By now, I’m sure you’re all familiar with the tale of Donald Sterling. Self-starter lawyer builds up a successful practice and real estate empire. Purchases NBA franchise on the cheap. Then blows it all with some very unfortunate racist comments that were recorded and made public by an ex-girlfriend. The public firestorm that ensues ultimately results in his franchise being sold for approximately $2 billion (yes, that is billion, with a B) over his objection by his estranged wife who had him somewhat surreptitiously declared incapacitated by a couple of friendly doctors. Given his incapacity, his wife was able to take over his family trust and sell the team without his permission.
I know what you’re thinking, “Boo hoo, Donald Sterling made himself $2 BILLION and you want us to feel sorry for him?” No, I don’t. I merely want to utilize Donald Sterling as a case study to illustrate some things to consider when planning your own estates. Let’s get started:
Don’t let your ex-wife make decisions for you
Donald and Shelly Sterling have a complicated relationship, to say the least. They have been together for sixty years and have three children from their union. The longevity of their marriage notwithstanding, Donald has had several mistresses during this time, most famously with V. Stiviano, the self-proclaimed “Silly Rabbit,” who released the even more famous recordings of Mr. Sterling’s racist musings. Due to such infidelities and God-knows what else, Donald and Shelly became estranged in 2012 when she kicked him out of their Malibu beach home and he took up residence in Beverly Hills.
Stop the tape.
At this moment, there are a number of changes that Donald and Shelly could have made to their estate plan to prevent a loss of control. Granted, without being intimately familiar with the details of their marriage, it is difficult to prescribe an exact plan of action for Donald and Shelly specifically, but I hope to illuminate some issues to consider in the event of an estrangement or especially in the case of a divorce.
In this case, Donald and Shelly could have amended their estate plan so that the other spouse did not have complete control of the trust in the event one spouse became incapacitated. For instance, they each could have appointed an incapacity trustee to act in their stead other than their spouse. This would have allowed Donald to appoint his own representative to act on his behalf with regard to the management of the trust assets instead of leaving full control to Shelly.
In the event of a divorce, the issues are much more clear-cut. Once the divorce is finalized, it is important to review the estate plan to remove the ex-spouse where appropriate. In most cases, this requires a complete purging of the ex-spouse from all documents. Most notably, the ex-spouse should be removed from any positions of authority within the estate plan (i.e. trustee, executor, attorney-in-fact, health care agent, etc …). In addition, the ex-spouse should be removed as beneficiary from all estate documents, including the trust, will, retirement plans and life insurance policies. I have come across a number of occasions where a client has passed away with the ex-spouse still named as a beneficiary on an account or insurance policy. That’s a recipe for litigation. Not fun.
Think About The Definition of Incapacity
In the Sterling case, Shelly was able to have Donald declared incapacitated by having two doctors certify that he was unable to make his own decisions. By having him declared incapacitated, she was able to gain full control of the trust to sell the team. In drafting estate documents, there is a lot of flexibility in how we define incapacity. Requiring two doctors to make a written determination of incapacity is a pretty typical definition, but there are other options as well. Clients can appoint an individual or panel of persons who have the authority to determine incapacity or even build in more complicated measures. These individuals do not have to be medical professionals but in fact can be laypersons. Given his ongoing estrangement from Shelly, Donald could have given his primary care physician or some other family members the authority to make an independent determination of his capacity. This would have prevented Shelly from being able to hire two doctors who were friendly to her to provide the determination.
In well-functioning marriages, another option is to give each spouse the immediate ability to act for the other. This is not dependent on incapacity and can make it easier for the healthy spouse to take care of an incapacitated spouse because they do not have to worry about getting the requisite doctors’ letters. This can be very helpful in a situation where a spouse is in a “gray area” with diminished capacity but the doctors are reluctant to make a full determination of incapacity or where a subject has dementia but refuses to cooperate with the loved one that is trying to take him or her to the doctor for an examination.
Capital Gains are a Pain
In 1981, Donald (and Shelly) Sterling bought the San Diego Clippers from Irv Levin for a song. A song worth $12.5 million. Fast forward thirty-four years and the Clippers were sold to former Microsoft CEO Steve Ballmer for approximately $2 billion. That’s a pretty nice return on investment!
However, all that glitters isn’t gold. Hidden below the headline are the taxes. Most specifically, capital gains tax. Assuming that Donald did not invest in significant improvements to the Clippers over the years, there is a taxable gain of slightly less than $2 billion. With top capitals gains rates of 20% (Federal) and 13.3% (California), we are looking at an approximate tax bill of over $650 million.
Alright, alright, so taxes suck. What else is new? Here’s the lesson. If the Sterlings had not been forced to sell the team, it is almost certain that they would have held on to it until one of them passed away. Why? Because of capital gains. One of the “gifts” that the Federal government gives us is something called a “step up in basis.” It’s a pretty cool gift, but the catch is that you have to die in order to receive it. Basically, in the event of a person’s passing, the government allows for the basis in all of that person’s appreciable assets to be “stepped up” to the fair market value of that asset on the date of the person’s death. For instance, in the Sterlings’ case, instead of the basis of the Clippers being the $12.5 million purchase price, the new basis in the Clippers would have been the fair market value on Donald (or Shelly’s) death. Had they played their cards right, Donald and Shelly could have potentially avoided several hundreds of millions of dollars in taxes.
So how does this apply to you? If you (or perhaps, your parents) are thinking about selling or making gifts of appreciable property, it is always good practice to have them consult with an estate planning attorney or tax professional. If the appreciable asset, whether it be real estate, stock, collectibles or otherwise, has a significant amount of capital gain associated with it, it may be better to transfer the asset AFTER the owner has passed. There may be other strategies which can be implemented to deal with this issue depending on the owner’s goals.
As you can see, even in the case of billionaires with high-stakes estate planning, some things can be overlooked. It is important to revisit your plan periodically and especially in the wake of major life events (birth, death, divorce, increases or decreases in health or net worth) to ensure that those changes are accounted for.