Islamic Estate Planning Attorney
Islamic Inheritance
If you are in Los Angeles on November 5, please see my workshop at the Islamic Center of Southern California on Islamic Inheritance and Islamic Estate Planning.
If you want a presentation in your community, call my office at (714) 384-6500. To schedule a no-obligation 15-minute Zoom call to discuss your Islamic Estate Planning, click this link.
One of the most overlooked aspects of estate planning, particularly for Muslims, is charitable planning. Yes, it is essential to ensure that whatever you own, passes on based on the Islamic rules of inheritance. However, that is not Muslims’ only goal when organizing their financial and family wealth affairs.
This charitable planning tool is primarily useful for successful business owners who want to do what is known as “business succession planning” or “exit planning .” The idea here is that business owners would like to keep the business within the family while at the same time saving and transferring taxes that may take place. They may also want to sell the business and tranfer much of the wealth for future generations in the most efficient way possible. Currently, the gift and estate tax regime ensnares only the most successful investors, professionals, and business owners. However, for them, the federal estate tax can take away millions of dollars and, worse, prevent a business owner’s goals,
What if I told you one of the techniques to help transfer wealth so the next generation, while potentially saving millions of dollars in taxes, is strategically giving cash to charities? No fancy charitable trusts (but definiately consider them for other reasons). I’m talking about writing checks. What is even more peculiar about this strategy is that the money the charity gets is not even a charitable contribution per se.
Allow me to introduce the “to charitable bailout.” I realize this is one of those articles that is not going to apply directly to many people reading this. Even so, it may benefit some people, maybe somebody you know (so forward this). More importantly, it may be one of several strategies that organizations, including Masajid and organizations for the benefit of the poor and other beneficial purposes, can use to obtain additional resources.
Step One: the business owner gifts some of his shares to a trust for the benefit of his or her children. There are reasons why you may not want to give it to the children directly: parents may be worried about divorce or lawsuits for example. Even so, the business owner is parting with a relatively small portion of the value of the business, maintaining the majority share.
Step Two: the business owner then donates shares of his privately held company (this is typically going to be a C-Corp) to charity. This is a valuable donation of shares in a successful company.
Step Three: the company (not the donor of the shares) in an informal arrangement, redeems the shares that are owned by the charity by paying cash for them.
By using this technique, a larger percentage of the company is now owned by a trust for the benefit of future generations. Gifting shares for the benefit of family members could result in significant transfer taxes (the estate tax, gift tax or generation-skipping tax).
This charitable strategy has been sanctioned by the United States Tax Court in a case called Palmer vs. Commissioner about five decades ago after the IRS challenged it. It still works.
Of course, I would not recommend ever doing this without getting tax and legal advice specific to a family or business’s particular circumstances. The point of this illustration is to show that there are a variety of ways the charity can be used to accomplish a wide range of goals. Many strategies might seem weird or novel sounding, even if they have been established for quite some time.
To discuss estate planning for Muslim families, feel free to schedule a 15-minute mini consultation over zoom.
We as a society have determined two things that tend to contract each other.
LLCs are one way to come to a compromise on these two things.
So say Elyas owns shares in Apple, a massive publicly traded company. He does not work for Apple in any capacity; he owns shares he purchased in a brokerage account. Someone sues Apple for employment discrimination.
Can Elyas be sued for something Apple did? Yes, of course, he can be sued. You can sue anyone for anything, never mind how ridiculous. However, Elyas would likely win such a lawsuit very quickly, as quickly as we would if he owned no Apple shares (though I am sure such a case would be frustrating and expensive for the person to suffer it).
This principle also works for non-publicly traded companies: Say Elyas owns a hardware store, and an employee sues for employment discrimination. Same thing, though, with a couple of significant differences. Elyas is always liable for stuff he does and says. So his liability is different if he did something that caused an employee to sue. If he owns Apple stock, he will usually have no opportunity to engage in personal conduct with Apple employees that would get him sued for employment discrimination.
There is another exception that applies the same way to Elyas’s Apple stock AND hardware store. If he is sued for something unrelated to those two things and loses, he can lose his shares in both the hardware store and the Apple stock, just like cash.
