Life Insurance Trusts - Alive or Dead?

What About Life Insurance Trusts? Over the past several decades, insurance counselors, estate planning attorneys and CPA’s have counseled clients to create Irrevocable Life Insurances Trusts (ILITs) in order to exclude policy death benefits from the insured’s taxable estate. Typically, the insured would create an irrevocable trust with another person or bank as trustee. The trustee would purchase an insurance policy on the grantor’s life. The grantor/insured would continue paying premiums on the policy. Appropriate Crummey notices are sent to various beneficiaries granting them a limited withdrawal right in order to qualify the premium payments for the annual gift tax exclusion.

The trust would be the named beneficiary on the policy. At the death of the insured/grantor, the trustee of the trust would collect the death benefit (free of any estate taxes) and use the proceeds to benefit family and/or provide liquidity to the insured’s estate by purchasing assets which might otherwise be illiquid, such as real estate or interests in a family business.

Does Anybody Care About ILITs Now? With the federal estate tax exemption now $3.5 million per person, or $7.0 million for a married couple, does anyone still care about ILITs? The typical lawyers’ answer to that question is "it depends". For large estates where there will be a federal estate tax on values above $7.0 million, ILITs are still a valuable part of the estate planning arsenal. Of course, if the current "sunset" provisions of the estate tax law become effective starting in 2010, ILITs will become popular again, when the individual estate tax exemption reverts to $1.0 million in 2011 and thereafter. We consider this highly unlikely, as there are currently Bills pending in both the House and Senate to eliminate the "sunset" provision and extend the estate tax on large estates.

However, there are many existing ILITs currently in operation where administrative or financial problems arise.

Problem #1: The first problem we encounter is failure to send Crummey Notices and retain copies. Why is this important? The answer: if there is an estate tax audit, which would be normal for large estates, failure to observe formalities can result in either the inclusion of the death benefits in the insured’s taxable estate, or disqualifying annual premium payments for the annual exclusion, bringing back those amounts into the taxable estate, possibly with penalties for failure to file appropriate gift tax returns.

Problem #2: Problems often arise when an insured determines that he or she does not want to keep paying premiums or when the insured, and his or her advisors, determine that the policy held by the trust is no longer appropriate because death benefits are too high or too low or because cash values are either too high in relation to death benefits, or too low the carry the policy for the desired period of time in the event that premium payments cease. In addition, changes in actuarial tables sometimes mean that less expensive alternatives are available after the trust has been in effect for a few years.

A recent suit against Key Bank in Indiana highlights the hazards of such changes. Key Bank was the trustee of an ILIT holding an insurance policy on an insured in his early 50s with a death benefit of $8.0 million. Without going into detail, the insured decided either to stop paying premiums or pay a lower amount and reduce the death benefit to approximately $2.7 million. Fortunately, Key Bank, operating as the fiduciary, retained an independent consultant to evaluate the old policy and the new policy and the reasons for the change. The change was then implemented. You can imagine the consequences. The insured died unexpectedly. Naturally, the family, upset with the lower death benefits, sued Key Bank for breach of fiduciary duty.

Key Bank won the case, in large part because of their retention of an independent consultant to evaluate these changes. The beneficiaries were not consulted, probably because the trustee of an ILIT is normally tied to, or affiliated with, the insured rather than the beneficiaries. The bank was also assisted in its defense by the fact that death was unexpected and that the insured had passed other physical exams close to the time that these changes were implemented.

However, the case does emphasize a couple of important points about ILITs. First, circumstances change with respect to the insured, insurance premiums, and changes in personal and business financial situations. Second, is the competitive environment and the availability of new policies, sometimes on more favorable terms. Third, and this is important, is that part of the reason for obtaining life insurance in the first place is that death is uncertain. Normally, we don’t know when we are going to die. If we do know, it is usually too late make changes in insurance coverage. (This ignores the now popular "life settlement" market for large existing policies.)

