NURSING HOMES AND LONG TERM CARE
What is the responsibility of the family for nursing home expenses?
What limitations apply to nursing homes in the area of restraining a patient?
What are the tax rules relating to long term care insurance?
What are the tax consequences of employer provided long term care insurance?
What are the benefits of Indiana Long Term Care Program policies?
With reference to long term care insurance, what is a “linked benefit policy”?
POWERS OF ATTORNEY, LIVING WILLS AND HEALTH CARE ADVANCE DIRECTIVES
Where can I find out about the risks of do-it-yourself planning?
When should estate planners advise clients about asset protection issues?
What are the benefits of gifts in estate planning?
What is the importance of and the motivation for business succession planning?
If a person is seriously ill and has a shortened life expectancy, is it too late to implement beneficial estate planning arrangements?
Does qualified terminable interest property have any significance in conjunction with the Indiana inheritance tax?
Is Indiana a community property state? If not, does a couple’s previous residence in a community property state impact their estate planning?
What is a trust?
If a residence is sold by a trust, will the residence qualify for the home sale exclusion?
What kinds of restrictions affect a person’s power to remove and replace a trustee?
What is an Alaska trust?
What should be considered when replacing a life insurance policy?
What are the tax consequences of accelerated death benefits or viatical settlements?
What is the distinction between a “lifetime settlement” of a life insurance policy and a viatical settlement?
INDIVIDUAL RETIREMENT ACCOUNTS
FAMILY LIMITED PARTNERSHIPS
Q. What is Elder Law?
A. Elder law is a specialty of law that caters to the needs of older clients and those with disabilities. It encompasses areas such as probate and estate planning, Medicaid, disability planning, long term care, housing options, powers of attorney, etc. Elder law is the only area of law defined by the clients we serve rather than the areas of law in which we practice. Elder law attorneys often deal “holistically” with their clients in talking about long term planning for health care and financial viability, family dynamics, end-of-life decisions, personal values and personal preferences. It is an area of practice that attracts attorneys who like to work with families and who are sensitive to the needs and feelings of others. Elder law is a fast growing area of the law because of the terrific demand created by 80 million baby boomers moving into their “golden years”, with one person turning 50 years of age every seven seconds! The National Elder Law Foundation offers a certification in elder law which encompasses years of experience, areas of expertise, reference checks and the successful completion of a day-long examination.
Q. What is the responsibility of the family for nursing home expenses?
A. Federal law prohibits a nursing home from requiring a third party to guarantee payment as a condition of a resident’s admission to the nursing home. However, many nursing homes throughout the country continue to obtain third-party guaranties by either ignoring or evading federal law. Because admission to a nursing home is such a traumatic event, family members and friends often feel guilty about their own inability to keep their loved one at home. They often do not have adequate time to give as much thought as they should about nursing home issues or to make advance plans about nursing home admission. Because of the influence that a nursing home has over an entering resident and his or her family, it is less likely that the resident or the resident’s family and friends will make many demands upon a particular facility. Consequently, people often sign documents that they really do not need to sign or that are legally improper. The 1987 Nursing Home Reform Act states explicitly that a nursing facility must not require a third party guarantee of payment as a condition of admission or continued stay in the facility. Sometimes guaranties are obtained by deception on the part of the nursing home staff. Often this is through convincing a “responsible party” to “voluntarily” agree to act as agent or sponsor for the resident. Frequently the family member or friend will sign an assumption of liability without realizing what he or she is signing. Such provisions are not only unenforceable because they violate federal law, they may also violate state consumer protection statutes and may be otherwise unenforceable as a matter of public policy. Because the appropriate federal regulatory agencies often do not prevent nursing homes from using such unenforceable or illegal guaranties and practices, it is important that the public be educated about their rights and that they seek legal counsel before signing nursing home admission documents.
Q. What limitations apply to nursing homes in the area of restraining a patient?
A. Federal law prevents the use by a nursing home of any medication or restraint for purposes of discipline or convenience. Consequently, the use of tranquilizing medication is prohibited if the purpose is simply to make a resident easier to handle. Similarly, a side rail is a physical restraint, as are ties or vests that hold a resident in a wheel chair, which cannot be used merely for convenience or for discipline. There have been instances in which a nursing home has asked the family for a waiver or a release from liability if, due to the objection of the family, a tranquilizing medication or physical restraint is not to be used which the nursing home desires to implement. It is probably improper for a nursing home to arrange for a waiver of its legal responsibilities and to condition the withholding of a restraint or medication which is not desired by the resident or family unless the waiver or release is provided. As an aside, courts have held that an Alzheimer’s resident was not liable for injuries to a nursing home staff nurse, holding that an institutionalized individual with a mental disability, who does not have the capacity to control or appreciate his or her conduct, could not be liable for injuries caused to caretakers who are employed for financial compensation.
Q.What are the tax rules relating to long term care insurance?
A. The same provisions of the Health Insurance Act, effective January 1, 1997, which clarified the rules relating to accelerated death benefits and viatical settlements, also provide that a qualified long term care insurance contract will generally be treated as an accident/health insurance contract. As a consequence, amounts received under a qualified long term care insurance contract will be excluded from gross income in the same manner as amounts received for medical care under health insurance policies and amounts received due to personal injuries and sickness. Most policies, but not all, will meet the requirements of a “qualified long term care insurance contract”. Generally, the contract must provide coverage only for qualified long term care services, such as diagnostic, preventive, therapeutic and rehabilitative services, and maintenance or personal care services, that are required by a chronically ill individual. It should also be noted that the 10% additional tax on premature distributions from an IRA will not be applicable after January 1, 1997, to the extent that the distributions exceed 7.5% of the adjusted gross income of an individual who uses the distributions to pay qualified medical expenses.
Q.What are the tax consequences of employer provided long term care insurance?
A. For contracts issued after 1996, an employer can provide coverage under a qualified long term care insurance contract, which will be treated as an accident and health plan. Consequently, the employer may generally deduct the premiums paid for this LTC insurance. In the case of an “S” corporation, since a shareholder employee who owns more than 2% of the outstanding stock is treated as a partner in a partnership rather than as an employee, the LTC premium payments can be deducted only to the extent that they are included in the income of the shareholder employee except to the extent that the stockholder is subject to the special rules which are applicable to partners and sole proprietors. On one’s personal income tax return, eligible long term care premiums are limited to certain deductible amounts based on age. The deductible amounts are adjusted annually. Please note, however, that discrimination requirements may be applicable to closely held “C” corporations which would prohibit special programs for officers, directors and highly compensated individuals .
