitu-9410028, 9347003 (Texas), and 9342003. tion, and Texas Family Code §§ 4.102 andBecause the transfers are revocable, the sub- 4.104. See Dalton v. Don J. Jackson, Inc.,ject matter of the gift is includable in the gross 691 S.W.2d 765 (Tex. App.--Austin 1985, noestate of the principal under IRC § 2038. writ).

Note: If the property is includable in theestate of the principal as a revocable transfer, 5. Partition of Community Propertythen property remaining in the hands of the Partition is often a method by whichdonees is entitled to receive a stepped-up separate property is created in the hands ofincome tax basis under IRC § 1014. However, each spouse, and then that property is used forproperty transferred to the donee and sold by some pertinent estate planning program, suchthe donee before the decedent's death does not as funding a life insurance trust. It is unclearreceive a stepped-up basis. IRC § 1014(a). whether community property may be parti-The basis of this predisposed property would tioned when one spouse is incompetent. Thebe determined under IRC § 1015(a) without an Texas Family Code requires that both spousesadjustment for gift tax paid as would normally must sign and enter into a written agreement inbe allowed under IRC § 1015(d)(1)(A). Priv. order to effect an enforceable partition of theirLtr. Rul. 9509034. community property assets.

In the event there is a voidable transac- One possible procedure would be to starttion, it would be wise to review the possibility the guardianship of the estate of the incompe-of obtaining a court order that would ratify tent spouse with seed separate property. Theand complete the gift during the ward's life- separate property would be either separatetime. The gift would be complete as of the property already owned by the incompetentdate of ratification. That would be the date for spouse or separate property which arises fromvaluation of the gift, as well as testing the gift a gift from the competent spouse. This wouldfor present interest status and any applicable clearly give the probate court jurisdiction overthree-year rule. This would also be the date appropriate property of the ward. The compe-for the making of a split-gift election by the tent spouse could apply to the district court tocompetent spouse. Priv. Ltr. Rul. 923103. begin a Family Code proceeding. The district

4. Gift of Joint Community and Incompetent competent spouse to manage, control, andSpouse's Special Community dispose of the community estate by entering

It would appear that the competent s- into a partition agreement with the guardian ofpouse would have no power to gift joint com- the estate of the incompetent spouse.munity property, nor the incompetent spouse's More specific statutes could support thisspecial community property, until he or she type of program. However, the current stateobtains an order from the district court. Gifts of the Texas rules regarding Family Codethrough the probate court under a guardian- proceedings and probate court proceedingsship proceeding would not be possible because may leave one a little squeamish about the

spouse's community interest.

court's order might include the authority of the



effect and finality of a partition of community amount of the marital deduction and triggerproperty under this procedure. estate tax liability.

B. Gifts of Incompetent Spouse's SeparateProperty

It is clear that a guardianship of the estate a disability who holds a power may release theof the incompetent spouse allows a specific power through the guardian of the person'sprocess for the gift of separate property. TEX. estate by order of the court. TEX. PROP. CODE

PROB. CODE §§ 865 and 866 permit effective § 181.053. The release of a general power ofsubstitution of judgment for the gifting of the appointment is a taxable gift under the provi-incompetent spouse's separate property within sions of IRC § 2514(b). The release coulda range of estate planning opportunities. also be a generation-skipping transfer depend-

C. DisclaimersIn the event an incompetent person is A release of the general power of appoint-

receiving an inheritance from someone who ment would utilize the incompetent spouse'sdies, the guardian can disclaim with prior court exemption equivalent. This may be prudent inapproval. TEX. PROB. CODE § 37A. The the event the property subject to the power isTexas statutory durable power of attorney appreciating in value and is otherwise andoes permit a disclaimer by the agent unless appropriate subject of an exemption equivalentthe principal elects out of the broad powers gift.given relating to estates, trusts, and other An inter vivos release of a general powerbeneficiary transactions. TEX. PROB. CODE of appointment would potentially trigger the§ 499(1). A power of attorney without provi- payment of transfer taxes. The source ofsions allowing disclaimer would likely be funds for the payment of the transfer taxesinsufficient to permit an effective disclaimer by raises some unique issues. For example, thethe agent. tax apportionment statute under Texas Probate

