Most Californians, like most Americans, don’t have to worry about the federal estate tax—especially now that Congress has doubled the lifetime exemptions to more than $10 million per person. Of course, those changes are set to expire after 2025, and depending on how the political winds blow, it’s always possible we could see a more aggressive estate tax in the future.
For that reason, it’s important to understand some of the finer points of the estate tax. For example, did you know that if a person has a general power of appointment over property, which is not the same as owning that property, he or she has to include the property is his or her estate for estate tax purposes? It’s true! In this post, I’ll explain what that means, and how something called HEMS can help protect against it.
General Powers of Appointment
So, a general power of appointment can cause a headache when it comes to estate planning. But what is a general power of appointment?
Put simply, a power of appointment is the power to decide what happens to property, even if you don’t own it. A general power of appointment is a person’s ability to appoint property to him- or herself, his or her creditors, his or her estate, or the creditors of his or her estate. This normally comes up in the context of trusts, because if someone owns property outright, then of course that property is going to be included in his or her estate for estate tax purposes.
Here’s an example: John leaves his property in a trust for the benefit of his wife, Sarah, while she lives, and then for the benefit of whomever Sarah wants to leave the property to. If there are no restrictions on Sarah’s power to “appoint” the property, then she could appoint it to, say, her creditors or her estate. Thus—and whether she uses the power that way or not—Sarah has a general power of appointment, and all of the trust’s property has to be included in her estate!
Just like that, what John thought was a clever estate plan is undone, and his surviving spouse may be forced to pay estate tax on property that she never really owned!
Exception: An Ascertainable Standard (HEMS)
Fortunately, there are ways to avoid that outcome. Most obviously, a person can be given a power of appointment that isn’t general. Maybe he or she can only appoint the property to his or her children or other relatives, or only to one of a handful of charities. Or maybe the power of appointment lets him or her choose anyone in the world—except him- or herself, his or her creditors, and so on.
But what if you want the person with the power of appointment to be able to appoint the property to him- or herself? For instance, what if you want to create a trust whose trustee is also a beneficiary (say, your financial-consultant son or daughter)? Well, you could limit that general power of appointment using what’s known as an ascertainable standard. And that’s where HEMS comes in.
HEMS stands for “health, education, maintenance, or support.” According to the IRS, if a general power of appointment is limited by a HEMS standard (e.g., “You can distribute money or property to yourself, but only for your health, education, maintenance, or support”), then the property subject to the power of appointment will not be included in the power-holder’s estate for estate tax purposes (unless it’s included for some other reason, that is).
What HEMS Means for You
The HEMS standard comes up in other contexts, too, but for now it’s enough to point out that the standard illustrates just how complex estate planning can become—particularly when you’re using trusts. For a well-drafted estate plan that takes advantage of sophisticated features like general powers of appointment limited by HEMS, you need to work with a knowledgeable estate planning lawyer, rather than trying to figure it out on your own.