Q. What are the benefits of Indiana Long Term Care Program policies?
A. A person who purchases an Indiana Long Term Care Program policy with an initial maximum benefit equal to the State-set dollar amount established for the year in which the policy is purchased can retain all of his or her resources and still become eligible for Medicaid. Program policies with less than the State-set dollar amount in maximum benefits will provide the former dollar-for-dollar asset protection. What this means is this: if you purchased a qualified Indiana program policy in 2013 which provided at least $291,050 of long term care benefits, then you will be able to obtain Medicaid eligibility after the policy pays out its benefits even though you have other substantial assets available to pay for your long-term care. This will apply without regard to the extent of those other assets once the approved long-term care policy has paid out its total benefits. For additional information, you should contact your insurance agent who is specially licensed to sell Indiana Long Term Care Program policies, or contact the Indiana Long Term Care Program of the Family and Social Services Administration, 402 W. Washington Street, W-382, Indianapolis, Indiana 46204 .
Q. With reference to long term care insurance, what is a “linked benefit policy”?
A. Linked benefit policies combine life insurance and long term care insurance in one policy. Such arrangements are structured differently by the various insurance companies which provide such programs. One type of arrangement involves the payment of a fixed sum into a single policy that will provide an immediate death benefit as well as lifetime long term care benefits at a particular daily amount for daily nursing home care or home health care. The death benefit would be payable to a named beneficiary upon the insured’s death. Payments of the long term care benefits may reduce the ultimate amount of the death benefit that will be payable. A rider can be purchased which would assure that the benefit payments for long term care services would not reduce the death benefit below a certain level. Typically, the policy would include a guaranty of insurability rider which would provide a limited right to increase both the death benefit and the long term care coverage by a certain amount (such as 5% annually) without evidence of insurability. Additional premiums would be charged based on the age attained for each purchase and this guaranteed purchase right will typically expire after a certain number of policy years or when the insured attains a certain age, such as age 85. There are variations of this single-premium approach. Some insurers offer policies with accelerated death benefits that can be used for qualified long-term care up to a maximum monthly percentage of the total current death benefit. It is also possible for people creatively to establish independent financial arrangements in lieu of life insurance, and for some people long term care insurance may prove to be unaffordable. One type of arrangement that individuals could establish for themselves would involve setting aside a portion of the individual’s investments in a way which will generate the income necessary to pay the long term care insurance premium, while still retaining assets which can be invested for growth in lieu of the purchase of life insurance. To the extent that long term care insurance may seem unaffordable, the premium may be brought to a more affordable level by reducing the period of coverage, increasing the elimination period or reducing the amount of the daily benefit. In short, there are many insurance options and financial plans available, and clients are advised to consult with their advisors and financial planners in order to structure or select the arrangements which seem to be the most suitable for them.
Q. Have Medicaid transfers been “criminalized”?
A. Section 217 of the Balanced Budget Act of 1997 (termed the “Granny Goes To Jail Law”), which was replaced by a later provision which was referred to as the “Granny’s Lawyer Goes To Jail Law”, attempted to criminalize certain transfers if a period of Medicaid eligibility resulted. It has been fairly clear all along that these provisions were unconstitutional. Further, and in any event, this provision would not have precluded asset protection planning, but it would have required that professional advisors scrutinize very closely what their clients do in order to be certain that the professional advisors themselves were not embroiled in legal complications. The Attorney General of the United States acknowledged in a letter to the United States House of Representatives that after close and careful scrutiny of the matter, the Department of Justice would not defend the constitutionality of this statutory provision which was raised in a case brought by the New York State Bar Association with the advice and counsel of the National Academy of Elder Law Attorneys. It was the opinion of the Attorney General that the counseling prohibition was plainly unconstitutional under the First Amendment to the United States Constitution. As a result, professional advisors are presently not too concerned regarding the so-called “Granny’s Lawyer Goes To Jail Law” which incidentally was also applicable to professional advisors other than attorneys. Nevertheless, everyone should obtain professional advice before embarking on an asset preservation plan, whether for the purpose of Medicaid planning or otherwise, in order to avoid possible future entanglements and other legal issues that arise from such complicated planning arrangements.
Q. How can a Medicaid appeal increase the community spouse’s share of assets?
A. The Medicare Catastrophic Coverage Act (“MCCA”) of 1988 mandates the use of special income and resource criteria to determine the eligibility for Medicaid of certain institutionalized persons who have a “community spouse”, that is, a spouse who is living at home. Under the usual resource rules, the community spouse can retain resources equal to the greater of $23,184 or one-half of the total “countable” resources up to a maximum of $115,920 as of January 1, 2013. However, by filing an appeal, an administrative law judge may award a substantially larger amount depending on the income of the community spouse. The amount of additional resources that can be retained by the community spouse can be phenomenal. As an example, assume that the combined “countable” resources are $300,000; in that event, one-half of that amount, or $150,000, would be greater than the maximum spousal share of $115,920. Consequently, in the absence of the special income and resource criteria, the community spouse could retain only $115,920 of resources and any excess resources would have to be spent down before the spouse in the nursing home would be eligible for Medicaid. Let us assume, however, that the income of the community spouse consists only of social security income of $600 per month. Because the community spouse is also entitled to a minimum income standard of $1,939 per month as of July 1, 2013, the community spouse’s income is less than the minimum standard by $1,339 ($1,939 – $600 = $1,339). This translates into an annual income of $16,068 ($1,339 x 12 = $16,068). If the community spouse had resources available to generate that level of income, which were invested at an annual interest rate of 5%, the amount of resources needed to generate that level of income would be $321,360 ($16,068 ÷ .05 = $321,360). In this instance, if the community spouse filed an appeal, the community spouse would be able to have the administrative law judge determine that the community spouse was entitled to resources of $321,360, and the institutionalized spouse would be eligible for Medicaid while the community spouse could retain all of the spouse’s countable resources. I have used this appeal procedure in many instances and have obtained a community spouse resource allowance as large as $500,000! It should be noted that there are numerous other special rules applicable to the determination of resources and eligibility for Medicaid, including the Deficit Reduction Act of 2005 which mandates the “income first” rule before additional resources can be retained. As in most planning situations, it is better to start the planning process sooner, and to move quickly, but it is never too late to make the planning situation better. This is especially true in the context of Medicaid and asset preservation planning.