D. Release of General Powers of Appoint-ment

There are no statutory rules and proce- ble gift tax. Therefore, the release of a generaldures for the exercise of a general power of power of appointment would result in theappointment. Therefore, the competent transfer tax being paid from the ward's estatespouse, the guardian of the estate of the in- or the community assets of the ward and thecompetent spouse, and the attorney-in-fact will competent spouse.not be able to exercise a general power ofappointment unless the instrument creating thepower may have provided otherwise. If spouses have properly agreed to hold

In the scenario of John and Mary, the community property with right of survivorshipgeneral power of appointment held by Mary (TEX. PROB. CODE §§ 451 et seq.), it may bepresents a double problem. First, it cannot be appropriate to dissolve the right of survivor-exercised. Second, the tax allocation clause in ship program in order to make certain that theMary's will may well provide that all taxes first spouse's estate has adequate assets toattributable to her death be paid out of her fund a bypass trust or other exemption equiva-probate estate. If the incompetent spouse's lent gifts.will gives everything to the surviving spouse, Texas Probate Code § 455 addresses thethis type of tax allocation could reduce the method of revocation. First, revocation can

Therefore, it may be wise to release thegeneral power of appointment during theincompetent spouse's lifetime. A person under

ing on the terms of the trust instrument and thetakers in default of the exercise of the power.

Code § 322A does not address inter vivostransactions, nor does IRC § 2207 burden theproperty subject to the power with the applica-

E. Revocation of Right of Survivorship

occur by written agreement signed by both


spouses. Secondly, a revocation can occur by of a gift from Mary (the incompetent spouse)a written instrument signed by one spouse and to the children. This would be accomplisheddelivered to the other. by creating a charitable lead trust that would

The first method of revocation would pay a unitrust or annuity amount to charity forrequire the participation of a guardian. An Mary's lifetime. If Mary's illness is such thatattorney-in-fact could possibly execute this she will not live her normal life expectancy,kind of an agreement. then the deferral time of the eventual gift to

The second type of revocation seems to the family is reduced, however, the IRCbe one which the competent spouse could § 7520 rates are still applicable if the individualinstigate. However, is delivery of the instru- who is a measuring life does not have a 50%ment of revocation to the incompetent spouse probability of death within one year. Treas.adequate? Will it be adequate if it is delivered Reg. § 200.7520-3(b)(3)(i). If the individualto the guardian of the person or estate of the in fact survives for 18 months or longer afterincompetent spouse? The statute does not making the transfer, the individual is presumedaddress the issues arising out of incompetency not to have been terminally ill at the time ofof one's spouse. the transfer. Id.

F. Charitable Remainder Trust H. Private AnnuitiesThe charitable remainder trust offers A private annuity is the transfer of assets

significant estate and income tax planning in return for an unsecured contractual obliga-opportunities. The competent spouse might tion to pay to the transferor a fixed periodicconsider establishing a charitable remainder sum for the transferor's life. The actuarialtrust with either his or her special community rates of IRC § 7520 will apply. Because theproperty, or his or her separate property. In private annuity contract terminates at the deatheither case, the trust could provide for the of the transferor, there is no inclusion in thespecific periodic payments to be made to the gross estate of the transferor. The goodcompetent spouse for life. Upon death of the news/bad news is that the private annuitycompetent spouse, the payments could con- generates the most benefit when the actual lifetinue for the benefit of the incompetent s- expectancy of the transferor is substantiallypouse, if living, and upon the death of both, less than the life expectancy reflected in thethe trust would terminate and distribute to actuarial tables. T. Randolph Harris, Wealthcharity. The income stream to the incom- Transfer Planning for the Terminally Ill Client:petent spouse could be paid to a support trust Even the Blackest Cloud Has a Silver Lining,established by the competent spouse. Priv. 24 ACTEC Notes, 243, 245 (Winter 1998).Ltr. Rul. 9831004. Payment to the support Observation: A private annuity is a "sale"trust for the incompetent spouse's benefit of assets. The appropriate guardianship pro-would possibly avoid the necessity for a guard- ceeding would be the process for sales of theianship to receive these distributions. ward's property. However, an abundance of

The guardianship court could approve the caution would suggest that the tax-motivatedgift of the incompetent spouse's separate gift procedure be incorporated.property to a charitable remainder trust pro-gram. Whether the competent spouse shouldbe included as a beneficiary raises the obvious The estate planning program for both theethical questions. competent and incompetent spouse requires a

G. Charitable Lead TrustThe charitable lead trust offers the oppor- payment of any estate taxes attributable to the

tunity to substantially reduce the taxable value policy proceeds.