Say Elyas and Bilal buy an investment property together. They own 50% each. Elyas has some other savings and owns a house. Bilal only possesses his interest in the investment property. A tenant’s customer suffers an injury after a roof collapses on him. He sues and wins the lawsuit.
Because Elyas and Bilal do not own their property in a business entity, say a corporation, a limited partnership, or an LLC, they are liable for each other’s obligations. Elyas can lose substantial assets, and a judgment against them could haunt them for years.
This kind of liability can strike Elyas for things he has nothing to do with and is unrelated to the building he owns with Bilal.
People often create general partnerships by accident. There are no legal formalities required, only a business relationship. This fact can sometimes hit people hard.
A limited liability company (LLC) is a creation of state law and a hybrid of a limited partnership and a corporation. There is a remarkable level of organizational flexibility in an LLC. Like a corporation, an LLC can be publicly traded or privately held. Owners are not called shareholders but “members.” There can be one owner or many (most states require two). Business owners can chose to have them taxed in a variety of ways.
Those who care about asset protection often find an LLC far superior to owning a corporation. Still, in some cases, it may be the same as a corporation, or in other situations, no different from doing nothing. LLCs can be different from one another based on the following:
When we create LLCs for Islamic Estate Planning, we rely on the flexibility for gifts, income distribution, wealth transfer, structuring valuation, and teaching future generations about business and real estate, among other reasons. Every client and circumstance is different in some way.
Organizers of Limited Liability companies can make them “member-managed” or “manager-managed.” Members can determine how to manage the LLC together in a member-managed structure. In a manager-managed LLC, one or more people act in a CEO-like arrangement.
Example:
Sohaib wants to gift a building to his daughter, Asia. Asia is young and is yet unmarried. He does not know who she will marry and if there may be problems in the future. He would also like to protect the gift so that it is for her benefit, notwithstanding any bad decisions she may make in the future. Sohaib would also like to draw income from the building for now.
This solution is to create an LLC where he is the manager to draw a salary for his work managing the business. He can also gift a portion of the LLC over time to his daughter or the whole thing. More than likely, Sohaib would want to place his daughter’s interest in a gifting trust so the shares can pass to Asia’s heirs per the Islamic Rules of Inheritance and increase the asset protection benefits.
Corporations must have a board of directors, which needs meetings and a minute book. Failure of the owner to follow these formalities could mean failure of the corporation itself.
One of the often-cited benefits of an LLC is that you don’t need to do the same formalities; there is no requirement for minutes. While this is true, it’s possible to overstate this as a benefit, as discussed below.
In the words of former Presidential Candidate Mitt Romney, “Corporations are people, my friend.” A business entity has “corporate personhood.” That means it can sue people and others can sue it; it has rights like freedom of expression.
If someone is suing your LLC, often, that means you are not, and if somehow you are, the LLC is protecting you because you maintained appropriate formalities.
Example:
Hamid has an LLC that owns a rental property. He uses the rent for his daily living expenses. The renters pay his LLC rent, which goes to a separate LLC bank account. Hamid draws from this account to pay for personal expenses, including vacations, gifts for his children, and his bills. He also maintained no minutes for his corporation.
A renter’s guest, Earl, sues Hamid. Earl was seriously injured when the railing from a stairway failed. The plaintiff claims Hamid should be personally liable because Hamid made no distinction between himself and his LLC; why should anyone else?
Earl would likely win here. If you don’t respect your LLC, don’t expect anyone else will.
The LLC operating agreement is a critical component, even though the state may not require it.
For example, Rashida and her sisters Sara and Haritha own an office building together, a gift from their parents years ago. Haritha wants to sell to the highest bidder, an outside investor. Sara and Haritha want the building to stay in the family. The operating agreement can determine if Haritha would be able to do this.
LLC operating agreements can also include voting, non-voting, and equity and non-equity interests. These are often useful in estate planning.
What tax treatment to select often depends on advice from a CPA or tax professional. It’s an important decision and usually not an obvious choice. The government can tax an LLC like a “c-corp,” traditional corporate taxation where the corporation pays income taxes, and dividends paid to the owner are taxed again. Many people don’t like the government taxing them twice; however, it will pencil out just fine in many situations. While it’s beyond the scope of this article, in some cases, it may be silly not to get a c-corporation.