Q. Will an interest in a trust always prevent Medicaid eligibility?
A. In an Ohio case, a court of appeals reversed the state Medicaid agency’s decision and held that, because the Medicaid applicant maintained only a beneficial interest in a discretionary trust, and had no ability to use or dispose of the trust assets, the trust was not an available resource for Medicaid purposes. In the particular case, a father created a discretionary trust for his daughter so long as the use or availability of the trust assets would not make the daughter ineligible for public benefits. When the daughter subsequently applied for Medicaid benefits, the state Medicaid agency nevertheless treated the trust as a resource. As a matter of federal law, pursuant to OBRA 1993, the establishment of a special needs trust will have different Medicaid implications depending on the relationship between the creator of the trust and the trust beneficiary and whether the trust beneficiary’s assets were used in the creation of the trust. A testamentary trust (that is, a trust created under a last will and testament), created by a spouse and which comes into existence upon the spouse’s death, will not constitute a “trust” for the purpose of the transfer of assets rules and will not be counted as a resource if the trust is established properly and if the trust beneficiary’s interest is a discretionary interest and is limited so as not to affect the beneficiary’s Medicaid eligibility. In other words, the trustee will be given the “discretion” to make benefits available for the trust beneficiary, which may be the surviving spouse, but the trustee will be directed not to make benefits available if the use of funds would affect the beneficiary’s Medicaid eligibility. Indiana and other states are obligated to comply with the OBRA 1993 trust rules. As for trusts not subject to the OBRA 1993 rules, the provisions of the trust must be reviewed for the purpose of determining the “availability” of the trust. Such a trust, if structured properly as was done in the Ohio case, will not affect the Medicaid eligibility of the trust beneficiary. Therefore, parents and others can set aside certain funds in trust to provide for the special needs or to supplement the care of a relative who may presently or in the future be a Medicaid beneficiary in a way which will not waste the trust creator’s resources or adversely affect the trust beneficiary’s Medicaid eligibility.
Q. What limitations apply to making gifts under a power of attorney?
A. Under the Internal Revenue Code, IRC Section 2038(a)(1), a decedent’s gross estate includes the value of all property to the extent that the decedent at any time made a transfer if the enjoyment of the property transferred was subject at the date of the decedent’s death to any change through the exercise of a power to revoke, alter, amend or terminate. The IRS takes the position that when an attorney-in-fact is not authorized under a power of attorney to make a gift, the transferor has the power to revoke any transfer made by the attorney-in-fact. Since the transferor’s executor would have a claim to recover the amounts transferred by the attorney-in-fact, the transferred property is includable in the transferor’s gross estate under IRC Section 2038. For this reason, particularly where federal estate taxes are an issue, it is extremely important that a power of attorney specifically authorize gifting provisions. Indiana’s Power of Attorney Act will permit gifting within certain limitations as long as the power to make gifts is specifically referenced in the instrument creating the power of attorney. The limitations on gifting can be removed by specific language in the power of attorney which authorizes gifting or other estate planning arrangements without limitation. It is extremely important that a power of attorney be drafted carefully and broadly, and with a view not only to the tax implications, but also with a view to asset preservation issues and protecting the person who is granting the power of attorney authority.
Q. What is the importance of living wills and other health care advance directives?
A. Efforts to prolong life frequently result in patients dying in pain, at great expense, and receiving treatment they do not want. The Robert Wood Johnson Foundation published a study several years ago of almost 10,000 patients at five U.S. medical centers, which noted that a surprising number of physicians do not know their patients’ wishes in regard to such particular procedures as cardiopulmonary resuscitation. Another study of nursing home residents in Pennsylvania found that many residents do, in fact, want more aggressive treatment to prolong their life, even if they may be mentally incapacitated. Again, however, and more importantly, is the fact that the nursing home residents’ wishes may not have been known to their health care providers and, as a result, their wishes may not be given effect. The answer to this dilemma is effective communication. In order to document and verify the patient’s wishes, it is important that all of us, particularly as we age, let our wishes be known through the execution of effective advance health care directives. One definition of an advance health care directive, as contained in the federal Patient Self Determination Act, is a written instruction, such as a living will or a power of attorney for health care, recognized under state law, relating to the provision of health care when an individual is incapacitated. One type of advance directive, the living will, is used frequently but often not very effectively. Although the term is well known thanks to the zealous advocacy of nationally prominent columnists and the well-publicized cases of Karen Ann Quinlan, Nancy Cruzan and Terri Shiavo, there is no national “official” definition of a “living will” or national living will form. Many people are executing “generic” living wills which may not be enforceable in many states or which may give rise to more problems than they will answer when particular health care circumstances occur. A power of attorney for health care is conceptually different, in that such an instrument designates an agent to make health care decisions for an individual on the specific terms and conditions specified by the individual. All health care advance directives should be personalized to the fullest extent possible. Each person should exercise the right to express his or her beliefs and desires and attempt to translate those beliefs into a workable, effective document. More than simply granting the power to make health care decisions, the person who is granting the authority should attempt to guide and shape that power in order to suit his or her particular needs, desires, philosophies and beliefs.
Q. What are the lessons to be learned from the Schiavo case?
A. One of the frequently-heard comments during the Schiavo case was that the situation would have been drastically different if only Terri Schiavo had executed a living will. Nothing could be further from the truth. A living will only speaks when a person is “terminal,” which in Indiana means that a physician has certified that the patient will die within a short period of time. A living will is not applicable to a persistent vegetative state, or an irreversible comma with significant impairment and little or no likelihood of recovery. In such a situation, decisions regarding the withdrawal or withholding of care and treatment, such as artificial nutrition or hydration, will be made by the person’s representative, who may be a relative under Indiana’s Health Care Consent Law, or who may be a guardian appointed by the court or a person designated in an appointment of health care representative instrument.