I. Insurance Policy Management

review of policy beneficiaries and ownership.Additional consideration must be given to the


1. Competent Spouse's Policy motivated gift program. Changing the benefi-The competent spouse may wish to make ciary of an insurance policy held within the

a gift of any insurance policy which is that guardianship estate does not squarely fit withinspouse's separate property or special commu- the terms of the tax-motivated gift provision.nity property. There should not be a problem TEX. PROB. CODE § 865. See also the discus-with a gift of the separate property policy, but sion at IV.I.3, infra.the attendant issues discussed above would A power of attorney might contain aaffect a transfer of the community property provision allowing change of beneficiary, butpolicy. it is unlikely. If the incompetent spouse has

The competent spouse may also wish to executed a statutory durable power of attor-change the beneficiary of the policy if it is ney, there are powers to alter the beneficiarycurrently payable to the incompetent spouse. of insurance with limits regarding the attorney-Payment to the incompetent spouse would in-fact. TEX. PROB. CODE § 498(4) and (10).possibly compound the estate tax problems forthe incompetent spouse's estate at his or her 3. Personal Elective Rights -- Non-Testa-death, and it would add funds to the guardian- mentary Transfersship proceeding. Therefore, the competent A body of law has developed in the courtsspouse may wish to make his or her policy that prohibits the alteration by a guardian ofpayable to the competent spouse's estate. This the beneficiary of non-testamentary transfersshould be done only after careful consideration created by the ward prior to incompetency.is given to the Fifth Circuit's opinion in Estate See Russell Austin & James C. Benton, Guard-of Street v. United States, 152 F.3d 482 (5th ian's Change of Ward's Beneficiary Designa-Cir. 1998). In order to avoid the effect of tion: A Breach of Fiduciary Duty?, AdvancedStreet, the competent spouse should make the Estate Planning and Probate Law Course,policy payable directly to children, or a trust State Bar of Texas, June 3-5, 1998. Thefor the intended beneficiaries. personal elective rights doctrine substantially

However, changing the beneficiary of a restricts the guardian's ability to alter thecommunity property policy to the children or ward's estate plan. In essence, this doctrineanyone other than the incompetent spouse or holds that the guardian does not have thea trust for the incompetent spouse's benefit power to exercise the discretion of the ward towill raise issues regarding fraud. These cir- designate, directly or indirectly, the beneficiarycumstances create uncertainty and should be of non-testamentary transfers. Id. The incom-avoided if possible. See Barnett v. Barnett, petency of the ward does not invalidate prior985 S.W.2d 520 (Tex. App.--Houston [1st beneficiary designations of non-testamentaryDist.] 1998, no writ). transfers, for example, the designated joint

2. Incompetent Spouse's Policy survivorship.The gift of a separate property policy Texas has recognized a contractual or

could be managed through the guardianship third-party beneficiary right in similar situa-court, and would obviously fit within the tax- tions. This right would allow the designatedmotivated gifts provisions of the Texas Pro- beneficiary to claim property from the ward'sbate Code. The Family Code proceeding estate which he or she was designated towould seem to be necessary in the event the receive under contract. See Egenbacher v.policy is the special community property of the Barnard, 575 S.W.2d 630 (Tex. Civ. App.--incompetent spouse. Eastland 1978, no writ); and Terrill v. Davis,

It is not clear whether the guardianship 418 S.W.2d 33 (Tex. Civ. App.--Eastlandcourt can authorize a change of beneficiary of 1967, writ ref'd). Texas previously held that athe incompetent spouse's policy under the tax- guardian could not make gifts. In re Guard-

tenants of a joint tenancy with rights of

http://www.TexasBarCLE.com/CLE/PMCasemaker.asp?table=US_5thcircuit&volume=152&edition=F.3d&page=482&id=51613_01





ianship of Neal, 406 S.W.2d 296 (Tex. Civ. administration in a manner that does not con-App.--Houston [1st Dist.]), writ ref'd, 407 form with the Section 867 trust rules? Will theS.W.2d 770 (Tex. 1966). The Neal case was creation of a bypass trust create tax savings forabrogated with the subsequent enactment of the "ward's estate" when the transfer under thethe tax-motivated gifts provisions of the Texas will outright to the surviving competentProbate Code. Therefore, it is not clear w- spouse will not trigger the payment of transferhether a guardian can effectively change the taxes by the ward's estate?beneficiary designation of the ward's insurancepolicy.