The other way is what is known as “s-corp” taxation. The corporation issues a K-1 to shareholders, but there is taxation only at the partner level, not the corporate level. This kind of treatment is not available to everyone and has many more restrictions.
An LLC can also be a “disregarded entity.” That means the IRS ignores the entity’s existence. This choice is common with investment properties.
Most publicly traded companies are incorporated in Delaware, regardless of their headquarters’ location. The reasons concern corporate law that founders of publicly traded companies have found beneficial. They can do this without visiting the state.
This kind of analysis enters into many decisions people face in the law. Lawyers often look for other jurisdictions regarding trusts and limited liability companies. While, like publicly traded companies, Delaware makes itself competitive for other things, the state is not the best place for everything.
The most common use of LLCs is for real estate ownership. Different owners have varying reasons for this, but flexibility, informality, and often superior asset protection compared to the corporate form. Several tax benefits are associated with investment property ownership, and many investors want those benefits. However, owning property in an individual’s name subjects the owner to unlimited liability.
The charging order is an essential concept in asset protection. You should think of it as being something like a “wage garnishment.” Say William does not pay his child support, a Judge orders that his employer pay his ex-wife a portion of the wage to cover child-related expenses.
A limited liability company may pay out income to an owner. Suppose a judge selects the “charging order” as the remedy to pay the judgement creditor (it is an “exclusive remedy” in some states). In that case, a creditor does not have other options readily available, such as forcing the sale of a property, replacing a partner in a business, etc. The charging order is not an exclusive remedy everywhere.
Remember that property taxes are different in California from just about anywhere else. So if you are not in California, you can skip this part. In California, changes in ownership will often trigger a reassessment. Remember, under Prop 13, long-term ownership has an inherent advantage because as the property appreciates, property taxes do not increase at the same rate. A new owner often pays more in property taxes than the prior owner.
But what if the new owner is the old owner, and the only difference is that the property is in an LLC wrapper? So long as the owner proprtionately distributes ownership to that business entity, the property tax should be the same.
Example:
Hasan and Amal own a fourplex apartment building; they own 50% each, purchased for $700,000 in 2010. In 2023, Hasan and Amal transferred the property to a Limited Liability Company, BiHafa Holdings LLC, 40% to Hasan, 40% to Amal, and 10% to their daughters, Fatima and Bilquis. Hasan is the manager.
The county assessor will reassess the property. The county will reassess the fourplex as the property has appreciated to over $3,000,000. Hasan and Amal will get a higher property tax bill as a result.
If, however, Hasan and Amal had transferred ownership to an LLC where they did not give gifts to their daughters, the property taxes would have been the same.
This example is not to discourage giving gifts to daughters. However, Hasan and Amal can structure their gifts with property tax consequences in mind.
LLCs are like Trusts because they do not die when the asset’s owner dies. They can have a perpetual existence. LLCs do not last forever since they cease to exist when the business entity stops paying fees and taxes. Perpetual does not mean forever.
People often create LLCs for asset protection, wealth distribution, and tax planning. In the gift and estate tax area, how much a family is taxed depends mainly on the value of things—many disputes between taxpayers and the government center around valuation. Property owners tend to undervalue their assets and governments (especially the federal government) are interested in overvaluing them. Valuation is vast area of law in itself.
So, for example, the property owned by Hasan and Amal in the example above was $3,000,000. What if Hasan and Amal wanted their LLC that owns the property to appraise at $2,000,000 and have that pass scrutiny? Yes, it’s possible with good LLC planning.
The gift and estate tax system in the United States is often subject to change in various ways. In 2023, parents can gift up to $17,000 a year free of any gift tax consequences or even the need to file a gift tax return. So, for a husband and wife, this is $34,000 per year. This ability can be helpful in many ways:
Example:
Abdullah and Salma have been married for 50 years. They have a diversified set of assets worth about 30,000,000. They are concerned about the federal estate tax. The exemption in 2023 is $12,920,000 per person, and for both of them, $25,840,000. They have many options to mitigate their estate tax liability while, at the same time, spreading wealth among family members.