While it is very important that people communicate with their families regarding their desires for care and treatment in certain health care circumstances, it is more important that they sign appropriate documents which clearly express their wishes. A living will may be helpful, but the most important document is an appointment of health care representative instrument which designates the person(s) who shall make health care decisions for you when you may become incapacitated and unable to make those decisions for yourself. Such a document should provide clearly expressed preferences regarding such treatment modalities as artificial nutrition and hydration, resuscitation, pain medication, and how to deal with so-called reversible secondary conditions (i.e., an infection, which is a secondary condition that can be treated, when the underlying primary condition, such as end-stage dementia, cannot be treated). Generic documents which do not address specific circumstances and particular treatment modalities are of very little benefit and in fact may create problems rather than resolve dilemmas. It is not at all uncommon for people to sign generic documents which are in conflict with each other, such as living wills which address circumstances in a different way than the appointment of health care representative instrument provides.
To suggest that people do not need to contact an attorney to deal with these issues is absolutely absurd. In a world when advertisers on television for aspirin even suggest that you contact your physician, to suggest that people involved in life and death decisions should not consult with an attorney regarding legal matters is not only insulting to the legal profession, but very poor advice to be given to consumers. As one of the relatively few Certified Elder Law Attorneys in the United States, and as one who was in the first group of Certified Elder Law Attorneys in the country in 1995, I have dealt with health care advance directives in literally thousands of situations since commencing the practice of law in 1975. Such suggestions do very little good for anyone, and instead impart extremely bad advice to those who may act in reliance on those suggestions.
Q. Where can I find out about the risks of do-it-yourself planning?
A. Many legal documents are created by lay people from time to time which they have constructed themselves or purchased from a local stationery store (or perhaps “adapted” from documents used by others). One such document for which forms and kits can be purchased is the revocable trust, which has gained much acceptance over the years because of the probate-avoidance benefits of living trusts and their use to prevent unnecessary court-supervised guardianships during the creator’s lifetime. A book written by Doug H. Moy, published by John Wiley & Sons, Inc., entitled Living Trusts: Designing, Funding and Managing a Revocable Living Trust, is directed to a lay audience. Mr. Moy does not endorse a simple do-it-yourself approach, but urges consultation with a professional estate planner, warning that “the bitterness of paying for an improperly designed estate plan will remain long after the sweetness of low price is forgotten”. You may wish to consult the book that I co-authored with Amelia E. Pohl, A Will is Not Enough in Indiana, (Eagle Publishing Company of Boca, 2004), which is available from Barnes & Noble and Walden Books utilizing the ISBN 1-892407-78-7, or which you may order direct from Eagle Publishing Company, 4199 N. Dixie Highway #2 Boca Raton, Florida 33431, telephone 561/338-0802, or e-mail address firstname.lastname@example.org. You may also wish to obtain my second book co-authored with Amelia E. Pohl, Guiding Those Left Behind in Indiana (Eagle Publishing Company of Boca, 2006), which is also available from Barnes & Noble and Walden Books utilizing the ISBN 1-932464-02-6, or which can be ordered as referred to above. People would do well to remember this admonition in various aspects of their legal relationships. Many people have seen advertisements promising quick and simple solutions to the problem of implementing legal documents and arrangements such as setting up a trust or forming a corporation. Everyone should be aware that these “kits” often give you very little and typically require you to do all of the paperwork or to mail the company that issued the “kit” the completed documents and fees for filing and so forth. The fees are often not as small as advertised and the completed paperwork almost always contains a representation that the company did not provide any counsel or advice. In the case of corporations, many of the formation steps, such as filing the Subchapter S election, preparing minutes and by-laws, and so forth (which in most cases you must complete yourself) involve additional charges. In many cases the total charges for performing all of the related work is more than the normal legal fee would be for completing the paperwork and providing proper advice and counsel! In addition, in almost every transaction, there are preliminary decisions which need to be made. For example, a trust is not always appropriate, and determining the type of trust and the benefits which may be available require much advice that one will not obtain by referring to a mail order package. In the case of business entities, some of the alternatives to a corporation, such as a limited liability company or a general or limited partnership, may be more appropriate in certain circumstances. It is my sincere belief that, in most instances, people who undertake to do this work for themselves will ultimately, perhaps following their death, incur a great deal more legal expense for themselves or their families than would have been incurred had good legal advice been obtained from the very beginning.
Q. When should estate planners advise clients about asset protection issues?
A. Although there is no legal duty established in the case law requiring that estate planners advise clients about asset protection techniques, it is advisable that asset protection issues be raised and discussed in appropriate circumstances as a part of the planning process. If a person faces a large liability due to his or her negligence or malpractice, the way that his or her property is arranged can have a significant impact on the family’s financial well being. These planning issues are also significant in the context of Medicaid and planning for long term care. While state fraudulent transfer laws may render certain transactions voidable, this type of planning will probably not be deemed to be “fraudulent” if the client is solvent at the time that the planning is implemented and if the planning is not done with the actual intent to defraud a particular creditor. Planning for asset protection may involve nothing more than dividing assets between spouses so as to minimize exposure to creditors claims; this type of transfer approach is often advisable, in any event, as a part of living trust planning and in order to achieve certain desirable federal estate tax planning results (such as, for example, by allowing each spouse to take advantage of the applicable “credit shelter” amount for federal estate tax purposes). In other instances, a transfer to a family limited partnership or particular kinds of trust arrangements may be appropriate. In Indiana, real estate owned by a husband and wife as tenants by the entirety will be protected against the claims of the creditors of only one spouse, and so in most instances it is desirable that spouses maintain their entirety form of joint ownership with regard to their residence and perhaps other real estate. Anytime a trust is used, the trust can be drafted so as to achieve certain asset protection goals. At the very least, asset protection should be explored during the estate planning and lifetime planning process.
