What is estate planning?

While you are alive, you will accumulate things.

You may buy real estate, cars or stocks. You might decide to have life insurance and put away some amount for your retirement fund. You might also have some government benefits or have taken out some loans.

All of these constitute your estate.

Eventually, this will pass to your heirs.

Your heirs may want to transfer the real estate titles, the vehicle registration or the stock certificates to their name.

However, they will have to pay estate tax as part of a process called “settling the estate” before they can do this.

With the current 6% estate tax in the Philippines, these taxes can be a hefty sum.

For a net estate of Php 10M (about USD 200k) after all deductions, this can amount to Php 600k (USD 12k). This is often very difficult for heirs to pay.

Among other goals, estate planning considers and puts in place certain mechanisms to reduce the tax burden on the estate.

What goals do you want to prioritize in estate planning?

Minimizing estate taxes is often the primary estate plan goal.

However, you might also want to include other goals.

For example, you may want to ensure you maintain a certain quality of life both for yourself and your heirs. You may want to keep your in-laws out of your business. You may also want to leave a legacy to your school.

You need to know your goals to plan your estate.

Everything will follow these goals.

Let’s go through a few common ones as examples.

You just want minimize estate taxes. A tax-free exchange where property is transferred to a corporation that the transferor gains control of would enable that. Heirs can then pay tax on the usually lower book value of the property. Note that the BIR will sometimes implement the high tax RR 6-2013 instead of the correct RR12-2018 so it is important to consult and work with an accomplished tax practitioner.

You may want to make sure that your business will run without interruption after your death. You may choose to not create a will. Your heirs can now run your business without pause as a will would require the long process of probate, which would very likely hold up your business.

You may want to make sure that your wife always has a certain quality of life. An irrevocable trust can be created with this specific purpose in mind.

So, setting your goals is extremely important.

Changing goals midway is very costly.

Before you do anything, sit down and think deeply about what you want to accomplish with your estate.

What factors affect estate planning?

Now that you have your goals, you should be aware of factors that can adversely affect your estate plan.

While there are several factors, I’ll list down some major ones here:

• Where your estate plan or will is carried out
• Where you, your heirs and your property is located
• What nationality you and your heirs possess
• Who administers or executes your estate
• The nature of your assets
• The personality and needs of your heirs
• In-laws and creditors and other factors

The first three affect your estate because different countries’ estate taxes might really lower your estate’s value.

Let’s take the United States.

If you are an American, you will be taxed on your total worldwide estate. If you own a Philippine condo you will also be taxed by the Philippine government. Your Philippine condo has now been taxed by America and the Philippines. This is called “double taxation” and really reduces your estate.

Dual citizens, long-term residents, and life decisions may also incur double taxation. The end result is very little is left for your heirs.

Another factor is the administrator or the executor of your estate.

These are positions of trust and competence. They need to be capable enough to implement your wishes. Also, they need to have a lot of integrity as they have a lot of power over your estate.

It is often wise to have 2 or 3 people as trustees and to pick people that you are very familiar with.

Another important factor is the nature of your assets.

Many countries have restrictions on property and stocks but less restrictions on cash.

In the Philippines, you will need BIR clearance to transfer real estate and stocks to another’s name. A clearance is not needed for cash meaning you can set up the trust much faster.

Lastly – and just as important – are the personality and needs of your heirs. While some heirs will follow your wishes others may decide to challenge the estate through the courts. This can cause the family both emotional and financial grief.

This must also be carefully considered in any estate plan.

What is your estate composed of?

Now is when you can dust off your accounting skills – either that, or hire one!

You are really going to need accounting chops for this as here we start to figure out what your estate is composed of.

Look at what makes up your assets.

Where are they located? Do you have complete documents? How are they currently being administered and are all the permits and taxes on them paid?

In many cases, there is a need to go through each property individually. Sometimes, you have to remove a cloud on a real estate title, reconstitute it if it cannot be found, or just transfer it to your name. These real estate issues may already entail court proceedings in the Philippines.

In addition, unpaid real estate taxes should be settled.

After problems are resolved and documents gathered, you’ll need to continually manage your assets and pay regular government fees and taxes on them.

Now it is time to take a look at your obligations.

If you have mortgages or have taken out other loans, you’ll also need these documents.

Find the original agreement and the receipts of all payments.

Find all other outstanding obligations.

These help, as loans lessen reduced the amount taxed and so lessen estate tax.

While tedious and time consuming, this basic accounting is necessary. It defines what needs to be worked on and sets the foundation for decisions down the road.

What laws will come into play?

Now you know what your estate is composed of.

The next step is to figure out what laws may affect it.

Up top, we discussed how foreign tax laws caused the estate to be taxed twice – which we call “double taxation”.

Double taxation happens when international properties, nationalities or addresses are involved.

To know how to address double taxation, the laws that affect your estate have to be studied.

Then, you and your legal counsel can come up with the best possible ways to lessen double taxation while still attaining your goals.

Often, the best way is through a combination of different legal entities.