Problem #3: Changes in the trustee. We have run into several instances where the trustee of an ILIT, for whatever reason, is not satisfactory to the insured or the insured’s family or, alternatively, resigns or dies. Changes in trustees sometimes require court approval. At one point several years ago it was difficult to find a bank which would act as trustee of an ILIT because of potential liability. Consequently, even for large insurance policies, individual trustees, lacking expertise in either trust administration or insurance, were appointed. Sometimes the trust does not contain provisions for filling the position of trustee, if a vacancy occurs, or a change is desired. In that case, a court petition is required.

Conclusion. Life is not certain and neither are ILITs. Great care should be taken in the administration of the trust, changes in policies, and the provisions of the trust relating to changing trustees. Banks and trust companies are now more willing to act as trustees, which provides some assurance that the formalities of administration and Crummey letters would be observed. Existing ILITs should be reviewed periodically by experienced attorneys, not just at the behest of an insurance advisor or agent. If you have an ILIT or are thinking of one, please contact Jim Modrall or any of the attorneys listed below for assistance in such review and evaluation.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau, David H. Rowe, or Nicole R. Graf at (231) 941-9660

©BRANDT, FISHER, ALWARD & PEZZETTI, P.C.

This newsletter is provided for informational purposes and should not be acted upon without professional advice.

SENIOR LIFE PRESERVER - REVERSE MORTGAGE?

Introduction. The subject of this month’s newsletter is a brief discussion about Reverse Mortgages. First, what is a REVERSE MORTGAGE? It is a government insured mortgage available to seniors over the age of 62. There are no monthly payments! The loan is repaid from the sale of the house when the occupant dies or moves out. The mortgage proceeds can be used to pay off an existing mortgage, paid out in a lump sum, or paid in monthly installments. The borrower can choose combinations of the above uses of funds with the exception that any existing first mortgage has to be paid off first before funds can be disbursed to the borrower.

Background. A Reverse Mortgage is technically called a "Home Equity Conversion Mortgage (HECM). Searching Google.com, you are likely to wind up at the website for Fannie Mae or the Federal Housing Administration (FHA), a unit of the Department of Housing and Urban Development. As explained at some length in an article in the Wall Street Journal for Wednesday, June 10th, the maximum value of a principal residence that can be the subject of a Reverse Mortgage was raised to $625,500 in February. This may be an opening to unlock equity in more homes and provide more assistance to seniors needing help with the expenses of daily living. Similarly, because there is no monthly payment, a Reverse Mortgage may be a better financial decision than renting, for seniors who are down sizing. Because of this flexibility, Reverse Mortgages are rapidly increasing in popularity. The Wall Street Journal article of June 10th notes that the number of Reverse Mortgages jumped nearly 20% in the months of March and April, from the same period a year ago.

How Does It Work? Again, using the WSJ example, a senior owning a house worth $500,000, with a $50,000 balance might get a $250,000 reverse mortgage. With these funds, the first mortgage would be paid and the borrower would have $200,000 left to draw in a lump sum, a monthly payment, or a combination. Or, for example, a couple in their 70's who are down sizing, might sell an existing home for $450,000. Rather than paying cash for a smaller residence, they might decide to take $50,000 from the sale proceeds and buy a $200,000 condo using a Reverse Mortgage of $150,000. Thus, they would have no monthly mortgage payment, but would simply be paying taxes, maintenance and insurance on the new residence. A careful financial analysis might demonstrate that based on their health and circumstances, their financial outlay might be reduced by using a Reverse Mortgage, rather than renting at $1200-$1500 per month or more.

How Much Can I Borrow? The maximum amount available is based on a HUD formula. That formula takes into account the age of youngest borrower, assumed interest rate, and the appraised value of your house. If the appraised value is higher than the maximum insurable amount for our area, then the lower figure is used. The maximum insurable amount in Michigan is now $625,000.

The age of the youngest borrower (if there are co-borrowers) affects the amount one can borrow. For example, an 85 year old borrower (or youngest borrower) can borrow substantially more against the value of the house than a 65 year old borrower. The reason is obvious - the life expectancy of the older borrower is less and, therefore, the interest that accrues on the loan until the youngest borrower dies or moves, would be much less for an older person.