Q. What are the benefits of gifts in estate planning?
A. Gifting is a basic technique of estate planning and can usually be implemented very simply; a person simply makes gifts to his or her potential heirs or beneficiaries. Even though gift transfers during life and estate transfers during death are taxed similarly, there are many advantages to making gifts. Not only can a person’s total transfer tax liability be reduced by making gifts, even so-called “taxable gifts” (that is, gifts in excess of $14,000 per donee per year), but conversely the total assets passing to the donees or beneficiaries can be increased. This results not only from using the annual exclusion as a means of sheltering the transfers from taxation, but also by removing the future appreciation of the asset from the donor’s potential estate. Gifts are often used in conjunction with other estate planning techniques, such as an irrevocable life insurance trust, as a means of “leveraging” the total tax benefits which are available by reason of the transfers.
Q. What is the importance of and the motivation for business succession planning?
A. Traditionally, most advisors have assumed that family business succession failures are primarily due to the impact of taxation and to poor decisions that were made relating to the transfer of authority. As a result, many strategies relating to succession planning are tax driven. Some recent research studies would suggest, however, that perhaps only 10% of most business breakdowns is attributable to planning and control issues, which traditionally have been a primary focus of succession planning. Rather, a substantial number of succession planning failures can be attributed to problems in the relationships among family members and to the heirs not being adequately prepared. Some authors suggest that professionals involved in business continuation planning should assess problems and solutions with a view to more than the tax objectives. Rather, a balanced approach goes beyond some of the traditional objectives of estate planning. Because the preference of most business owners appears to be to procrastinate about planning for business continuation, understanding some of the reasons for a business owner’s reluctance can help advisors to be more persuasive in their efforts to get the planning process started. My experience has been that succession planning is a process which takes from several months to several years to implement fully and that the succession plan must be re-examined periodically in order to assure that the arrangements which were implemented previously are still in keeping with the business and family objectives. There is a great deal more involved in this process than technical knowledge or tax or investment expertise.
Q. If a person is seriously ill and has a shortened life expectancy, is it too late to implement beneficial estate planning arrangements?
A. A shortened life expectancy, perhaps due to a serious illness, will limit a person’s ability to employ certain planning strategies. If this eventuality occurs, a number of options should be considered. One option is converting bequests under a last will and testament into gifts. Doing so can reduce both administrative costs and estate taxes by virtue of the availability of the annual donee exclusion of $14,000 per donee per year. In addition, the donor should consider making direct payments of tuition and medical expenses for the donor’s beneficiaries, and it may be possible to pre-pay some of such expenses. Gifts of partial interests in a business or other property may be valued at a discount, which may offer some gift tax and potential estate tax advantages. A private annuity should also be considered. If it is structured properly, a private annuity would exclude the annuity property from the transferor’s estate without incurring a gift or generation-skipping transfer tax. It should be noted, however, that if death is eminent, it may be necessary to utilize special tables for the purpose of making the necessary annuity calculations. However, if the transferor survives for at least eighteen months, the transferor will be presumed not to have been terminally ill (unless the contrary is established by clear and convincing evidence).
Q. Does qualified terminable interest property have any significance in conjunction with the Indiana inheritance tax?
A. Indiana imposes certain QTIP (Qualified Terminable Interest Property) election requirements which are different than the requirements applicable to the federal QTIP election. For readers who are unfamiliar with this concept, a “QTIP” transfer arrangement is one which qualifies for the federal estate tax marital deduction (or for the Indiana exemption applicable for transfers to spouses) in cases when the transfer may not otherwise have qualified for the federal estate tax marital deduction. In an Indiana case, the Indiana Department of Revenue disallowed the QTIP deduction because the formal election as required by the applicable regulation was not attached to the return when it was originally filed. The Indiana requirements are somewhat different and more onerous than the federal requirements, but the Indiana Tax Court nevertheless upheld the determination by the Indiana Department of Revenue. For those with an interest in and access to Indiana cases, the case cite is Department of State Revenue vs. Estate of Phelps, 697 N.E.2d 506 (Ind Tax Ct 1998).
Q. Is Indiana a community property state? If not, does a couple’s previous residence in a community property state impact their estate planning?
A. Indiana is not a community property state, but Indiana residents who previously resided in a community property state may be eligible for tax benefits that are frequently overlooked. There are several community property states, including Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas and Washington. Wisconsin follows a marital property system which is a form of community property and treated as such for tax purposes. Also, the State of Alaska has passed legislation creating a procedure by which a married couple can elect to treat certain assets subject to Alaska jurisdiction as marital property. If property was acquired by a married couple under circumstances which gave rise to marital property, the relocation of the spouses to a non-community property state will not necessarily affect the status of the property as community property. Retaining the community character of property imported into a common law state, or acquired in a common law state with the proceeds of community property, often results in substantial federal income tax advantages. These savings are realized under the provisions of Section 1014(b)(6) of the Internal Revenue Code, which gives the entire community property a new basis upon the death of one of the spouses, even though only the decedent spouse’s one-half interest is included in his or her gross estate for federal estate tax purposes. For example, assume that H & W own as community property stock worth $250,000, which has a tax basis at cost of $10,000. If they later move to Indiana, but the stock retains its status as community property, then upon the death of H, W’s tax basis in the stock will be $250,000, even though only $125,000 of the value of that stock would be included in H’s estate for federal estate tax purposes. This can result in a substantial tax benefit for the surviving spouse. However, in order to maintain the status of “imported” community property, it is important for people and their planning advisors to be cognizant of the estate planning techniques applicable to community property.
Q. What is a trust?
A. A trust is a fiduciary relationship relating to property. It subjects the person holding property to equitable duties and requires that the assets be dealt with only in the interest of the beneficiary. Under certain circumstances, trusts may be created orally, although generally trusts must be established in writing. The person who creates a trust is sometimes called the “grantor” or the “trustor”. A trust may arise by virtue of an agreement or declaration established by the creator during his or her lifetime, or it may arise under the terms of a person’s last will and testament. If it arises under a will, it is called a testamentary trust. Some states require that trusts be registered, that is, that the written document creating the trust be filed in a public office. Indiana does not have such a requirement. Although, generally, a trust must be “funded” in order to be valid, a trust may certainly be created presently even though property may not be transferred into the trust until a later time. The person or entity (that is, a bank, trust company or other corporate fiduciary) which holds the property in trust is referred to as the “trustee”. Typically, the trustee is given particular responsibilities or authority, and generally certain standards are utilized in the nature of “instructions” which are given to the trustee so that the trustee will know how and when to act. There is a great deal of misinformation communicated regarding trusts, and in particular living trusts.