Here, they decide to create a special kind of gifting trust that helps with their tax and estate planning.
For many people, it makes sense to get an LLC in the state they are in. As discussed above, the state matters. Your attorney should help you determine the best fit in terms of protection that you need. LLC laws are regularly changing, as are other things, like costs, privacy, and service.
It’s not hard in and of itself. Many states make filling out a form easy and pay a small fee. There are other aspects to an LLC, however, that go beyond mere formation. As I mentioned above, many people create LLCs and place themselves in no better position than when they started the entity.
Many people look at the “asset protection” benefit of an LLC and figure it may be nice to place their home in an LLC. Though there is no rule against this, courts have pierced the corporate veil when a business entity owned a personal residence. So, the gesture is pointless. People have options for protecting their home; this is not it.
The nature of insurance is to compensate people for loss. So if a tree fell on your parked car, an insurance company would pay you for a new car. If sued you over something covered by the policy, an insurance company would pay a lawyer to defend you, and if there were damages, pay for those damages.
Say Amal and Hasan want to insure their fourplex. They would have liability insurance of $2,000,000 and an umbrella policy that covers liability from $2,000,000 to $5,000,000. This second policy tends to be cheaper than the first since the second insurance company pays only after the first insurance company pays.
There are some significant limitations with insurance. The biggest one is that they often don’t pay when you need them to. Insurance contracts are not one sentence long; there are exclusions- often many of them. Then there is always a limitation on what they pay even when they agree it’s covered, and they pay those liabilities after attorney fees and other costs that may eat up much of the coverage.
A limited liability company is often an excellent firewall against further liability.
A structure like a limited liability company is helpful when sued, as it discourages someone suing you from thinking the case can be worth more. If they know a defendant has taken steps to limit their liability, they won’t dream about going after personal assets. They may be more likely to settle for insurance money.
One ongoing issue with limited liability companies is that some claim, not incorrectly, that LLCs don’t have the same kind of formalities as a corporation and that board minutes are not required. But this only tells part of the story.
Anyone with an LLC should develop facts that would help them fight any claims that the business entity is an “alter ego” of the owner. This kind of finding will cause, in the language of lawyers, a piercing of the “corporate veil.” Maintaining a minute book, meetings, and other formalities, like a separate bank account and accounting, is vital when protecting your assets. Asset protection is a dynamic process.
The reasons to own multiple LLCs are obvious; how many eggs do you want in each basket? If it’s too many, you are vulnerable. Real estate investors generally prefer to own their properties in individual LLCs so long as this is economical.
Judgment creditors, who have won a judgment, have immense power even in a world where we have Limited Liability Companies. In some states, a charging order is the “exclusive remedy.” That means that if the manager declares income, the judgment creditor is entitled to some of it.
But judgments, and judgment creditors, tend to go nowhere. They can lurk around for years. They can sell their judgments to well-funded businesses that specialize in making life miserable for debtors. If you want to enjoy your wealth at some point, having a judgment hanging over your head is not a lifestyle anyone would want.
Some people create additional firewalls and techniques that include LLCs to protect their wealth over the long term. These firewalls can consist of asset protection trusts, private retirement plans, and other methods as part of an integrated asset protection strategy.
An LLC does not distribute your assets after death. An Islamic Living Trust does that, sometimes acting as the LLC membership interest owner. There is much more to business planning, however. Here is an example:
Salman owns Falafel Properties LLC, which owns several LLCs with different properties. Salman’s son Abdul Matin has been helping him with the investment property business. Other children, all adults, have developed other career paths. He has been gifting part of his company to his children and grandchildren in trusts for several years.
After he passes, Salman wants to keep Falafel Properties LLC as a functioning real estate business. He would like to have Salman and perhaps other family members manage the company over time. Maybe in the future nobody in the family would be able to act as manager, and the family would need to hire a professional manager.
An LLC operating agreement, trust planning, and other documents can address several important issues. For example:
If you own investment property or need to think about asset protection by building walls of protection around your business, or want to integrate business planning into your Islamic Estate Plan, schedule a 15-minute no-obligation mini-consultation with Attorney and Certified Specialist in Estate Planning, Trust, and Probate Law, Ahmed Shaikh, by clicking here.