Query: Does the tax-motivated gift Significant complications arise if thestatute allow a court-authorized transfer of a incompetent spouse is a party to a revocablenon-testamentary program (such as a life trust. The trust must be carefully reviewedinsurance contract) which would in effect de- regarding (1) the established estate plan; (2)feat the beneficiary designations by the donee's the ability of the trustee to carry out estatechange of the beneficiary? If the guardian planning programs, such as gifting; and (3) thereceived permission to make a gift of the ability of anyone other than the incompetentinsurance policy to anyone other than the spouse to revoke the trust.designated beneficiary, would this be a breach It is often the situation that a trust isof fiduciary duty? created by a husband and wife with community

J. Exclusion From Probate EstateMary's will gives all of her property to A revocable trust funded with separate prop-

John. The guardian of Mary's estate could erty will unlikely give revocation powers tocreate an effective bypass program. This anyone other than the settlor.would be accomplished by transferring assets Revocation of an inter vivos trust may beto an irrevocable trust. The separate property necessary in order to remove assets from anassets of the ward would be given to a trust inflexible estate planning forum. For example,which would retain all benefits for the ward the assets may be better managed within aduring her lifetime, and upon her death, the guardianship because of the court's ability totrust would be distributed according to the approve tax-motivated transfers. However,ward's exercise of a limited power of appoint- the revocation of the trust must be ordered byment. In default of the exercise of the power, a court of competent jurisdiction, and in manythe trust would continue for the benefit of the cases, the guardianship court would not beward's husband in the form of a bypass trust able to order the revocation. Weatherly v.program, with remainder to children. Byrd, 566 S.W.2d 292 (Tex. 1978).

This program would be consistent withthe ward's intent and the statutory presumptionthat the ward intends to reduce taxes as much Fiduciary duty restrictions and legal ethi-as possible. The retained power and interest cal issues run amuck in the incapacitatedwould cause the trust to be includable in the spouse scenario. The problems are obviousward's gross estate for estate tax purposes, and and the following will highlight a few.thereby receive the benefits of (1) the use ofthe ward's exemption equivalent, and (2) astepped-up basis for the assets held in the trustat the ward's death. Existing fiduciary relationships (trustee,

Query: Is this going too far? Can the attorney-in-fact, competent spouse) can createprobate court authorize a giving program that serious restrictions on the ability of the fidu-effectively removes the assets from the court's ciary to conduct estate planning programs for

K. Revocation of Revocable Trusts

property. Amendment and revocation of thetrust requires some form of joint participation.

V. ETHICAL ISSUES

A. Fiduciary Representation of Incapaci-tated Spouse's Estate






the incapacitated spouse. For example, if the established with a person under disability.competent spouse's self-interest rises to the Comment 12, Disciplinary Rule 1.02(g).level of a fiduciary conflict of interest, the This duty to seek protection of the clientefficacy of the estate planning program initi- could arise out of a situation where the com-ated on behalf of the incompetent spouse petent spouse has inquired about making giftscould be called into question. If the transac- of community property subject to the compe-tion is legally questionable, then the transac- tent spouse's control. The lawyer could advisetion may also be void or voidable and result in the competent spouse that this is permittedan ineffective transfer. under Texas law. However, once the lawyer

B. Ethical Issues for the AttorneyThe ethical issues for the attorney will to a questionable donee, then the lawyer may

differ depending on the underlying facts. For be required to (1) seek the appointment of aexample, this may be a situation where the guardian for the incompetent client, andattorney is beginning to represent either or (2) withdraw from the representation of bothboth of the spouses for the very first time. On spouses. Disciplinary Rule 3.08.the other hand, the attorney may have repre-sented both of the spouses in the past in a 2. Client Communicationsmutual estate planning program, or he or she If a client is under disability, communicat-may have represented only the incompetent ing with any legal representative of the clientspouse regarding the separate property of that is required. Disciplinary Rule 1.03. Addi-spouse. All of these scenarios present differ- tionally, the lawyer should seek to maintainent possibilities for the extent of the past reasonable communications with the clientengagement of the attorney. In all of these under disability insofar as possible. The usualcases, there will be issues arising regarding the attorney-client relationship cannot be main-attorney's obligations to communicate with the tained, but regardless, the client may have theclient, protect confidential information, avoid ability to understand, deliberate upon, andconflicts of interest, and assure the adequate reach conclusions about some matters affect-representation of the incompetent spouse. For ing the client's well-being. The law recognizesadditional comments, see Rust E. Reid, Ethical degrees of competency. The fact that a clientProblems in Multi-Party Representation in is disabled does not diminish the desirability ofEstate Planning, Probate and Fiduciary Mat- treating the client with attention and respect.ters, Annual Advanced Estate Planning and Comment 5, Disciplinary Rule 1.03.Probate Course, State Bar of Texas, June 5-7,1996. 3. Confidential Information