Q. If a residence is sold by a trust, will the residence qualify for the home sale exclusion?
A. A Private Letter Ruling (IRS Letter Ruling 199912026) determined that the owner of a revocable trust that holds title to a home is treated as the property’s owner for the purpose of the home-sale exclusion. The taxpayer may claim the $250,000 home sale exclusion (up to $500,000 for qualified married taxpayers filing jointly) if the taxpayer (through the trust) owned the home and used it as a principal residence for at least 2 of the 5 years preceding the sale. Although private rulings cannot be cited as precedent, they do represent the position of the IRS in regard to the tax issues at the time of the issuance of the ruling. The holding of this ruling is the result that was assumed to be the case by most tax-planning professionals, but it is nevertheless palliative to have a definite indication of the position of the IRS on this issue.
Q. What kinds of restrictions affect a person’s power to remove and replace a trustee?
A. In a Private Letter Ruling, PLR 9735023, the IRS ruled that a child did not hold a general power of appointment over trust assets by virtue of the child’s power to remove and replace the trustee of the trust with a trustee who is not related or subordinate to the child. In Rev Rul 95-58, the IRS had ruled that a grantor’s reservation of an unqualified power to remove a trustee and appoint an individual or corporate successor who is not related or subordinate is not considered a reservation of the trustee’s discretionary powers of distribution over the property. Similarly, the 8th Circuit in Estate of Vak v. Commissioner, 973 F.2d 1409 (1992) concluded that a decedent had not retained dominion and control over assets transferred to a trust by reason of his power to remove and replace the trustee with a party that was not related or subordinate to the decedent. An unrestricted right to remove and replace a trustee could result in the IRS taking the position that the holder of the right has a general power of appointment, which would give rise to income, gift and federal estate tax implications.
Q. What is an Alaska trust?
A. An Alaska statute (and similar laws in certain other states) may benefit people in all 50 states. Under this statute, a person can place money in trust and protect it from creditors, and possibly also from inheritance taxes, even though the creator is a beneficiary of the trust. The trust must be created after April 1, 1997, and it must be irrevocable. It must be “discretionary” as to the creator (i.e., it cannot require that any of the income or principal be distributed) and the transfer of the assets must not be intended to hinder, delay or defraud creditors. The trust creator cannot be thirty days or more in default of child support payments. The grantor can retain the right to veto distributions to other trust beneficiaries, or to control the disposition of the property upon his or her death (but if the creator retains these rights, the property will definitely be subject to federal estate taxes). For the Alaska law to apply, some of the trust assets must be deposited in Alaska, and at least one trustee must be a resident of Alaska or a bank or trust company with the principal place of business in Alaska. This kind of arrangement may serve an important asset protection purpose and may permit the trustee to give back some of the assets if an emergency arises. The other advantage of an Alaska trust is that Alaska has no income tax, so any income that is accumulated can be accumulated free of state income tax. Because Alaska has abolished the rule against perpetuities (which has also been abolished or modified in several other states), the trust can last indefinitely.
Q. When are appraisals required for charitable contributions?
A. The IRS requires donors (those who “gift” property) and donee organizations (charities that receive gifts) to supply certain information to prove a taxpayer’s right to deduct charitable contributions. If an item (or a group of similar items) is donated and worth more than $5,000, the donor must get an appraisal. The appraisal must be a “qualified appraisal” and an “appraisal summary” must be attached to the first tax return on which the deduction is claimed. There is no specific penalty for failure to get a qualified appraisal or to attach an appraisal summary to the taxpayer’s return, but the charitable deduction is only allowed if the contribution is verified according to the applicable tax regulations. If two or more gifts are made, even to multiple donees, the claimed value of all similar property (such as stamps, paintings, books, etc.) are added together in determining whether the $5,000 limit is exceeded. The qualified appraisal must meet certain complex and detailed requirements and must be prepared and signed by a qualified appraiser. The “appraisal summary” is made on Form 8283 which is then attached to the donor’s return.
Q. What is a charitable remainder annuity trust?
A. A Charitable Remainder Annuity Trust (“CRAT”) is an irrevocable trust which pays a fixed dollar amount each year to a beneficiary, such as the donor of the trust assets who creates the CRAT. The annual income could be paid to the donor and the donor’s spouse, or the donor’s children or others. After the death of the income beneficiaries, or at the end of a set number of years (up to a maximum of 20 years) the remaining assets in the trust must be distributed to the charities named in the trust. The donor is entitled to a charitable income tax deduction based on the current value of the charity’s right to receive the trust assets at some time in the future. Obviously, the longer the time during which the charity must wait, then the smaller will be the value of the charitable deduction. This value is determined with reference to an applicable federal rate mandated for federal tax purposes. In addition, the value of the interest passing to the charity at the death of the donor will escape federal estate taxes in the donor’s estate. With a CRAT, almost everyone benefits. The taxpayer may contribute an asset which may be highly appreciated and low income producing, and receive an income tax deduction. The CRAT can sell the appreciated asset without paying any capital gain taxes and can then reinvest the entire proceeds at a higher rate of return. The trust will then pay out a higher return than the donor previously received, which when coupled with the income tax deduction can create a substantial increase in cash flow. Ultimately, however, the property will pass to charity. If the donor to desires to replace this “wealth” for the benefit of the donor’s heirs, then a portion of the increased cash flow can be used to purchase life insurance which can be owned in such a way as to escape federal estate taxes. The only party that loses is the Internal Revenue Service which receives less income tax during the donor’s lifetime and less federal estate tax at the donor’s death. CRAT’s are fairly complex devices which involve many special rules and tax requirements. Nevertheless, the CRAT is a very useful device in the proper planning context and should not be overlooked for persons with large estates or who are holding substantially appreciated assets.