What Are the Fees Involved? There has been a lot of negative publicity about the fees that are incurred in Reverse Mortgages. The origination fee, payable to the lender, is limited to 2% on the first $200,000 and 1% on any amount over that, with a cap of $6,000. There is an insurance fee of 2% of the maximum claim amount, and an annual ongoing fee of 1/2 percent of the mortgage balance. In many cases, the origination fees for the lender and for the insurance are paid out of the loan. In some cases, we understand, the borrower has up-front fees. However, in our experience in counseling clients, we have generally seen the origination fees paid from the loan. That is, the fees are added to the loan balance due to the lender when the house is sold. These fees do add up and should be a consideration in the decision to use your home to augment retirement income. You will note that the federal rules require counseling and a full explanation of costs. Our local agency suggests shopping around, as fees may vary.

What If The Amount Owed Exceeds The Value Of The Home, Or The Sale Proceeds? There is no deficiency payable from the borrower’s estate, if the proceeds from the sale of the home are less than the amount owed. The lender cannot force the sale of the home so long as it is occupied as a principal residence. If the borrower moves out or dies, the borrower or the borrower’s estate generally has six months in which to sell the home before it has to be turned over to the lender. We understand that obtaining an additional six months extension for the sale is relatively easy to get. Again, this probably depends upon the amount owed in relation to the value of the property. In the event that the sale proceeds exceed the amount owed, the balance goes to the borrower’s estate or trust.

Will HUD Be Able To Honor The Insurance? With the decline in housing prices, there is some concern that certain Reverse Mortgages may wind up under water. However, HUD is collecting insurance premiums from all borrowers which will help defray all losses incurred by the lenders. As with any insurance program, losses are possible. However, HUD is building reserves to cover future losses. Current appraisals will take into account the decline in property values, so seniors exploring the Reverse Mortgage option now may find that they are not able to borrow as much as might have been possible two or three years ago.

What Is the Bottom Line? Reverse Mortgages are not for everyone. If a senior has already moved to assisted living, a nursing home, or moved in with relatives, this option is no longer available. We have found that the program is most appealing to older seniors, often in the 80's, whose fixed income from social security or pension benefits is being squeezed by increased expenses. Because of their age, they generally can borrow larger amounts against the equity in their homes. Reverse Mortgages, despite their up-front costs, can often permit seniors to stay in their homes and augment their income without having to sell the residence and move to a rental. Moreover, as we pointed out above, in some cases where seniors plan significant down sizing, a Reverse Mortgage may be an attractive option to eliminate a monthly mortgage payment on the new, smaller residence.

Reverse Mortgages can be part of overall estate planning for seniors, and need to be considered in relation to the borrower’s age, health and the possibility that Medicaid might be needed to pay for nursing home costs. A Reverse Mortgage is not a "one size fits all" solution, but can be a handy tool in estate and financial planning. If you have questions regarding these matters, or government assistance programs such as Medicaid or VA Benefits, please call Jim Modrall or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660

©BRANDT, FISHER, ALWARD & PEZZETTI, P.C.

This newsletter is provided for informational purposes and should not be acted upon without professional advice.

SPECIAL DEAL ON LONG TERM CARE INSURANCE

Long Term Care Insurance - Peace of Mind and Protection. As we have mentioned in prior newsletters, we estate planners typically recommend Long Term Care ("LTC") insurance for clients who want to protect their assets from the drain of long term care, whether provided in a nursing home or in the patient’s own home. The principle objections or obstacles to the purchase of long term care insurance is: (1) the cost; or,(2) bad health.

We have pointed out in previous newsletters that both cost and health conditions may be mitigated by single premium life insurance policy with an LTC rider. That is, excess liquid funds such as CD’s can be converted into an insurance policy with LTC benefits and a death benefit for family, in the event the LTC benefit is not needed.

Special Incentive. A recent article in the insurance section of the MainStreet.com newsletter of March 3, 2009 has called our attention to a special provision of the Pension Protection Act of 2006 ("PPA") that permits the conversion of existing life insurance policies or annuities to LTC insurance effective January 1, 2010 without income tax penalties.

