Michigan Estate Planning by John Tamboer

Democratic House Members Propose Returning Estate Tax Rates and Exemptions to 2001 Levels and Imposing Other Restrictions on Estate and Gift Tax

2011-12-01T09:09:00.000-05:00

Democratic Ways and Means Committee member Jim McDermott (D-Wash.) and Rep. Charles Rangel (D-N.Y.) have introduced H.R. 3467 (Nov. 17, 2011), “the Sensible Estate Tax Act of 2011,” which would raise the top estate and gift tax rate (and the sole GST tax rate) to 55 percent, lower the applicable exclusion amount to $1 million, indexed for inflation after 2012 (but using inflation adjustments starting from 2000), restore the state death tax credit, restrict the use of valuation discounts for investment assets, require grantor retained annuity trusts to have a minimum ten-year term, require consistent basis reporting between an estate and the person acquiring property from the decedent, and eliminate the protection afforded by an allocation of GST exemption after 90 years. This is a major departure from the current exclusion amount of $5 million afforded to decedent's estates. We will keep you posted as this legislation develops.

Mixing Pleasure and Business: Are Vacations in the 21st Century Deductible?

2011-11-29T17:56:00.000-05:00

Technological developments of the 21st century have been transformative. Anyone can be in constant contact with their offices and clients, even while away on vacation. Technology has essentially erased the physical boundaries between a place of work and almost any vacation location on the planet. The deductibility of business expenses while away from the office is explored in this article.

When it comes to vacations and taxation, several Internal Revenue Code Sections come into play. First, Section 262 declares that "no deduction shall be allowed for personal, living, or family expenses." Accordingly, on the face of it, any and all expenses incurred while away on vacation should not be deductible.

But Section 162, which permits the deductibility of ordinary and necessary business-related expenses, relaxes the strict limitations imposed by Section 262. Specifically, business expenses incurred while on vacation open the door to possible tax deductions.

Most technology-related expenses (cell phones, connectivity charges, printing, fax charges, and the like) are deductible to the extent that they are necessary to maintain contact with staff and clients while away from a place of business. Nevertheless, vacationing taxpayers should not be lulled into thinking that because they log on to their computers on a daily basis to check their e-mails, or regularly call into their offices, their vacation expenses are now entirely deductible. Likewise, taxpayers should not think that even some part of the vacation expenses they incur are now deductible based on the ratio of the hours spent doing business-related work vs. being away from home on vacation.

The main reason that such expenses are not deductible is due to the scope of Section 162, as defined by a long line of case law that addresses travel expenses incurred while away from home. The U.S. Supreme Court set the standard for deductibility of travel expenses in Commissioner v. Flowers, 326 US 465 , 66 S. Ct. 250, 90 L Ed 203 (1946). The Court held that the following three conditions must be met before a travel expense is deductible:

The expense must be a reasonable and necessary "travel expense," as that term is generally understood.
The expense must be incurred "while away from home."
The expense must be incurred in pursuit of business. This means that there must be a direct connection between the expenditure and the carrying on of the trade or business of the taxpayer or of the employer. Moreover, such expenditures must be necessary or appropriate to the development and pursuit of the business or trade.

For most vacationing taxpayers, satisfying the third Flowers condition of deductibility is likely to be the most problematic. Taxpayers must prove there is a "direct connection" between the vacation expenses they incur and the furtherance of their business enterprise. But there is nothing about being away from the office that enhances the prospects that the business issues under discussion will be more successful simply because the taxpayer, for example, is relaxing in a hammock in the Bahamas rather than being stressed out in her regular office. To the contrary, the IRS may argue that the prospects for successful business endeavors are diminished while the taxpayer vacations because the taxpayer lacks immediate access to the resources typically found in an office environment, such as management advice, secretarial assistance, photocopy machines, and the like.

The fact is that the vast majority of vacationing taxpayers incur expenses first and foremost specifically to get away from their businesses. This is evident for most people when they are accompanied on vacation by their families, friends, or significant others but not by their business associates or colleagues. As a result, under the Flowers decision, the Service and the courts would likely deny that all or even a portion of the most common expenses that taxpayers incur while on vacation (e.g., transportation, lodging, meals, and entertainment) are deductible.

Nevertheless, Flowers does not preclude the deductibility of all expenses while away on vacation. While away on vacation, for example, a taxpayer might have a crisis back at the office requiring his full-time or significant attention. In these limited instances, when the fundamental nature of the trip has been transformed from pleasure to business, there may be a justification to deduct many of the taxpayer's expenses while he is away from home. These occasions are likely to be rare, however, and the fact that a taxpayer, while on vacation, voluntarily chooses to spend even two to three hours daily checking her e-mail and/or reaching out to customers and clients does not fundamentally transform the nature of her trip to make it business-oriented.

The vast majority of vacationing taxpayers incur expenses first and foremost specifically to get away from their businesses. As a result, under the Flowers decision, the most common expenses that taxpayers incur while on vacation (e.g., transportation, lodging, meals, and entertainment) are likely nondeductible.

Protect Your Tax-Free Gifts to Children by Using a "Crummey" Trust

2011-11-17T16:22:00.002-05:00

It is commonly known that a person can give away gifts up to the gift tax exclusion amount (currently $13,000) each year to each of an unlimited number of donees, free of gift and generation-skipping transfer tax. Where the donee is a minor, many parents and grandparents make their annual gifts to a custodial account under the Michigan Uniform Gifts to Minors Act (UTMA). A UTMA account works well and is easy to create and maintain. However, it has one major defect: when the child (or grandchild) reaches age 18, the beneficiary can do whatever he or she wants with the money in his or her custodial account. If, for example, the beneficiary wants to buy a sports car instead of going to college, there is nothing that can be done about it.

Most parents don't want their children (or grandchildren) to receive significant amounts of cash at age18. Fortunately, there is a special kind of trust that avoids this problem. It is called a “Crummey” trust, named after a court case that paved the way for the use of this kind of trust. With a Crummey trust, the property can remain in trust for as long as required without forfeiting the gift tax annual exclusion. Thus, property can be transferred to remain in a Crummey trust for the beneficiary's entire lifetime or until an appropriate age (e.g., age 30) or event (e.g., graduation from college). Parents can then decide how the money is to be used and how much the beneficiary can receive.