Q. What is a charitable gift annuity?
A. A charitable gift annuity may be the answer for a person who is seeking to gain a high and tax-favored income guaranteed for life, while reducing current income taxes, while at the same time converting highly appreciated assets into a sound income investment without incurring a capital gain tax. This can be accomplished while supporting your favorite charity. As an example, a person age 70 who gifts a $100,000 asset with a tax basis of $5,000 would receive a monthly annuity payment of approximately $625 for life and a charitable deduction of approximately $34,000. The effective rate of return is approximately 8.9% per annum. Considering that certificate of deposit rates are hovering at close to zero at this time, it is obvious that the charitable gift annuity may produce an extremely favorable financial result. Since the property, if sold, would give rise to a substantial capital gain tax, the creation of an income stream without the incurrance of capital gain taxes, while at the same time producing a substantial charitable deduction, will be very beneficial financially in the circumstances of this example. A gift annuity is similar to an annuity sold by an insurance company, except that the annuity is created by the transfer of an asset (which could be appreciated real estate or securities) directly to the charity in return for an agreement to pay a lifetime annuity. Furthermore, approximately one-half of the monthly income will be considered a return of principal and not “taxable” which produces a higher effective after-tax rate of return. A charitable gift annuity produces a result similar to a charitable remainder trust arrangement. However, because your only security is the charity itself in the case of a charitable gift annuity, it is extremely important that the charity chosen be an established charity that is likely to be around to fulfill its legal obligations.
Q. What should be considered when replacing a life insurance policy?
A. Because the various states individually regulate insurance companies, the replacement of a life insurance policy will involve different procedures depending on the particular state. However, often the replacement decision is based on a computer illustration which may not be fully understood or completely accurate. In deciding whether or not to replace a life insurance policy, you should consider not only the strength of the new company as compared to the company which issued the existing policy, but also the true cost of the new policy because of additional costs for increased age, changes in health conditions, or differences in the types of policies. You should also be aware of the fact that new policies usually involve new start up costs because of the initial sales commission and that the policy will probably involve a new two-year suicide clause. You should also determine the impact of previous dividends and cash value growth, which may be more favorable with the older policy because of the length of time that it has been owned. In every case involving a life insurance purchase, including the replacement of an existing policy, illustrations should be obtained from the insurance agent which should reflect both the guaranteed and projected values. These illustrations should be reviewed quite carefully. No purchase or policy replacement should occur until these and many other issues have been reviewed carefully.
Q. What are the tax consequences of accelerated death benefits or viatical settlements?
A. Effective January 1, 1997, if certain requirements are satisfied, accelerated death benefits received from the insurer under life insurance contracts on the life of a terminally ill or chronically ill individual may be received free of income taxes. Similarly, if all or a portion of a life insurance contract is sold to a third party investor (this process is called a “viatical settlement”), amounts received from the third party may be excluded from gross income. Consequently, an individual diagnosed with a fatal or long term illness may obtain the proceeds of a life insurance contract from the insurer or assign the benefits of a life insurance contract over to a viatical settlement company without paying tax on the proceeds. There previously was some uncertainty about the taxability of accelerated death and viatical settlement benefits. In order to receive these favorable tax benefits, however, the individual must meet certain requirements.
Q. What is the distinction between a “lifetime settlement” of a life insurance policy and a viatical settlement?
A. A “lifetime settlement” is a means of “selling” a life insurance policy to a third party investor in lieu of cancelling the policy in return for its cash surrender value. Although this arrangement must be entered into cautiously, and it certainly is not for everyone, it may provide a significant increase in available funds from life insurance policies that a person may own but no longer needs or wishes to maintain. Subject to certain underwriting criteria, virtually any type of policy, even a term policy with no cash value, may qualify for a lifetime settlement. The transaction involves the payment of a lump sum amount and relief from future premium payments in return for an assignment of ownership of the policy to the third party investor. Subject to certain minimum amounts, policies of almost any size can be sold or a group of smaller policies may be sold in the aggregate for an amount which will justify the transaction. It should be noted that a lifetime settlement differs from a “viatical” settlement, which is generally only available in the case of persons with a terminal illness or a chronic condition that will substantially reduce a person’s life expectancy. The tax consequences of a viatical settlement may be more advantageous in such situations, since the sale of the policy in a lifetime settlement transaction may give rise to capital gain to the extent that the amount received exceeds the owner’s total investment in the policy. Even though the insured need not be terminally or chronically ill to qualify for a lifetime settlement, nevertheless the settlement of the policy is based on the age of the insured as well as the current contract value and premium schedule.
Q. Is it still difficult to name a trust as an IRA beneficiary?
A. “Current” federal tax regulations have been issued which modify the requirements for naming a trust as a beneficiary of benefits payable from a qualified plan or IRA. The old rules (“proposed” and never finally adopted) required that (1) the trust must be valid under state law; (2) the trust must be irrevocable; (3) the beneficiaries must be identifiable from the trust instrument; and (4) a copy of the trust instrument must be provided for the plan. The current rules permit the designation of a revocable trust to be treated as a designated beneficiary provided that the trust becomes irrevocable upon the death of the plan participant or the IRA owner, and the current rules provide relief from the requirement that the plan must be provided with a copy of the trust document if certain certification requirements are met. The current rules do not change the requirements relating to the validity of the trust and the beneficiaries being identifiable.
Q. In the area of IRAs, what is the meaning of the required beginning date?
A. This date (the “RBD”) is the date when certain amounts must be taken out of the IRA from that time on. These withdrawal amounts are referred to as “minimum required distributions” (“MRD”). Since IRA participants may wait until April 1st of the year following the year in which they turn age 70½, then the period which begins January 1 of the year the participant reaches age 70½ and which ends on April 1 of the following year (the “RBD”) is called the “limbo period”. In the year a person reaches age 70½, he cannot make a rollover to an IRA from a plan (or another IRA) until after he has withdrawn the MRD from the plan or the IRA, and he is unable to convert a traditional IRA to a Roth IRA until he has withdrawn the MRD from the traditional IRA. If a person dies during the limbo period, without having taken the MRD, the obligation to make those distributions is cancelled and the first required distribution will be the post-death distribution.