Built-in Tax Penalties. Many clients have life insurance policies, often paid up, which have a potential income tax cost on the income build up in the policy, in the event the policy is cashed in during lifetime. Similarly, annuities - variable, fixed or combination - often have a built-in tax liability on accumulated income. Being able to acquire LTC insurance with a lump sum premium (the cash value of the life insurance policy or annuity) could be a good alternative for clients with existing contracts who want to protect their estates against the cost of long term care, whether home bound or nursing home.

New Products. MainStreet.com points out that insurers are currently designing policies to meet the demand for the tax free exchanges permitted by PPA. Heretofore, a single premium life insurance with LTC benefit has been a popular option for clients who have liquid assets and are young enough or healthy enough to qualify for a single premium policy.

Keep in touch with your insurance advisor to stay informed of new products which may be offered later this year with LTC benefits that are attractive. These products may mirror some of the special features of existing single pay policies such as return of premium and/or death benefit in addition to LTC coverage. MainStreet.com estimates that new policies will probably provide for single premiums of $50,000-$200,000, depending on the benefits chosen, age, etc.

Why LTC Insurance? Long term care needs are a fact of life for many of us as we live longer. Statistics show that of people reaching the age of 85, 50% will have some form of mental deficiency such as Dementia, Parkinson’s, Alzheimer’s, or related brain dysfunctions. While the term "nursing home" has bad connotations, my personal experiences have been that nursing home care may not only be a necessity but a blessing for both the patient and family members. Care giving chores for dementia patients can become onerous for individual care givers and beyond the abilities of many. Many patients do better in a nursing home with continual company and attention as opposed to many hours of solitude in their own surroundings.

Moreover, we have seen the benefits of long term care insurance in helping patients to remain at home as long as possible by providing a care giver with much-needed assistance.

Many clients recognize the benefits of long term care insurance but are either too old or unhealthy to qualify or, alternatively, state that they cannot afford the premiums. We advise clients to investigate LTC coverage before age 70. The new tax free exchange provisions of PPA may provide just the incentive many people need to acquire LTC coverage on a tax advantaged basis and thereby protect assets from the devastation of nursing home costs, should an extended period of nursing home care be required.

If you have any questions concerning long term care insurance, Medicaid planning or your estate planning, please contact Jim Modrall or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660

©BRANDT, FISHER, ALWARD & PEZZETTI, P.C.

This newsletter is provided for informational purposes and should not be acted upon without professional advice.

DIVORCE TRAP

Have You Been Divorced or Do You Have Friends Who Have Been Divorced? Hardly anyone I know could avoid a yes answer to either of these alternative questions. Divorce has become a common part of our daily lives.

The recent decision of the United State Supreme Court involving a divorced decedent and his retirement plan highlights at the highest level a problem that we as trust and estate attorneys see frequently.

The Kennedy Facts. William Kennedy worked for DuPont. He named his wife as beneficiary of his retirement plan, with no contingent beneficiary. William and his wife divorced with a provision in the divorce decree divesting his wife, Liv, of her interest in William’s retirement plan. This is a common provision in divorce decrees and settlement agreements.

You can guess what happened. William did not file a change of beneficiary before he died. DuPont or the plan administrator paid the balance of the retirement funds to Liv. William’s Personal Representative, his daughter, filed suit against DuPont for improper payment of the plan benefit based on several legal arguments. The estate won in the District Court. The Circuit Court reversed, holding that Liv was the beneficiary under the plan and that the plan administrator was therefore bound to pay the benefits to her. Going all the way to the United States Supreme Court, the Circuit Court was affirmed. Payment to Liv, the ex-wife, was proper despite the divorce decree. The Supreme Court did not mention any rights that the estate might have against Liv to recover the funds already paid.

Divorce Settlements Can Be Confusing. As mentioned above, it is a common provision in divorce decrees and property settlements that the respective parties either relinquish any interest as a spouse in the other’s retirement plan, or sometimes when the retirement plan assets are large and disproportionate, the divorce decree and settlement provides for an assignment to the less advantaged spouse of a portion of the other spouse’s retirement plan under what is called a QDRO, a Court Order dividing a qualified retirement plan and permitted by federal law.