There is one catch to a Crummey trust: annual contributions made to the trust will not qualify for the gift tax annual exclusion unless the beneficiary is notified that a contribution has been made, and give him or her a limited period of time (usually 30 days) in which he or she can withdraw the contributions from the trust. It is usually understood that the beneficiary won't exercise his or her right to withdraw the contributions, but will let them remain in the trust. However, that expectation should always remain unwritten because, if there is any evidence of it, the IRS will use that evidence to say that the beneficiary did not really have a power of withdrawal. If the beneficiary violates the unwritten understanding by withdrawing property from the trust, there is nothing that can be done about it, except not making any further contributions, so it is important to use Crummey trusts only in certain situations that make sense.

Preventing Estate Tax on Life Insurance

2011-11-01T13:00:00.000-04:00

Under current estate tax rules, life insurance proceeds are included in the estate of the policy owner upon his or her death if either:

(1) The owner's estate is the beneficiary of the insurance proceeds, or

(2) The owner possessed certain economic rights (called “incidents of ownership”) in the policy at death (or within three years of death).

Avoiding the first situation is easy: just make sure the estate is not designated as beneficiary of the policy.

The second rule is more complex. Insurance proceeds are included in the policy owner's estate regardless of who the beneficiary is. The result is the same even if the policy is transferred to another person if the original owner keeps any so-called “incidents of ownership” in the policy. These rights of ownership, if retained by the owner, will cause the proceeds to be taxed in the owner's estate:

... the right to change beneficiaries,

... the right to assign the policy (or to revoke an assignment),

... the right to pledge the policy as security for a loan,

... the right to borrow against the policy's cash surrender value, and

... the right to surrender or cancel the policy

Keep in mind that merely having any of the above powers will cause the proceeds to be taxed to the owner's estate even if the powers are never exercised. However, there are a couple of common strategies that can be used to avoid taxation of death benefits to the estate of the policy owner, including buy-sell agreements and life insurance trusts.

Buy-sell agreements. Life insurance obtained to fund a buy-sell agreement for a business interest under a “cross-purchase” arrangement will not be taxed in the owner's estate (unless his or her estate is named as beneficiary). For example, say Al and Bob are partners who agree that the partnership interest of the first of them to die will be bought by the surviving partner. To fund these obligations, Al buys a life insurance policy on Bob's life. Al pays all the premiums, retains all incidents of ownership, and names himself beneficiary. Bob does the same regarding Al. When the first partner dies, the insurance proceeds are not taxed in his estate.

Life insurance trusts. A life insurance trust is an effective vehicle that can be set up to keep life insurance proceeds from being taxed in the insured's estate. Typically, the policy is transferred to the trust along with assets that can be used to pay future premiums. Alternatively, the trust buys the insurance itself with funds contributed by the insured. As long as the trust agreement gives the insured none of the ownership rights described above, the proceeds will not be included in his estate.

The three-year rule. A person who gives away or transfers life insurance to avoid estate taxes must live for at least 3 years after the transfer is made. Otherwise the life insurance proceeds will be taxed as part of his or her estate. For policies in which a person never held incidents of ownership, the three-year rule doesn't apply. Also, bear in mind that taxation of life insurance may not be a concern when the value of the owner's estate is less than the "applicable exclusion amount" (currently $5 million per person), which is the threshhold amount that will cause his or her estate to incur any tax.

Benefits of a Life Insurance Trust

2011-10-25T16:58:00.002-04:00

Few people realize that, even though they may have a modest estate, their families may owe hundreds of thousands of dollars in estate taxes because they own a life insurance policy with a substantial death benefit. This is so because life insurance proceeds, while not subject to federal income tax, are considered part of your taxable estate and are subject to federal estate tax.

The solution to this problem is to create an irrevocable life insurance trust that will own the policy and receive the policy proceeds upon death. A properly drafted life insurance trust keeps the insurance proceeds from being taxed in the estate as well as in the estate of the surviving spouse. It also protects the trust beneficiaries from their own “excesses”, against their creditors, and in the event of divorce. Moreover, the trust also provides reliable management for the trust assets. Here's how the irrevocable life insurance trust works.

An irrevocable life insurance trust can be created to be the owner and beneficiary of one or more life insurance policies. Cash can then be contributed to the trust and used by the trustee to make premium payments on the life insurance policies. If the trust is properly drafted, the contributions that are made to the trust for premium payments will qualify for the annual gift tax exclusion, so gift taxes won't have to be paid on the contributions.

The life insurance trust typically provides that, during one's lifetime, principal and income, at the trustee's discretion, may be paid or applied to or for the benefit of spouse and descendants. This allows indirect access to the cash surrender value of the life insurance policies owned by the trust, and permits the trust to be terminated if desired despite its being irrevocable. Upon death, the trust continues for the benefit of the spouse during his or her lifetime. The spouse is given certain beneficial interests in the trust, such as the right to income, limited invasion rights, and eligibility to receive principal. On the death of the spouse, the trust assets are paid outright to, or held in further trust for the benefit of descendants.

An irrevocable life insurance trust may be of substantial benefit to anyone who owns a life insurance policy with a significant death benefit.

Duties of a Trustee

2011-10-17T12:45:00.029-04:00

A trustee's duties are determined by the trust instrument, common law, and state statutes. A trustee's basic duties are to hold the assets of the trust, to administer them solely for the benefit of the trust beneficiaries and to carry out the terms of the trust instrument. A trustee's duties include the following:

(1.) Duty of loyalty. The trustee must act with undivided loyalty and solely in the interests of the trust beneficiaries. The trustee must act in a manner that avoids placing the trustee's personal interests in conflict with those of the beneficiaries.

(2.) Duty of care. The trustee must act with the same level of care and diligence in carrying out the purposes of the trust as would a person familiar with the role of a trustee. If a trustee holds itself out as a professional trustee or as having special skills, it may be held to a higher standard of care.