1. Duty to Seek Appointment of Guardian lawyer's obligation to not disclose any confi-Rule 1.02(g) of the Texas Disciplinary dential communications and information re-

Rules of Professional Conduct provides that a ceived by the lawyer during the attorney-clientlawyer shall take reasonable action to secure relationship. It may well be necessary for thethe appointment of a guardian or legal repre- lawyer to withdraw from the representation ofsentative for, or seek other protective orders the couple; seek the appointment of a guardianwith respect to, a client whenever the lawyer for the incapacitated spouse's estate; and relatereasonably believes that the client lacks legal this information to the representative of thecompetence and that such action should be incapacitated spouse.taken to protect the client. Unless the lawyer The duty to not misuse client informationis legally authorized to act on behalf of the continues after the client-lawyer relationshipclient, no attorney-client relationship can be has terminated. Comment 8, Disciplinary Rule

learns that the gift is going to either jeopardizethe economic security of the client, or be made

Disciplinary Rule 1.05 deals with the


1.05. Comment 17 of Disciplinary Rule 1.05 A lawyer shall decline or withdraw fromaddresses whether the client will be able to the attorney-client relationship if the lawyerconsent to the disclosure to the court of confi- will be a witness, or representation woulddential information in a proceeding to appoint violate any other applicable rules of profes-a guardian for the client. The lawyer is pro- sional conduct or other law. Disciplinary Ruletected when the disclosure of confidential 3.08 provides that an attorney who will beinformation is required for the appointment of called as a witness may have to decline toa guardian and compliance with Rule 1.02(g). represent a party. If the attorney would be

An addition to the Texas Probate Code in called to testify about Mary's intended estate1999 will give some relief to the attorney plan, he or she must review whether thisregarding the duty to not disclose confidential circumstance would violate the limits of Disci-information. If enacted, new Section 865A plinary Rule 3.08 regarding the lawyer actingwill permit the guardian to file an application as a witness, and if so, whether the lawyerto the court seeking an in camera inspection would have to withdraw.of true copies of the ward's estate planningdocuments. This inspection would occur atthe time of filing an application to make tax-motivated gifts. An attorney who complies The following are some thoughts aboutwith the court's order does not violate the what the King family can consider. First andattorney-client privilege. (See Appendix D.) foremost will be how Mary should be repre-


4. Conflicts of Interest sider this person to be the appointed ad litemThe conflict of interest rules under Disci- to represent Mary in future tax-motivated gift

plinary Rule 1.06 may prohibit an attorney applications.from representing the competent spouse and The guardian of Mary's estate should bethe incompetent spouse's estate. The rule carefully considered, and her husband Johnregarding conflicts and confidential communi- may not be the best candidate. It might becations may well present a difficult situation better to consider one of the children or afor the attorney to continue the representation totally independent guardian.of either or both spouses. John should implement a district court

The lawyer may be able to represent two proceeding under the Family Code whichclients in a conflicts atmosphere, but this may would give him clear, complete, and extensiveoccur only upon reasonable belief that the powers over the community estate of John andrepresentation of both clients will not be mate- Mary. This proceeding should also include therially affected, and both clients give informed appointment of an attorney ad litem (althoughconsent after full disclosure. Disciplinary Rule discretionary with the court) who would1.06(c). Obviously, the required dual in- effectively represent Mary. This ad litemformed consent would not be possible when should also be knowledgeable in the estateone spouse is incapacitated. planning programs so that appropriate actions

5. Decline or Terminate Relationship the ad litem should consider recommending

VI. WHAT CAN BE DONE FOR THEKING FAMILY?

sented in the estate planning program.A guardianship for the separate property

estate of Mary should be implemented. Animpartial attorney ad litem should beappointed, and this person should be oneknowledgeable in estate planning programs.Hopefully, the court would continue to con-

can be recommended to the court. Likewise,


appropriate supervision of the gifting programs. - A difficult asset for this estateThe following are suggested consider- planning program. The guard-

ations for particular assets. ianship court has no jurisdiction! John's separate property AT&T stock to approve a gift of this commu-

- This stock is freely transferable, nity property policy, althoughand a gift of this stock could use the guardian might seeksome of Mary's exemption t- approval as a "belt-and-suspend-hrough an election by Mary's ers" approach.guardian to treat Mary as the - This policy could be gifted underdonor of one-half of the gift. the approval of a Family Code(See IV.A.1.c.) proceeding. (See IV.A.4.)