Q. How does a Roth IRA Differ From a Traditional IRA?
A. The significant differences between a traditional IRA and a Roth IRA are: (i) contributions to a Roth IRA are not deductible; (ii) distributions from a Roth IRA may not be included in gross income; (iii) the required minimum distribution rules do not apply to a Roth IRA during the lifetime of the owner; (iv) contributions to a Roth IRA can be made if the owner is older than 70½ years of age; and (v) eligibility to contribute to a Roth IRA is subject to special modified income limits. In general, however, in order to avoid income taxation, a distribution from a Roth IRA must be made at least five years after the contribution to the Roth IRA, and be: (i) made on or after the participant/owner reaches age 59½; (ii) made after the participant/owner’s death; (iii) attributable to partial or total disability of the participant/owner; or (iv) used for the purchase of a first home and be less than $10,000. Although no minimum distribution rules apply to the Roth IRA, all the same rules governing traditional IRAs apply to other Roth IRA beneficiaries. Further, non-qualified distributions are subject to the 10% penalty tax unless the distribution is made after age 59½ or meets one of the other exceptions to the penalty.
Q. What are the distribution requirements applicable to a Roth IRA after the owner’s death?
A. Roth IRA distributions are tax free if the payment is made on account of death, disability or the purchase of a home by a qualified first-time home buyer (limit of $10,000). However, if the distribution is made before the five-year holding period has been satisfied, then it will be subject to tax to the extent that the distributions cumulatively exceed contributions. These distributions will not be subject to the 10% penalty tax. Following the death of the owner of the Roth IRA, if the beneficiary is an individual, then distributions to the beneficiary must begin within a year after the owner’s death. The distributions can be spread over the beneficiary’s life expectancy. If the beneficiary is the owner’s spouse, there is some uncertainty whether the spouse must begin taking distributions within a year of the owner’s death, but it is clear that the spouse-beneficiary can roll over the decedent’s Roth IRA into the spouse’s own Roth IRA. If the spouse-beneficiary rolls over the inherited Roth IRA, and then designates children or grandchildren as the beneficiaries, then the Roth IRA can continue to appreciate tax free until the spouse’s death because the owner of a Roth IRA, including a spouse with respect to a roll-over Roth IRA, can avoid lifetime distributions. If there is more than one individual beneficiary of a Roth IRA, then the distributions to all of the beneficiaries cannot be spread out longer than based on the life expectancy of the oldest beneficiary. Similarly, in the case of a trust which is the beneficiary, the life expectancy of the oldest beneficiary of the trust will be used to determine the pay-out period. In the case of a beneficiary which is an estate or a charitable organization, the Roth IRA must be distributed within five years after the owner’s death. The biggest advantage of Roth IRA’s is that the owner of a Roth IRA is not subject to any mandatory lifetime distribution rules. This creates interesting estate planning opportunities.
Q. What are the advantages of a family limited partnership?
A. The Family Limited Partnership (“FLP”) device is an extremely useful mechanism in the estate planning context, especially in situations when the client wishes to transfer partial interests in property without having to sever the property and when the client wishes to retain control. The FLP, if structured properly, is one of the few instances in which clients can “have their cake and eat it too”. The purpose of implementing an FLP is to place some of the family wealth in a separate entity for management and transfer purposes, so that transfers can be made of interests in the FLP over time, without having to carve out or separate the properties themselves (particularly real estate properties). Because valuation discounts are allowed for the lack of marketability of such interests, and because minority interest discounts are also available when the interest being valued does not possess control, there can be substantial transfer tax savings through the use of the FLP. The combined lack of marketability and minority interest discounts can be substantial, reducing the undiscounted value of an interest by as much as 30 to 50 percent. It is possible to use other entities to achieve some of these same objectives, but there are numerous factors weighing in favor of using an FLP for valuation discounts and for control purposes. To illustrate the advantage of the substantial discounts which are available, let us assume that a partner in an FLP wishes to transfer some of his or her percentage interests in the FLP within the amount of the $14,000 annual gift tax exclusions. If the person was giving away the underlying property, it would be necessary for the donor to carve off a piece of the real estate, and then deed that small piece, thus severing the property and creating title problems and other legal complications. Each gift would be a relatively complex event. In the case of the FLP, the partner would simply determine the underlying value of the property to be transferred based on the percentage interest. After applying the appropriate discount, there would be gifted enough of the percentage interest to utilize the amount of the annual exclusion. If we assume that the total value of the FLP assets is $1,000,000, then a 1.4% interest in the FLP based on the underlying asset value would be $14,000. However, because of the substantial discount which is available, a substantially larger percentage interest could be gifted to arrive at the $14,000 net gift value. If we assume that the applicable discount would be 35%, then the value of the underlying property, after applying the discount, which could be gifted would be $20,000. That is, a 35% discount applied to property having a value of $20,000 would equal $7,000. When this discount is subtracted from the gross value, then the remaining value would be $13,000. As a result, the partner could gift approximately a 2% interest in the FLP, based on the underlying asset value, rather than a 1.4% interest. This approach enables the partner to gift away substantially larger amounts over a given period of time as a means of transferring wealth more rapidly and reducing potentially applicable transfer taxes.
Q. What is a “disregarded entity”?
A. A “disregarded” entity is an entity which is treated as having the same identity as the entity’s owner. Disregarded entities include a Qualified Subchapter S Subsidiary (a “QSub”) as well as a business entity that has a single owner and which is not a corporation, such as a single-member limited liability company (“LLC”). The IRS issued AdvNotice 99-6 which applies to disregarded entities for federal employment tax purposes. The IRS will accept reporting and payment of employment taxes for the employees of a disregarded entity in either of two ways: (i) the entity may calculate, report and pay all employment tax obligations by its owner as though the employees of the disregarded entity are employed directly by the owner; or (ii) a separate calculation, reporting and payment of all employment tax obligations by each state law entity may been made with respect to the entity’s employees under its own name and its own taxpayer identification number. The IRS also issued AdvRev Rul 99-5, which explains the tax consequences when a single member domestic limited liability company (“LLC”) that is disregarded for federal tax purposes becomes an entity with more than one owner that is classified as a partnership. The ruling deals with two situations, each of which begins with an LLC being formed and operated in a state such as Indiana which permits an LLC to have a single owner. Later a second party buys into the LLC so that it ceases to be a disregarded entity. The tax consequences can be significantly different depending on the form of the change in the ownership of the entity. The IRS also explained in AdvRev Rul 99-6 the tax consequences when a partnership LLC is purchased by one person, and thus becomes a disregarded entity.