(3.) Duty to administer the trust by its terms. The trustee is bound to administer the trust as it is written. If the trust instrument contains ambiguities, it may be necessary to seek help from a court or attorney.

(4.) Duty of impartiality. The trustee is required to treat all of the beneficiaries of the trust impartially, unless the trust instrument provides otherwise. “Impartially,” however, does not necessarily mean “equally.”

(5.) Duty to segregate property. The trustee must not commingle the trust property with the trustee's own property or other property not held by the trust. Absent statutory authority or authority under the trust instrument, the trustee should not even commingle assets of separate trusts created under the same trust instrument.

(6.) Duty to preserve trust property. The trustee is under a duty to use reasonable care and diligence in preserving and protecting trust property for the benefit of the beneficiaries. Thus, for example, a trustee may be required to maintain fire and casualty insurance for any buildings owned by the trust.

(7.) Duty of confidentiality. The trustee is bound to keep personal information about the trust beneficiaries while acting as trustee confidential, and should not reveal details of the trust to third parties (including other beneficiaries), except where otherwise required by law.

(8.) Duty to keep records. The trustee must keep detailed records showing the assets, liabilities, receipts, and disbursements of the trust.

(9.) Duty to account. The trustee must periodically give a written report to the beneficiaries describing how the trust is being administered. The form and frequency of the accounting varies from state to state.

(10.) Duty to furnish information and communicate. In addition to any written accountings, the trustee is required to keep beneficiaries informed regarding the trust and its administration. The trustee should also furnish other information to a beneficiary that is reasonably requested.

(11.) Duty to enforce and defend claims. The trustee is under a duty to enforce any claims the trustee may have, including against a predecessor trustee, and to defend claims brought against the trust. However, the trustee can also compromise claims if it is the best interests of the beneficiaries to do so. The trustee should consider the economics of suing or defending in making these decisions.

(12.) Duty not to delegate. In general, a trustee is not allowed to delegate the trustee's discretionary (as opposed to ministerial) powers. State law, and possibly the terms of the trust instrument, can vary this duty.

All of these duties are owed to all of the beneficiaries of the trust. Troubles for a trustee often arise when some of the beneficiaries are not treated impartially or kept informed of the trustee's actions, or are not even informed of the existence of a trust.

Inclusion of Jointly-Held Property in Gross Estate

2011-10-11T16:55:00.001-04:00

Right of Survivorship. Joint ownership with right of survivorship means that at the death of one co-owner, his interest immediately and automatically passes to the other co-owner. The estate tax rule for property owned jointly with a spouse is easy: 50% of its value is included in each estate. If the joint owner is not a spouse, it depends on how the property was acquired. If it was a gift or inherited, again, 50% is included. (If there are three owners, 33.3%, etc.) If it was purchased, then the amount includible in the estate depends on how much the person and the corresponding joint owner (or owners) contributed to the purchase price.

For example, say A and B (unmarried) bought investment real estate for $30,000 back in 1950. A contributed $20,000 and B contributed $10,000. The value has risen to $1 million at the time of A's death. Because Because A contributed 2/3 of the cost, 2/3 of the value ($666,667) is included in his estate. Had B died first, only $333,333 would have been included in her estate. This difference of $333,334 was caused by a difference of only $10,000 in contributions at the time of purchase.

The effect of debt. If the property owned jointly (not with a spouse) is subject to debt, the debt will have an impact on the rule estate tax described above. Any debt that is outstanding at the time of death is treated as contributed equally by the joint owners. And payments made to pay down the balance of the debt are treated as contributions to the cost of the property.

Example (1). C and D buy investment property that they own jointly with right of survivorship. C contributed $20,000, D contributed $30,000, and a $50,000 mortgage was taken out. C dies when the value of the property is $150,000. The balance due on the mortgage is still $50,000 (only interest had been paid on it). C is treated as having contributed $45,000: the actual contribution of $20,000 plus half of the outstanding debt. This is 45% of the cost. Thus, at C's death, $67,500 (45% of $150,000) is included in his estate.

Example (2). The facts are the same as in Example (1) except that $10,000 of the mortgage had been paid off with the $10,000 in payments made by C. Now, of the $100,000 cost, C will be treated as having contributed $50,000: his original actual $20,000, his mortgage payments of $10,000, and one-half the debt balance (1/2 of $40,000 = $20,000). Thus, $75,000 would be included in his estate.

Tenancy in common. Another form of joint ownership is tenancy in common in which the co-owners do not have any survivorship right. Thus, for example, if there are three equal co-owners and one dies, his interest passes to his heirs and not to the other owners. Where a decedent dies owning property held in this form of joint ownership, the fraction of the property's value representing the decedent's ownership share is included in his estate. It is irrelevant how much each owner contributed to the cost.

Take Advantage of Annual Gift Tax Exclusions Before It's Too Late

2011-10-05T10:08:00.001-04:00

The first $13,000 of gifts ($26,000 for married couples who split gifts) made by a donor to each donee in calendar year 2011 is excluded from the amount of the donor's taxable gifts. (The exclusion remains at $13,000 for calendar year 2012.) These exclusions can save both transfer tax for the donor and family income taxes. The transfer is free of gift tax. Estate tax can be saved because both the value of the gift on the date of transfer and post-transfer appreciation (if any) in the value of the gift aren't included in the donor's estate. Family income tax savings can be realized where income-earning property is given to family members in lower income tax brackets.

Don't wait! Taxpayers must act no later than Dec. 31 to take complete advantage of annual exclusions. Unused annual exclusions can't be carried over and are forever lost. Finally, if a gift is made by check near the end of 2011 and the donor wants to take advantage of the exclusion this year, the donee should be urged to deposit the check before year-end, so that there's no doubt as to when the gift was made.

IRS Notice: Estate Tax Return Must Be Filed for Surviving Spouse to Claim Unused Exemption

2011-10-04T10:17:00.000-04:00

IRS has reminded estates of married taxpayers dying after 2010 that estate tax return must be filed in order to pass along unused exclusion amount to surviving spouses. Details and instructions are provided in Notice 2011-82.