- The stock could also be used by - The guardianship court couldJohn as a gift to a QTIP trust for not change the beneficiary ofMary with remainder to a bypass this policy. (See IV.I.3.)trust for John. This would like- ! The closely-held corporate stock ofwise use Mary's exemption. John and Mary(See IV.A.1.d.) - This stock is in John's name and

! Mary's limited power of appointment would be his special communityover the GST Exempt Trust property. Any gift of this stock- This limited power of appoint- to the children, or just to the

ment cannot be effectively exer- daughter who works in the busi-cised. (See IV.I.3.) Therefore, ness with balancing gifts to thethe takers in default must be sons, would have the inherentreviewed in light of the other problems of voidable gifts ofestate planning programs. community property. (See I-

! Mary's general power of appointment V.A.2 & 3.)over the non-exempt trust ! Mary's special community property- This power cannot be effectively IRA

exercised. (See IV.I.3.) - The IRA should remain payable- This power may need to be re- to the surviving spouse as the

leased in order to (1) take ad- primary beneficiary. This wouldvantage of Mary's exemption, maintain the substantial tax ben-and (2) reduce the tax impact on efits of this type of program.the marital gifts at Mary's death. Otherwise, a change of the bene-(See III.F and IV.D.) ficiary to any other format of

! Mary's separate property policy on estate planning would be diffi-John's life cult, if not impossible. (See- This policy could be the subject IV.I.3.)

of a court-approved tax-moti- - John might be able to get man-vated gift to the children or a life agement rights over the IRAinsurance trust for Mary's de- through a district court proceed-scendants. This gift will avoid ing under the Family Code.John becoming the owner at ! John's qualified plan accountMary's death under the terms of - Treas. Reg. § 1.401(a)-20, Q&Aher Will. (See III.E.1, IV.B, and 27, allows the incompetent s-IV.I.2.) pouse's legal guardian to waive

! Mary's special community property the QJSA or QPSA, even if thepolicy on Mary's life guardian is the participant.


99999XRV.WP5

- A change of the beneficiary from spouse's will, power of attorney, orthe surviving spouse to any revocable inter vivos trust?other format should be carefully ! What effect will a recovery of com-analyzed, particularly in light of petency have on the programs estab-substantial income tax benefits lished during incapacity of thethat may be lost. spouse?

! John and Mary's CPWROS ! What limitations will be caused by- John may want to revoke the the creation of a fiduciary relation-

survivorship agreement. (See ship between the ward and the donee;IV.E.) the ward and a fiduciary; the fidu-

VII. CONCLUSIONA number of issues arise in the estate spouse offers a number of challenges, and the

planning program for the incompetent spouse. current law and statutes offer significant op-Likewise, a number of issues remain unan- portunities. Clarification within the statutes,swered as to the scope and authority of the and expansion of the statutory scope would berepresentatives of the incapacitated spouse and helpful. In the meantime, this is an area thatthe agents for his or her property interests. continues to have uncharted waters whichThe lawyer, the competent spouse, and family should be navigated with careful and thoroughmembers, as well as the courts must consider planning.the following when considering an estate plan-ning program for the incapacitated spouse:

! What is the marital property charac-teristic of the assets subject to theplan?

! Is the proposed gift one which can becompleted by the competent spousealone?

! Is the proposed gift of property onewhich requires the joinder of bothspouses, such as homestead propertyor joint community property?

! Is the proposed gift one that can beaccomplished or facilitated through apower of attorney, and if so, is theexisting power of attorney adequate?

! Is the proposed gift one that requires,or should involve, court approval?

! Are the proceedings under the TexasProbate Code and the Texas FamilyCode broad enough to clearly en-compass the proposed program?

! What effect will court proceedingsdeclaring the incapacity of a spousehave on existing estate planning doc-uments such as the incapacitated

ciary and the donee?Estate planning for the incapacitated

Documents

ESTATE PLANNING FOR THE INCAPACITATED SPOUSE · marriage offers unique challenges fo r descendan ts unless she provides differently by implementation of an estate planning program