Each legal entity has pros and cons.

Some have higher tax rates. Some allow certain possibilities while others do not. Some are difficult to set up and cost a bit of money.

The correct choice of legal entities goes a long way in helping mitigate against double taxation.

Note that while taxes are a primary concern when a legal entity is chosen but that the choice of legal entity can also help or hinder attaining your goals, simply by their very nature.

How should you educate your heirs?

At this point, you’ve already accomplished a lot!

But while you are busy accounting for your estate and figuring out the laws, remember to pay attention to your heirs.

Your heirs are a decisive factor.

Heirs often have misconceptions about inheritance. Heirs also need to be told what your expectations and wishes are. Heirs can end up fighting each other and we all want to avoid that.

Your heirs need just as much attention and time as all the other parts of estate planning – perhaps even more.

You should sit down and discuss things with them candidly. Make them aware of your wishes and how you expect them to behave with regard to each other. Teach them about estate laws and regulations. Better yet, have them attend estate planning seminars.

The surest way to help your heirs avoid trouble is to educate and talk to them about their responsibility.

What does Philippine Law mandate regarding inheritances?

Philippine laws are pretty definite about inheritances.

• Philippine law determines who your heirs are.
• Philippine law defines the proportion of the estate that your heirs receive.
• The only way an heir can be disinherited is though a court case.
• The proportion heirs receive cannot be changed
• If an heir passes away before the estate owner, it is possible that his children may receive the portion allocated to him due to what is called “the right of representation”.
• Illegitimate children are also heirs.
• Even if you create a will, you can only dispose of the so-called free portion while the rest is allocated by law.
• Wills require a court process called probate that validates the will.
• The fastest court cases take 1 year.

I’m sure that at this point you’ve got a lot of questions.

People often ask who heirs are and what proportion they are entitled to. They often want to change the heirs or the amounts. If they do this though, the entire estate can be questioned and a will can be overturned.

So, to reiterate.

Philippine law determines your heirs and the amount they receive. You cannot change these mandatory heirs or the proportion received although you may dispose of a free portion through a will.

You must craft your estate with these legal restrictions in mind.

What are Philippine taxes on your estate?

I’ve written a post the delves into the nitty gritty of estate taxes.

Still, you might be interested in the main points:

• Estate tax is 6% on the net estate due to the TRAIN law which was effective Jan 1, 2018. Prior deaths are governed by a graduated table depending on the estate’s amount.
• Net estate is the Gross Estate less Estate Obligations
• Gross estate is not necessarily all the assets of the deceased. For instance, it excludes accruals from the SSS and irrevocable life insurance policies.
• Estate Obligations are claims against the estate such as loans, mortgages, etc.
• You have a standard deduction of Php 5M and also a deduction of up Php 10M which you can use depending on the amount of your family home.
• You must reduce the gross estate or increase the estate obligations to reduce estate tax.

Estate calculations can be very complicated.

What I’ve listed down is only meant to serve as a guide.

You should really work with estate advisor to determine estate taxes since his knowledge could save you quite a bit of money.

How do you operationalize your estate plan?

If you’ve managed to read through this short (cough, cough) article on estate, you already know quite a bit on Philippine or Philippine and foreign estates.

If you’ve managed to actually do your accounting and have already consulted with your lawyer, even better.

Now you have to start deciding what legal entities or tools you will use to transfer your estate.

You might want to buy life insurance.

You might want to construct irrevocable trusts.

Or you might decide to separate properties and put them into various companies for your children.

Remember that setting up all these tools takes a lot of time and money. You will have to pay to register some legal entities such as corporations. You will also have a reporting requirements with the BIR. You might need a full-time bookkeeper at this point.

This is an on-going continuous thing – as your estate grows and more property is added you will have to make decisions that affect the estate.

It is often wise to go back every 2 or 3 and adjust your estate plans as needed.

Estate planning is nothing more than identifying and addressing concerns regarding your estate and heirs during your lifetime.

You have to:

• Set your goals
• Understand factors that can affect your estate
• Understand the Philippine and foreign laws the come into play
• Account for your estate’s assets and liabilities
• Educate your Heirs
• Operationalize your estate plan
• Maintain your estate plan

If you’ve gone through this guide carefully, you’ve gotten a crash course in estate planning.

You now understand estate law fundamentals and what we family lawyers think about when we assess estates.

However, remember that an estate isn’t just about pieces of paper or property.

An estate is tied to people and families.

Often estate planning becomes sensitive when emotions are involved.

One child might feel excluded. Another child might remember a slight from childhood that has never quite gone away. Managing emotions and expectations are very important and have to be handled with tact.

Also remember that estates only work when you are absolutely up front with your estate advisor.

Given that illegitimate children are heirs, it is not wise to hide this fact from your estate advisor.

If he is aware, he can plan for it and cause minimum disruption. If he is unaware, all your careful plans might go to waste.

An estate plan should be considered an important part of planning for the future, much like saving for your children’s college education or upcoming medical expenses. At the end of the day, the best estate plan serves you and your family.