Estate and Gift Taxes Remain Part of President's Deficit Reduction Plan

2011-10-03T11:04:00.000-04:00

The Administration's proposals for deficit reduction includes the statement that “[t]he Administration . . . supports the return of the estate tax exemption and rates to 2009 levels.” This would return the estate tax applicable exclusion amount to $3.5 million and the gift tax exemption to $1 million, and the top marginal rates to 45 percent (down from current exemptions of $5.0 million for both estate and gift tax). Earlier proposals from the Administration would preserve the portability of a deceased spouse's unused estate tax applicable exclusion amount, and this may remain part of the Administration's tax reform proposal. (Office of Management and Budget, “Living Within Our Means and Investing in the Future: The President's Plan for Economic Growth and Deficit Reduction,” (Sept. 2011)

Tax Court Warning: Agreements to Care for Aging Parents Must Be In Writing

2011-09-28T14:51:00.000-04:00

The Tax Court has held that an estate could not deduct as a claim against the estate a large amount supposedly owed by the decedent to her son for care taking services he provided to her for several years before her death. The claim was based on an alleged agreement that had not been reduced to writing, even though the son had been a practicing attorney before he became engulfed in care taking. The only evidence the estate offered to prove the alleged agreement was the son's testimony, which the court found to be improbable, self-serving, and uncorroborated. (Estate of Emilia W. Olivo, TC Memo 2011-163)

Emilia W. Olivo died without a will on April 26, 2003. At the time of her death, she was a widow living in New Jersey. She was survived by two sons and two daughters. One son, Mr. Olivo, the administrator of the estate, lived with his mother at the time of her death. He cared for his mother and father for many years before their deaths. His care taking started in the fall of 1994, when his mother fell and suffered a compression fracture of her lower spine that left her nearly paralyzed in both legs.

Mr. Olivo was a lawyer, but his practice began to disintegrate during the mid '90s, in part because of the amount of time he devoted to his parents' health problems. He prepared durable powers of attorney for his parents and they executed them in 1995 (father) and 1996 (mother). His father died in the fall of 1995, and the probating of his will was highly contentious. Family relationships became strained after that and remained so until 2000.

Emilia had numerous health problems during the last years of her life. The compression fractures to her spine left her incapable of caring for herself and basically paralyzed in both legs. Mr. Olivo purchased a Hoyer lift to move her from bed to her wheelchair and back. She also required assistance to use the bathroom, to get dressed, and to bathe. She had a number of other problems including incontinence, which required Mr. Olivo to clean up after her and change her clothes. She was a diabetic, which required Mr. Olivo to test the insulin levels in her blood several times each day and, if needed, inject her with insulin.

Mr. Olivo was also responsible for preparing all meals and doing general housekeeping. He employed home health aids to assist him, but the aids were not registered nurses and therefore could not administer Emilia's medications or do the blood sticks and insulin injections she required. Mr. Olivo kept extensive records of his mother's medications, hospital visits, and diagnoses. He also kept a composition notebook where he recorded her blood sugar levels, blood pressure, pulse, and body temperature.

Caring for his mother took a toll on Mr. Olivo. At some point during 1998, his brother, an M.D., became concerned about Mr. Olivo's health. After being criticized by a sister, Mr. Olivo offered to stop providing care and to hire round-the-clock nurses instead. His three other siblings, however, asked him to continue the care and he did so until his mother's death. Mr. Olivo prepared an estate tax return before he was formally appointed as administrator (there was a delay because one sister initially refused to renounce her right to be appointed as administratrix). This return claimed a deduction of $1,240,000 as a debt the estate owed to him for the care he provided to his mother pursuant to an alleged agreement he had with her to compensate him for his services in caring for her (alleged agreement).

Regarding the alleged agreement, during the Tax Court trial, Mr. Olivo testified that at some point during 1998, he learned that one of his sisters had commented that all he did was sit around and watch television while getting free room and board. He was upset by the remark, and he told his mother, who offered to pay him $1,000 per week for the care-giving. Mr. Olivo said that he suggested that $200 per day would be agreeable to him. However, he further testified that he became worried about his mother's finances, and he suggested that she defer the payment until her death. He said that, to avoid a complicated interest calculation, she agreed to pay him $400 per day with payment deferred until after her death.

However, Mr. Olivo never reduced the alleged agreement to writing. He acknowledged during his testimony that he “could have and should have” memorialized their agreement, but he was too distracted by the day-to-day details of caring for decedent. He explained that he was not thinking like a lawyer during that time.

The Tax Court observed that the only evidence the estate offered to prove the alleged agreement was the testimony of Mr. Olivo. It stressed that Mr. Olivo never reduced the alleged agreement to writing, nor were there any other witnesses to the alleged agreement or any other corroborating evidence. The Tax Court said it did not have to accept testimony that is improbable, self-serving, and uncorroborated by other evidence. The Tax Court also noted that, under New Jersey law, the oral promise of a decedent must be proved by clear and convincing evidence. However, it did not decide whether to apply that standard because it found that Mr. Olivo's testimony failed to satisfy even the less exacting preponderance standard normally applied by the Tax Court.

The court said that Mr. Olivo's testimony recounting the facts surrounding the alleged agreement was highly questionable. Although the court understood that he had a lot on his mind during the years when he was caring for his parents, his claim that he was unable to think like a lawyer during that period was belied by the fact that he prepared powers of attorney for both of his parents and had his parents execute them. Given his training and experience as an attorney, how contentious the probating of his father's estate had been, the apparent animosity between him and one sister, and his vested interest in ensuring that he would receive compensation from his mother pursuant to the alleged agreement, the court did not believe that he would not have reduced the alleged agreement to writing or at least have some corroborating evidence beyond his self-serving testimony.

In light of the foregoing, the court declined to accept Mr. Olivo's uncorroborated testimony regarding the alleged agreement. Accordingly, it concluded that the estate failed to establish that his mother entered into the alleged agreement with Mr. Olivo. Consequently, the court held that Mr. Olivo's claim for compensation pursuant to the alleged agreement may not be deducted by the estate.