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So you have an Islamic Estate Plan: A living trust designed to respect your wishes. You have a will, designed to back it all up. An attorney drafted a power of attorney in the event of financial incapacity. Your lawyer transferred your real estate to the living trust so that the home transfers how you want after death and your family avoids probate. You also transfer your bank account so that your trust owns it. If you have a business, you transfer or assign your shares so that it all flows the way you want. All good things. But there may still be a problem.
There are many retirement plans out there, the 401(k), the 403(b), the Individual Retirement Plan (IRA), the SEP-IRA, and so much more. Most of them follow the principle that customers cannot hold assets in a trust because the financial institution already has them in a special account. Unlike your home, business, and bank accounts, accounts like 401(k)s and IRAs are governed by a separate contract.
Estate Planning Attorneys at an organization I am part of recently started complaining about the difficulty in administering estates per the descent’s wishes. Let me give you an example:
Abdullah has a living trust and will that designates his estate to be distributed based on the Islamic Rules of Inheritance. He does not, however, do something called a “beneficiary designation” for his 401(k) worth $1.8 million. Abdullah’s family is a bit complex. He has five children from two prior marriages and is now newly married. Different branches of his family don’t like each other, and nobody seems to like his new wife.
Abdullah has a 401(k) with a brokerage that has a policy of giving the entire estate to his wife unless he specifically designates otherwise in the brokerage’s own form. What he says in his will or living trust is irrelevant. This was NOT his intention. According to the Quran, his wife is entitled to only ⅛ of the estate. It is possible she will consent to give up the retirement plan (which she can roll over into her own). Maybe she will, but given the bad relationships in the family, and also, because it’s a large amount of money, maybe she won’t.
A popular brokerage like Schwab, for example, has a “line of succession” policy independent of a client’s wishes. So if Abdullah does not do a beneficiary designation, a huge injustice can occur.
Abdullah wanted his successors to distribute his assets based on the Islamic Rules of Inheritance after his death. He could draft a beneficiary designation based on the Islamic Rules of Inheritance on his brokerage’s form. So Abdullah can name all beneficiaries and their percentages. This can be tedious and may eventually be wrong since you don’t know who your survivors will be when you die.
Given that inheritance is a moving target, he may need to adjust the shares if, for example, he gets divorced and remarried, has more children, or a parent, child, or spouse passes away. To simplify this, it may also make sense to name his trust as the beneficiary, which should be designed with retirement plans in mind and provisions that protect it from periodic changes in life.
Of course, Abdullah would have to revise his estate planning periodically, but it’s easier to do that through a living trust.
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You are an adult. If you are still blessed to have parents or one parent, you are also a child and may even be regularly called this by your parent, no matter how old you are. If your parent is single, they may want to get married-often, a discomforting thought to adult children. Let’s walk through an example:
Idris is 72 and has been a widower for about one year. He found a 43-year-old bride, Salma, in Morroco online and is not looking for an attorney to bring her to the United States. His children, Shahina (36) and Siraaj (45), don’t know what to make of this.
Idris retired a year ago; he has some assets but is not rich. He lives in a free and clear home, now worth $2,000,000 (he was lucky in picking the neighborhood years ago); he has some savings and is receiving social security benefits.
Shahina and Siraaj never received any inheritance when their mother passed away. They did not expect any since their father lived in the home owned jointly with their mother and had little by way of liquid assets anyway. Now they are worried about a few things:
It’s tough to lose a wife to death, and it’s sometimes tough in divorce (depending on the circumstances), and it’s no mystery why men may be eager to get remarried as soon as possible, even though this does represent a massive risk. A marriage, after all, is a grant of trust, perhaps the biggest one you can give. Yet, many men and women provide that grant of trust over conversations on the internet.
There are serious financial and social risks, not just to the people getting married. In this instance, Salma is leaving her homeland, the world she knew. She may end up not liking her new husband or have step-children who do not like her.
From the beginning, he must be open with his children about the journey he is embarking on. The problem may be that the children won’t accept the notion of his getting married at all. There may also be other aspects to consider; there may be a complex family history. The children may live far away and have little contact with Idris. Assuming he has a good relationship with his children, he should not simply tell them how it will be.
