Islamic Estate Planning: The Law & Other Considerations
As an attorney who received her legal education and training in both the Middle East and the United States, I came to appreciate the similarities and the differences (primarily differences) between the two legal systems. One of the most important is that laws in the Middle East are heavily influenced by religion. Especially in the area of family law and inheritance. In contrast, the laws in the United States, primarily because of the separation between church and state, are intended to be secular and religion neutral. As an attorney who practices estate planning, I have experienced the challenge of working in these two systems. Nearly one million Muslims reside in California, many of whom want to create an Islamic-compliant estate plan to administer their affairs upon death.
A brief overview of the inheritance rules under Islamic Law (Shari’a Law) is helpful to better understand the challenge of estate planning for Muslims. Shari’a sets out strict inheritance rules that determine how a Muslim’s estate will be divided between his or her heirs on death. In Islam, after a person is deceased, his/her property will be distributed according to fixed portions or shares. Under this law, testamentary freedom is restricted to just one-third of the deceased’s net estate after deducting all debts and funeral expenses. The remaining two-thirds share is divided in accordance with Shari’a. The specific inheritance rules for this two-thirds share are dependent on the Islamic sect the deceased belongs to and the number and type of his or her surviving relatives. Accordingly, when Muslim clients seek assistance in drafting their estate plan, their first inquiry is usually whether they can have the documents prepared in a way that would allow them to comply with Shari’a law and California/U.S. probate and estate tax laws. The simple answer is yes!
California’s Probate Code (similar to other state probate codes) allows any person of minimum age, sound mind, and following certain formalities, to draft a will or a trust and dictate how his/her assets would be distributed upon death. The probate code gives the testator absolute freedom in disposing of their assets upon death. Accordingly, a testator may disinherit those who would have inherited under California’s default rules or even bequeath their entire estate to charity. Because of this flexibility, estate planning lawyers can draft an Islamic compliant will and trust to accommodate their Muslim clients’ needs that comply with the appropriate state probate laws.
While an estate plan can technically comply with Islamic and state probate laws, such compliance may create extra challenges when trying to achieve tax-saving goals. Hence, an Islamic estate plan requires creative planning to achieve both goals. For example, with a married couple, the beneficiaries of the wife are not the same as those of the husband, and upon the death of the first of them, the wife, for example, her heirs, would immediately have rights in her property as beneficiaries pursuant to their specified shares. Strictly following this requirement may minimize taking advantage of the Unlimited Marital Tax Deduction, which allows one spouse to transfer an unlimited amount of assets to his or her spouse without incurring any tax liability. Traditional estate plans direct that upon the death of the first spouse, all of his/her assets shall be transferred to the surviving spouse (usually in an A/B or A/B/C trust structure), thus, avoiding estate tax upon the first death. As with any client, the estate planning lawyer must carefully outline the tax consequences of any distribution decision balanced against the non-tax objectives. In the case of Muslim clients, since the maximum distribution to a surviving spouse under Shari’a law is one-half of a deceased wife’s estate and one-quarter of a deceased husband’s estate (this assumes no children), strictly following this distribution requirement could create significant tax consequences. Accordingly, using special trusts and other creative planning strategies may be one way to meet the religious and tax objectives.
To illustrate this issue, let us take an example: a husband and a wife have three kids, two girls and a boy, and want to create an Islamic compliant trust. The husband and wife’s estate is equal to 30 million dollars, and they both own everything equally. Upon the husband’s death, his 50% share of their estate will be distributed as follows: the wife gets 1/8 of his property, the daughters share 7/16 of his property, and the son gets the remaining residual, which is 7/16 of the husband’s estate. Note that the son inherits twice as much as each daughter (sons inherit in a 2 to 1 ratio to daughters). This rule is justified under Islamic Law by imposing upon the male of the family, be it a husband, father, brother, or son, the responsibility to provide for the females.
Following Islamic distribution, the wife will get $ 1,875,000, which will pass tax-free because of the unlimited marital deduction. However, the remaining $ 13,125,000, which will pass to the children, will incur estate tax calculated on the amount that exceeds the lifetime exemption at $12,060,000. Thus, the beneficiaries will pay estate taxes on a taxable estate of $1,065,000. This burden would usually be avoided in traditional estate planning, whereupon the first death, everything is transferred to the surviving spouse tax-free! Furthermore, upon the wife’s death, her children will inherit in the ratio of 2 to 1 again, creating another layer of taxation. To simplify the illustration, the above example assumes that no parents of each side of the couple are alive. Had grandparents been alive, they would have been included as beneficiaries, adding to the distribution complexity and potential tax burden.
However, some techniques could be used to minimize taxes while still following Islamic law. For example, the husband could create a Qualified Terminable Interest Property Trust (QTIP), which enables the grantor to leave assets to the surviving spouse yet determine how the assets will be distributed upon surviving spouse's death. A Muslim couple would create a QTIP, where income is paid to the surviving spouse. This way, the couple can take full advantage of the Unlimited Marital deduction since no estate tax will be incurred upon the first death. The QTIP will then stipulate that upon the surviving spouse's death, the remaining estate will be passed to the beneficiaries under Islamic law. Hence, the beneficiaries will pay taxes only upon the amount that exceeds the $24 million tax exemption, the couple’s lifetime tax exemption combined. As a result, beneficiaries will only pay estate tax on $6,000,000 of the $30,000,000 estate (and shelter from taxation any asset appreciation following the first death)! It shall be noted that using a QTIP might not secure full compliance with the Islamic shares as the amount paid to the surviving spouse may be more or less than the pre-determined share. Again, it is a creative planning vehicle that could be offered to a Muslim couple to try to help them achieve both goals of following Islamic law and maximizing the amounts distributed to their family.
In addition to tax efficiently designing an Islamic compliant estate plan, there are a few other unique issues under Islamic law to consider. Although beneficiaries receive a fixed portion of the estate under Islamic law, these portions vary depending on who the surviving relatives are. Since this is likely a moving target, the trust document should specify all the current beneficiaries and percentages and include a statement that the grantor intends to have their estate distributed according to Islamic provisions. We typically add a provision that imposes upon the trustee an obligation to ensure distributions are Islamic compliant. While the documents are revocable, all good estate plans should be reviewed periodically to make revisions as needed; these provisions safeguard that the religious wishes will more likely be followed. Finally, the comprehensive estate plan will include pour-over wills where the funeral and burial decisions can be clearly outlined. Under Islamic law, the deceased person should be washed and buried as quickly as possible after death. In addition, there is rarely an open casket at an Islamic funeral. These traditions and others can be listed and specified in each person’s will.
Estate planning for Muslim clients combines traditional planning techniques with the added complexity of a thoughtful understanding and creative application of Islamic law. In addition to the issues discussed in this article, there are many more, including planning for non-citizens/U.S. residents, assets located in foreign countries, community and separate property issues, and Islamic compliant investments. Given these diverse and unique issues, hiring an attorney with the right background and experience is critical.
Muzna Zeitouni
Author