In the alternative, the estate contended that Mr. Olivo was entitled to some recovery under quantum meruit. Even in the absence of a contract, when one party has conferred a benefit on another and the circumstances are such that it would be inequitable to deny recovery to the party conferring the benefit, New Jersey courts allow recovery in quasi-contract. Quantum meruit is a type of quasi-contractual recovery that allows a plaintiff to recover the reasonable value of services rendered when the plaintiff conferring the services had a reasonable expectation of payment.

The court stressed that Mr. Olivo's care for his mother during the last years of her life was extraordinary, and the efforts he expended on her behalf were commendable. However, it concluded that the estate did not show that Mr. Olivo was entitled to recover for that care under quasi-contract because there is a presumption under New Jersey law that services rendered to a family member living in the same household are rendered gratuitously.

Young Children Require Special Attention in an Estate Plan

2011-08-02T17:28:00.000-04:00

Making sure that young children are cared for is usually a top priority for parents when drafting an estate plan. Parents should consider including a trust in their estate plan. A trust permits a person selected by the parents to manage assets for the care and support of children. Creating a trust must be done with great care, and follow up planning is required to ensure that assets will be available to the trustee. For more information about estate planning for children, see our web site at http://jtlaw.us/estate-planning-tools/planning-for-minor-children/.

10 Ways to Prevent Estate Litigation

2011-07-24T17:56:00.002-04:00

There are many things that can be done to avoid protracted litigation over estate assets. Here are a few suggestions:

1. Treat Siblings Equally. Litigation can be avoided most of the time by treating people with the same degree of relationship equally. However, decisions get more complicated with multiple marriages. Another area of dispute may occur if one child predeceases his or her parent. The default rule is that a deceased child’s share goes to his or her kids. If estate planning documents mirror the default rules, there is very little for heirs to gain by fighting.

2. Decide Who Gets What. Direct important items of personal property to the specific person who should receive it. These directives may be contained in a will, trust, or by a list (referred to as a “personal property memorandum”) attached to either document.

3. Keep Track of Loans and Advances. Specify whether any loans are to be forgiven or repaid at death. If a loan must be repaid, then it may be identified as an “advancement”, and counted against the share distributed to an heir.

4. Transfer a Business with a Contract. A business may be transferred to an heir by contract, rather than by will or trust. Contracts are generally harder to contest than a will or trust.

5. Check Ownership of Assets. A will can only direct the distribution of property owned by the person who signed the will. Jointly owned property goes to the surviving joint owner, and assets with a specific beneficiary will be distributed to that person - regardless of the what the will says.

6. Get Your Own Lawyer. It’s common for one lawyer to draft estate planning documents for a couple and perhaps even more family members. But if the lawyer represents someone other than the testator (the person writing the will), trouble can result. For example, if a lawyer represents both the testator and a second spouse — the children from a first marriage may contest the documents by claiming that the lawyer had a conflict of interest.

7. Consider a Corporate Executor. A professional trustee or executor is expensive, but there’s less chance of fights among siblings.

8. Establish Mental Capacity to Sign Documents. One of the most common allegations in estate litigation is that the testator lacked the mental capacity to sign his or her will. Proper witnessing of the documents will prevent most problems related to claims of incapacity. If the testator's capacity is in doubt, one way to counter a claim is to be evaluated by a physician before signing the documents. The document signing procedure may also be recorded with video or audio equipment, but it should be carefully controlled so as not to generate more evidence for people who want to fight.

9. Include a “No-Contest” Clause. No-contest clauses are also known as “in terrorem” clauses. A typical no-contest clause says that if any beneficiary of the will contests the validity of the will or any provision of the will, he or she forfeits his interest. No contest clauses are not fully enforceable in Michigan due to statutory restrictions on their use. However, putting one in a will or trust may cause enough fear on the part of a beneficiary to make it work.

10. Spell Out Any Disinheritance. Disinheritance of a beneficiary should be explicit rather than by omission. It is not necessary to provide a reason for disinheriting a beneficiary.

11. Don’t Delay. Deathbed estate planning is almost always a recipe for trouble. Claims of incapacity and undue influence are more common in such situations.

Is the Mortgage Interest Deduction Dead?

2011-07-18T09:49:00.000-04:00

As lawmakers continue to debate how to handle the nation's debt and aim to do “something big” rather than simply patch the problem, it seems probable that many broader tax reform issues may resurface during the course of the negotiations. One such issue, which was addressed by President Obama in his 2012 and 2011 budget proposals, is the mortgage interest deduction—one of the largest tax expenditures. According to various estimates, the deduction cost the Treasury Department somewhere between $80 and $103 billion in 2010, and its value over the 10-year budget window is expected to exceed $1 trillion. This article examines the mechanics of the deduction, arguments for and against reforming it, reform proposals, and the projected effect of any changes on both taxpayers and the budget.

Background. Interest paid with respect to a mortgage on real estate is deductible interest on indebtedness under Code Sec. 163(a) . Itemizing taxpayers can deduct their mortgage interest on up to $1 million of qualifying acquisition debt on a qualified principal and, if applicable, secondary residence. A residence includes a house, condominium, cooperative, mobile home, house trailer, or boat. (Reg. § 1.163-10T(p)(t)(ii)) In effect, this deduction reduces the after-tax cost of financing a home. In contrast, taxpayers are not permitted to deduct the costs of renting a home.

Itemizing taxpayers can also deduct interest on up to $100,000 ($50,000 for married individuals filing separately) of home equity debt—i.e., debt secured by a taxpayer's qualified residence up to the fair market value of the residence, as reduced by the amount of acquisition indebtedness on it. (Code Sec. 163(h)(3)(C)(i))

Arguments for and against reforming the deduction. The mortgage interest deduction is often criticized as being an “upside-down” subsidy, in that it tends to provide greater benefit to taxpayers with higher incomes. The amount of interest paid by lower- and moderate-income taxpayers is less likely to be sufficiently high to make it worthwhile to forego the standard deduction, so they are less likely to claim any benefit from it.