This journey is fraught with risk for himself, his wife, and his children. It’s important to navigate this journey with this in mind.
There are a few things to consider here:
The heirs of Idris’s wife (and his children’s mother, as well as other heirs like parents-in-law) should have their inheritance established. Before long, that may become guesswork, or any injustices can become permanent because of other deaths.
Without establishing this, Idris’s new wife will become the beneficiary of wealth that does not belong to her and belongs to the heirs of his previous wife. Family members can agree on things, and that is fine. But make sure there is an agreement and nobody gets railroaded.
California has community property, absent a prenuptial or postnuptial agreement. In general, community property means anything earned through “skill, labor, and effort” by a member of a “community” (that means marriage). Retirees don’t make money through skill, labor, and effort for the most part. They already have wealth and earn a pension, social security, investment income, and capital gains.
In both community and non-community property states, spouses (even from later marriages) have rights to assets in the event of death or divorce. It’s just less than you may expect from a long-term marriage.
That does not necessarily mean a younger spouse marrying a retiree won’t make like a bandit.
A lot of the problems that can sometimes emerge in these marriages are the financial dynamics of the household. While in many cases, you will find that both spouses handle finances separately, most of the time, one spouse handles the money. An older man with a substantially younger wife who is smart and confident would often prefer to sede bill paying, spending decisions, and other financial decision-making to his wife.
I call this “executive capture.” When the wife takes over executive decision-making functions, this is a power (that disempowers the other spouse) that a new spouse can use to transfer wealth to herself and her family.
Anything I say here will be general, as relationships among family members vary as much as there are relationships, and then some, as relationships change over time. However, assuming the family is close and wants to keep it that way, it’s important to have an organized discussion, focusing on the interests of the various parties.
There are substantial risks for the wife entering marriage as well. A wife gives up years of her life and enters an environment where people may be hostile. Marriage has benefits but ends when the husband dies or divorces her.
This financial uncertainty is why the wife or her representative will negotiate a maher. It may be a small or even ceremonial gift, or it could be a small (or in some cases large) fortune.
Hear me out on this; the financial circumstances of the marriage should be clear early on, lest the relationship devolves into suspicion and mistrust. The children want to protect their father and ensure an estate is left when he passes away. The new wife wants to build a new life and provide financial security.
Maher is an underutilized resource in the Muslim community. Marriage is a creature of contract by its nature, and maher is a way to accomplish long-term goals in ways that Muslims vastly underappreciate. Putting some thought into maher can reap long-term dividends for everyone.
Maher can be a cash payment, at the nikah, after death, incapacity, or both. It does not need to be cash, however. For example, it can be the ability to have a place to stay. The husband can pay for education, funding of a business, or a variety of other things. The family must consider what will happen in death, incapacity, a health emergency, and divorce. The maher can play a part in all of these things.
Example:
A maher can include:
The idea is to make the financial aspects of the relationship transparent. The wife gets what she negotiated, but not more (other than her inheritance right).
In nearly all states, prenuptial agreements are best negotiated by the prospective spouse’s lawyers. Both parties must have independent lawyers.
An irrevocable trust is a vast concept that can mean many things, but it differs from a revocable trust (the most common kind) done for estate planning. In the example in this article, a widower did not distribute his late wife’s estate to her heirs. This failure to distribute is a problem that an irrevocable trust can resolve. Transfer what belongs to the heirs to an irrevocable trust instead of selling assets, like a house, and distributing it outright to the heirs if doing so is impractical and could cause hardship. This way, you can respect the Islamic Rules of Inheritance and protect against the wealth of a late wife going to the new wife and her family.
Irrevocable Trusts can also be used for Islamic Inheritance for older adults, for asset protection for everyone, for tax planning, and has a variety of other uses.
Marriage is a wonderful thing that can bring a level of security but also expose a range of insecurities. Families can resolve these issues using Islamic principles, including Islamic Inheritance, the tradition of maher, and a dose of creativity, thoughtfulness, and compassion.
To discuss some of the planning in this article and website, you can schedule a 15-minute mini-consultation on Zoom with Islamic Estate Planning Attorney Ahmed Shaikh by clicking here.
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