Estate planning made simple

By Jules E. Riego

First Published in Business World (7/29/2013)

DEATH is almost always unplanned but an event that we should all prepare for, whether we believe in an afterlife or not. Hell, after all, is not just a spiritual concept, but an unfortunate reality that heirs of a decedent usually experience when there is no plan for the settlement of his or her estate and for the payment of taxes that will fall due from the transfer of assets to the heirs.

After hearing numerous horror stories from heirs left behind by a person who, almost always, died suddenly, the top two problems in such a situation are (1) liquidity, that is, where to get the money to pay the local transfer tax (LTT) and estate tax due; and (2) securing a new Transfer Certificate of Title and/or tax declarations for the heirs when there are real properties involved.

Do you know that while the bereaved are still grieving, heirs already have to pay the LTT due from the estate within 60 days from the death of the decedent? On the surface, the LTT might look small, with a maximum rate of 75% of 1% of the fair market value of the real estate assets involved in an estate, but the common problem is that heirs point to each other to foot the bill. This results in delays in payment, with corresponding penalties and interests.

The estate tax return, on the other hand, must be filed within six months from the death of the decedent and, ideally, the estate tax must have already been paid at that time. However, if paying the tax will bring undue hardship to the heirs, the Commissioner of Internal Revenue may extend payment for two years in case of extrajudicial settlement of the estate. Extrajudicial settlement means that the decedent died without a last will and testament and that the heirs, in accordance with law, decided to execute a partition agreement as to how they will divide the estate among themselves.

In case the decedent died with a last will and testament, a probate of the will has to be done. This means that a case in court has to be instituted by the heirs where the validity of the last will and testament should be proven. In this case, the Commissioner may grant an extension of five years within which to pay the tax.

However, time and again, the heirs are often forced to do a fire sale of prime properties and assets from the estate just to settle the LTT and estate tax due. As prime properties are the easiest to sell, these are sold at bargain prices just to avoid paying the 25% surcharge and 20% interest per annum imposed on the late payment of estate tax.

Preserving peace and harmony among heirs would be ideal. More than the wealth to be passed down, maintaining cordial relationships between the heirs should be secured. We often hear the phrase, “that will never happen to our family, we are all at peace with each other.” Yet, just as frequently, I have seen families end up in court engaging each other in costly suits over the partitioning of the estate. One should never assume that your heirs will live happily ever after when your time is up. I would rather go by this saying, “Blood is thicker than water, but money is thicker than blood.”

With foresight, these unfortunate things can be easily avoided — if one accepts the inevitability of death and plans for it. A few simple tools come to mind that may be considered in addressing the common problems mentioned above:

• Life insurance. The proceeds of a life insurance policy taken out by the decedent upon his own life, which designates the heirs as the irrevocable beneficiary, is not subject to estate tax. Thus, life insurance can address the liquidity problems of heirs. The premiums paid for the life insurance policy is also effectively carved out of the assets of the decedent, and hence, will reduce the taxable estate.

• Sale of Assets. One may just consider selling assets to a potential heir (except a spouse) rather than allowing it to become part of the estate. In particular, the sale of real property that is considered a capital asset will only attract 6% capital gains tax, 1.5% documentary stamp tax and 75% of 1% local transfer tax, compared with estate tax which has a maximum effective rate of 16%. One just has to make sure that the heir who will buy the property has the capacity to buy and will actually purchase the property.

It is interesting to note that selling to a spouse is actually an effective estate tax — saving mechanism recognized in other jurisdictions, such as the United States and the United Kingdom. However, in the Philippines, sale between spouses is allowed only when the husband and wife are under the regime of complete separation of property.

• Donation. If the potential heir has no capacity to buy, one may just donate the property. Donor’s tax has a maximum effective rate of 12.5%, which is still lower than the maximum effective estate tax rate of 16.5%. The amount or value of the asset donation is also already carved out from the estate, reducing the taxable estate. Please note, however, that if you donate to a stranger (that is, someone who is not your brother or sister, ancestor or lineal descendant or first cousin), the donor’s tax goes up to 30%.

Interestingly, one question that some people ask is how they can exclude sons-in-law and/or daughters-in-law from inheriting the property that their own children will receive upon their demise. Strangely, some people worry that they might be working too hard for their in-laws. How then do you address this practical problem?

One way is through the execution of a last will and testament. At least, for assets pertaining to the free portion, one may impose conditions as to who, when, and how succession will take place with respect to those assets. The free portion is the part of the estate that a testator may dispose freely to anybody he wants to, after the legitime of the compulsory heirs has been served. Legitime is the minimum entitlement of each compulsory heir under the law and which cannot be made subject to any condition or imposition whatsoever. Compulsory heirs are heirs who will inherit from us whether we like them or not, e.g., spouse or children.

Keeping these considerations in mind, it makes sense for one to plan ahead to avoid subjecting one’s heirs to a hellish experience. Remember: Prosperity is a blessing from God, but it can also become a curse if not handled properly.

Jules E. Riego is a principal of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.