Proponents of the deduction argue that it encourages home ownership and makes it affordable to taxpayers who would otherwise not be able to own a home. Critics claim in response that, rather than encouraging home ownership, the deduction actually encourages middle-class and wealthy taxpayers to take on more debt and buy larger homes than they otherwise would. Further, critics argue that the deduction tends to benefit taxpayers with larger incomes who likely would have purchased a home regardless of the deduction.

Illustration: A married couple who takes out a $150,000 mortgage on Jan. 1, 2011, payable over 30 years with 7% interest, pays $9,584.85 in interest in the first year. Unless the couple has other itemized deductions, they may simply opt for the $11,400 standard deduction. If the same couple were to double their mortgage to $300,000, same interest and term, their interest payment in the first year is $19,169.71. If the couple were to again double their mortgage to $600,000, the interest payment would be $38,339.42.

Critics of the deduction also claim that the deduction artificially drives up home prices. However, this same argument is cited by its proponents, who observe that eliminating the deduction could further impact home prices in an already depressed market.

Proposals. A number of different proposals have been advanced regarding the mortgage interest deduction. In light of the popularity of the provision, and the strength of the real estate lobby, it appears unlikely that it would be repealed outright. In general, the proposals tend to focus on converting the deduction to a credit, capping the maximum mortgage amount, and limiting the credit to a primary residence.

The President's Fiscal Commission proposed a 12% nonrefundable credit on up to a $500,000 mortgage, with no credit for a second residence or for home equity. The Debt Reduction Task Force would have a 15% refundable tax credit capped at $25,000. Other proposals suggest a 20% credit, whereas another proposal is to simply have a fixed credit for owning a home as opposed to having a mortgage.

President Obama's 2012 budget proposal, as well as his 2011 proposal, suggested capping itemized deductions, including mortgage interest, for taxpayers in the top two tax brackets (33% and 35%). Under the proposal, these taxpayers would only be able to reduce their tax liability by a maximum of 28%.

Illustration: The current structure of the mortgage interest deduction reduces the after-tax cost for each $100 borrowed by a taxpayer in the 35% bracket to $65. However, the after-tax cost for each $100 borrowed by a taxpayer in the 10% bracket is $90. In other words, the higher a taxpayer's tax bracket, the greater relative benefit he will receive from the deduction. The Administration's proposal would limit the benefit to higher-income taxpayers by five or seven percentage points, such that the after-tax cost for each $100 borrowed would rise to $72.

Economic effect. Given the amount of foregone revenue from the deduction, the effects of reforming or repealing the provision could be significant.

If the deduction was repealed flat out, estimates are that the average tax bill of those who claim the mortgage interest deduction would increase by $710. However, this increase would vary widely among taxpayers—those with $30,000 to $40,000 incomes would face an average increase of $70, whereas taxpayers making over $1 million would face an average increase of $4,000. However, given the popularity of the deduction, its outright repeal seems unlikely.

According to the TPC, replacing the current mortgage interest deduction with a 20% nonrefundable credit, limiting mortgages eligible for the credit to $500,000, and limiting the credit to primary residences would only have a nominal or positive effect on the majority of the tax bills of those who claim the deduction. Again, those who would face the largest increase are taxpayers in the top tax brackets with the largest mortgages.

The economic effect of replacing the deduction with a flat credit for home owners, regardless of whether their home debt-financed, would obviously depend on the amount of the credit. In general, credits are considered more progressive than deductions, and the benefit of a flat credit to higher-income taxpayers would presumably be less than that under the current regime. However, the incentive towards home ownership would remain intact.

The Joint Committee on Taxation estimates that President Obama's proposal to limit upper-income taxpayers' itemized deductions to 28% would yield $293,261 million over the 2011 through 2021 period. (JCX-19-11) This increased revenue would be largely attributable to the limits on mortgage interest and charitable contribution deductions.

Conclusion. While it seems unlikely that the deduction will be repealed outright, it is nonetheless possible that this popular tax expenditure could be somehow reformed or curtailed. The context of the looming debt crisis may well provide the necessary push for lawmakers to take action on this issue. What choices will be made and when remains to be seen—stay tuned.

Estate Planning is Crucial for Unmarried Couples

2011-05-18T17:21:00.000-04:00

Same-sex and unmarried couples do not enjoy the same legal rights as those of traditional married couples because Michigan does not recognize same-sex marriage or common-law marriage for its residents. Michigan law does not provide for ownership of property, or recognition of decision-making power, for unmarried couples unless specific legal documents are in place for those purposes. Therefore, it is very important for life companions to pay special attention to their estate plans, including wills, trusts, beneficiary designations, and property ownership, to ensure that each of them receives the property intended by the other partner.

Married couples enjoy certain property rights under Michigan law even if they did not make advance arrangements for each other prior to death or incapacity. For example, if a married person does not provide any property for his or her spouse upon death, the survivor is still entitled to certain cash or property “allowances”, and a portion of the deceased spouse’s estate. Most states have rules specifically designed to prevent a surviving spouse from being disinherited. Unmarried couples do not have any such rights.

Unmarried couples must also give special consideration to medical and financial powers of attorney so that their companion will be recognized to make decisions in case of incapacity. Again, Michigan law grants no such power to unmarried couples no matter how long they have been together. Living trusts are especially useful for unmarried couples to maintain uninterrupted property management and decision making power for each other.

Similarly, federal law does not grant any rights to retirement plans, annuities, or other financial assets for an unmarried partner. Therefore, it is critical to designate beneficiaries on all insurance policies, annuities, retirement accounts, and other financial assets.

Unmarried couples with children have even greater estate planning needs because children have higher priority to inherit property than an unwed partner. In that case, conflicts are certain to arise with respect to property ownership. The only way to overcome these challenges is ensure that beneficiary designation and estate planning documents are coordinated to achieve specific objectives.

Life companions must carefully plan every aspect of their estate to prevent unintended consequences. They cannot depend on protective laws to correct mistakes, or to compensate for failure to plan.

Court of Appeals Denies Estate Tax Reduction for Family Limited Partnership

2011-05-17T14:20:00.002-04:00

The Ninth Circuit has affirmed a Tax Court decision that assets transferred by an individual to two family limited partnerships (FLPs) were includible in her gross estate under Code Sec. 2036. This decision is instructive on the planning requirements for FLPs to achieve estate tax savings.

Background. Individuals typically transfer assets to FLPs in the hope of achieving large valuation discounts for the assets that would not otherwise be available if the assets were retained in outright ownership. The valuation discounts, in turn, could result in substantial estate tax savings. However, in order to achieve the desired results, a number of legal hurdles must be overcome.

Facts. Erma V. Jorgensen (Ms. Jorgensen) was a resident of California when she died with a will on April 25, 2002. In 1995, Ms. Jorgensen and her husband, who died a year later, formed an FLP called the Jorgensen Management Association (JMA-I) by each contributing marketable securities valued at $227,644 in exchange for 50% limited partnership interests. Other family members were given interests in the partnership.

A second FLP, JMA-II was formed by Ms. Jorgensen on July 1, 1997 when she contributed about $1.8 million of marketable securities in exchange for her initial partnership interest. Children and grandchildren received interests in JMA-II. Because the value of each of these interests exceeded the then available $10,000 annual exclusion, gift tax returns should have been but weren't filed.

Neither JMA-I nor JMA-II operated a business. The FLPs held passive investments only, primarily marketable securities, and neither maintained formal books or records. Although the partnership agreements stated that withdrawals could only be made by general partners, Ms. Jorgensen was authorized to write checks on the JMA-II checking account, and she wrote checks on both the JMA-I and JMA-II accounts. Some withdrawals were used to make gifts, some of which should have been, but weren't, reported on gift tax returns.

In 2003 through 2006, JMA-I and JMA-II sold certain assets, including stock that Ms. Jorgensen had contributed to the partnerships during her lifetime. In computing the gain on the sale of those assets, the partnerships used Ms. Jorgensen's original cost basis in the assets, as opposed to a step-up in basis equal to the fair market value of the assets on Ms. Jorgensen's date of death under Code Sec. 1014(a). The JMA-I and JMA-II partners reported the gains on their respective Forms 1040 and paid the income taxes due.

Tax Court's Decision. The Tax Court determined that Ms. Jorgensen's estate included the value of the securities which she contributed to both of the FLPs. The court rejected the estate's argument that the transfers of securities weren't “transfers” under Code Sec. 2036(a). The estate's claim that the transfers were bona fide sales for full and adequate consideration, because Ms. Jorgensen had several nontax reasons for making the transfers, including management of her assets and financial education of family members, was overcome by circumstances surrounding the formation, funding, and management of the partnerships.

The court also concluded that there was an implied agreement at the time of the transfers that Ms. Jorgensen would retain the economic benefits of the property, even if the retained rights were not legally enforceable.

Ninth Circuit Affirms. The Ninth Circuit agreed with the Tax Court's decision to include the transferred amounts in Ms. Jorgensen's estate. The estate argued on appeal that, although Ms. Jorgensen retained some benefits in the transferred property, the amounts for which benefits were retained should be considered de minimis or should be limited to the actual amount accessed by decedent. However, the Ninth Circuit rejected these arguments, finding that the $90,000 in checks personally written by Ms. Jorgensen and the use of $200,000 FLP funds to pay her personal estate taxes weren't de minimis.

The Ninth Circuit also agreed with the Tax Court's conclusion that there was an implied agreement that Ms. Jorgensen could have accessed any amount of the transferred assets, and the fact that she only accessed a specified amount doesn't undermine that conclusion. Additionally, it found no clear error in the Tax Court's conclusion that the transfer wasn't a bona fide sale for adequate consideration. Noting that transfers to FLPs are subject to heightened scrutiny, the Ninth Circuit agreed that the nontax reasons advanced by the estate were either weak or refuted by the record.

Planning Lessons. FLPs can be still be used to achieve large assset valuation discounts that result in significant estate tax savings. However, the IRS scrutinizes these transactions very carefully - especially among family members. Great care must be taken to ensure that the FLP has a legitimate business purpose, appropriate gift tax returns are filed, detailed management records are maintained, and that the FLP owners don't use the partnership assets as though they were still personally owned by themselves.

Senator Shelby Proposes Repeal of Estate, Gift and GST Taxes, and Enactment of Flat Income Tax

2011-05-16T14:20:00.000-04:00

S. 820, 112nd Cong., 1st Sess. (April 14, 2011), introduced by Senator Richard Shelby (R-Ala.), would, if enacted, repeal the estate, gift, and GST taxes, with respect to the estates of decedents dying, and gifts and generation-skipping transfers made, after December 31, 2011, and replace the present graduated income tax system with a flat tax. We'll let you know if this proposal ever comes up for a vote.

Designating IRA Beneficiaries to "Stretch" Investment Growth

2011-05-09T08:34:00.002-04:00

Desgnating beneficiaries of an IRA can be tricky - especially when using a trust. I posted an article on my web site to describe the various options for designating the beneficiary of an IRA to "stretch" the payments for maximum investment growth. Special provisions are required when designating the trustee of a trust as a beneficiary. Click here for the full article.

New Michigan Law Limits Collective Bargaining for Public School Employees

2011-04-01T11:41:00.003-04:00

Collective bargaining by public school employees is not really related to estate planning, but there is a great deal of news coverage on the topic. Therefore, I thought it might be informative for readers to see how Michigan has decided to handle this issue. Click here for the text of the new statute that limits collective bargaining for public school employees. Section (3) of the statute contains the topics that can no longer be the subject of bargaining by teachers and school employees.

Implementing "Portability" of a Deceased Spouse's Unused Exclusion Amount

2011-03-29T11:24:00.000-04:00

One of the most important changes under the Tax Relief Act of 2010 is the addition of “portability” for unused estate tax exclusions of married couples.Portability is a major shift in estate tax law. I have drafted an article to explain this new concept, and to provide examples of how it is implemented. Click here to read the full article.

New Tax Law May Impact Your Estate Tax

2011-03-14T16:15:00.003-04:00

I have posted an article on the new estate tax changes. The changes are generally favorable for taxpayers, but they only last until 2013. Click here for the full article.

President's 2012 Budget Proposals Include Permanent Estate and Gift Tax Reforms

2011-03-12T21:40:00.004-05:00

In a release dated February 14, 2011, entitled “General Explanations of the Administration's Fiscal Year 2012 Revenue Proposals”, the Treasury Department explained how the President's 2012 budget proposals contain several important changes in the estate, gift, and GST taxes. These changes include:

• Restoring the 2009 estate, gift and GST tax rules on January 1, 2013. These would include a top estate, gift and GST tax rate of 45 percent, a $1 million gift tax exclusion, and a $3.5 million estate and GST basic exclusion amount;
• Making portability of the deceased spousal unused exclusion amount permanent;
• Require consistency in valuation for income and estate tax purposes, so that beneficiaries were required to use estate tax values to determine the adjusted basis of property received from a decedent;
• Permit the Treasury to issue regulations that expand Code Sec. 2704(b) , to ignore in valuing partnerships, LLCs, and other entities, a new category of “disregarded restrictions,” so as to reduce the use of valuation discounts for such entities;
• Require a minimum ten-year term for GRATs, require a positive value to the remainder interest in a GRAT, and prevent the use of decreasing payments in a GRAT; and
• Provide that the allocation of GST exemption to a transfer protects that transfer from GST tax for no more than 90 years.

If adopted in 2013, these changes would provide much-needed clarity in the areas of estate and gift tax. Even now, it is helpful to know that the estate tax exclusion amount will probably not drop below $3.5 million.

Senate Passes Tax Patent Reform

2011-03-10T10:31:00.004-05:00

On March 8, the Senate passed “The America Invents Act” (Patent Reform Bill). Sec. 14 of this bill would prevent individuals or firms from receiving patents on tax avoidance strategies. Dozens of such patents have been issued, and applications for dozens more are now pending.

This is a meaningful win for all taxpayers because a huge industry has sprung up to create and promote tax avoidance strategies - some of which were duious or outright illegal. In my opinion, it makes no sense to issue a patent that may limit how the tax code may be used, regardless of how novel or inventive it may. Several patented strategies in the area of estate tax planning have arisen in recent years. It's hard enough to comply with the tax code without having to worry about impinging on someone else's patent. Now, we are one step closer to making the tax code the rightful property of all taxpayers. Congress does get things right from time to time.

Bankruptcy Facts You May Need To Know

2010-10-14T16:33:00.005-04:00

I am not a bankruptcy lawyer, but I get so many questions about this topic that I decided to educate myself on the basics. I have posted a primer on bankruptcy law at http://jtlaw.us/bankruptcy. My site is not designed as a "how-to manual" for filing bankruptcy without a lawyer, but simply as a starting point for reference. I have links for bankruptcy forms and means testing, and a table of exempt assets. Please pass it on to anyone that may need this information.

Protect Your Assets from Creditors and Lawsuits!

2010-10-08T14:04:00.014-04:00

I am frequently asked whether a living trust is an effective way to protect assets from creditors. A living trust does protect the trust assets against claims by the creditors of the trust beneficiaries, but it does not protect the assets against claims by creditors of the owner of the trust.

I have drafted an article with 10 Tips to Protect Your Asset From Creditors and Lawsuits, and posted it on my website. These tips are simple things you can do to reduce your exposure to lawsuits and creditors. I hope you find this information useful.

Top 10 Reasons Not to Use Estate Planning Forms

2009-12-15T12:40:00.001-05:00

Top 10 Reasons Not to Use Estate Planning Forms

A lot of people think that estate planning is nothing more that filling out a form. Forms don't work for many reasons. Here are just a few:

1. Forms Do Not Think – When drafting documents, an attorney must take into account numerous laws relating to tax, real estate, insurance, wills, trusts, guardianship, estate administration, and many other areas. Estate planning is a massive legal puzzle, and laws change on regular basis.

2. Forms Do Not Give Advice - You can’t get answers from a form. Some form providers will “review” your document, but this is little more than a spell check.

3. Forms Do Not Work – Drafting a “valid” document is not the same as drafting one that actually works for you. People that draft forms rarely have any real experience with handling property after someone dies. You must clearly understand how a document will be used in order to draft it properly.

4. Forms Cause Higher Risk of Litigation – We have first-hand experience with families that were forced to spend thousands of dollars on probate litigation simply due to a form that was not clearly drafted. An attorney is more likely to draft a document that clearly states what the client intended.

5. Forms Cannot Coordinate Your Assets – Did you know that all of your assets are not covered by a will or trust? Do you know which ones? Are you certain about where your assets will end up?

6. Forms Do Not Protect Your Children – Minor children need special protection if you die. Your assets must be used for their care and support over many years. A will or trust does not automatically perform this function. Do you know how to make sure your family is protected? Are you prepared to take a chance on a form?

7. Forms Do Not Save Money – Probate litigation costs thousands of dollars if something goes wrong. Professional drafting and advice reduce the risk of litigation. The cost of a form is high compared to the value actually provided. Consider the risk of using a form compared to cost of professional services. The advice and counsel of an experienced attorney costs less than you think. [See our Schedule of Fees]

8. Forms Are Not Drafted by Specialists in Michigan – Every state has different laws regarding wills and trusts. Michigan has very specific laws on the meaning of certain words in a will or trust. Using the wrong words can makes a difference. For example, Michigan courts were recently asked to interpret the following phrase in a will: “50% to my brothers and sisters that survive me share and share alike or to the survivor or survivors thereof". Several families fought for years over the meaning of this phrase. Does it seem clear to you?

9. Attorneys Must Stand Behind Their Work – Ask yourself why forms always contain a disclaimer of liability. Form companies make certain that they not responsible for their documents. Attorneys cannot disclaim their work by law. Only an attorney will answer your legal questions even after the document is drafted. And if a question does arise after someone dies, an attorney can testify about what the deceased person really wanted.

10. Every Person Is DIFFERENT – We have drafted thousand of documents, and every one was customized to meet the needs of our clients. It is impossible to create a form that will meet the needs of millions of different people. You might get lucky with a form that fits your exact situation, but the odds are extremely low. Forms are nothing more than high-stakes gambling , and your family is the bet.