In addition to retirement plan benefits, typically divorce decrees and property settlements have specific provisions relating to life insurance policies and the obligation of the spouse/owner to continue a beneficiary designation or permitting a change of beneficiary. Michigan law (and also the laws of other states) provides that a divorce nullifies a spousal beneficiary designation. Problems arise where no action has been taken to formally change the designation of a divorced spouse as primary beneficiary prior to the death of the insured.

The difference between life insurance and retirement plans, however, is that federal law trumps state law where certain qualified retirement plans are concerned, as was stressed by the US Supreme Court in the Kennedy v. DuPont case.

Result for the Decedent’s Estate. Both situations involving retirement plans and life insurance (or annuities, as the case may be), with an intervening divorce, are a ripe area for litigation, and possible loss by the decedent’s estate, children, or subsequent spouse. The situation arises because of the failure of the spouse who is the owner of the retirement plan or insurance policy to carry through with the terms of a divorce and change the beneficiary designation. Whether this is the fault of the individual or the individual’s attorney, can be debated in each case based on facts and circumstances. This lack of attention to housekeeping details can be disastrous and is a common source of litigation. The insurance company or retirement plan administrator does not mind paying out the death benefit, it just does not want to pay out twice.

The moral of the Kennedy case and similar situations is that divorced individuals should pay attention to the details of their property settlements and divorce decrees and make sure that each item requiring attention has been attended to, including deeds, title transfers and beneficiary designations.

Often, unfortunately, after a long, difficult divorce proceeding, the parties are so relieved to have it finished that they neglect the details of implementing the agreement. If you have been divorced, check again to make sure that all of the property divisions agreed to have been accomplished including beneficiary designations. If you have friends who have been divorced, you might remind them of the Kennedy case and suggest that they attend to their own details to make sure that their families are not subjected to the expense and delay of litigation to say nothing of the possible lost resources.

Conclusion. Divorce plays an important role in estate planning and needs to be carefully considered when the estate plan of each spouse is reviewed and updated. If you have a need for a review or update of your estate planning documents, with or without references to a divorce decree, please contact Jim Modrall or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660

©BRANDT, FISHER, ALWARD & PEZZETTI, P.C.

This newsletter is provided for informational purposes and should not be acted upon without professional advice.

Anatomical Gifts - Recent Developments

Michigan Expands Laws. Effective May 1, 2008, Michigan adopted the Revised Uniform Anatomical Gift Law, which amended, expanded and replaced many of the provisions of the original 1978 statute.

Drivers licenses and the Secretary of State’s Registry have been the primary method for expressing willingness to make an anatomical gift at death. Paramedics and ambulance crews are experienced in reviewing the back of your drivers license to see if there is any indication of a willingness a make an anatomical gift. However, let’s face it, most of us don’t like to think about this subject. I would venture a guess that very few people have made a donor intent known by inscribing the back of their drivers license and, more probably, have not registered with the Secretary of State for electronic recording of a willingness to make an anatomical gift.

Expression By Will. Our Estate Planning Questionnaire contains a space for indicating a desire to make an anatomical gift at death. Frankly, a relatively small percentage of clients make such wishes known in their Will.
　
The new statute broadly defines a document of gift to include donor card or "other record used to make an anatomical gift", which would include a Will.

In the event of an accident, or in the event of many medical interventions, a donor’s Will simply is not available. Its contents may not be known to family and friends, much less hospital and doctors.

How To Address the Problem. The new statute, MCL 333.10112 makes it mandatory for any person rendering medical assistance to make a reasonable search of an individual for indication of donor intent or refusal. This obligation is imposed on medical professionals, hospitals, law enforcement officers, fire fighters, doctors or other emergency rescuers. This new provision does not impose civil or criminal liability so has no practical teeth.

From an estate planning standpoint, however, the important point is make donorative intent, if any, known to medical professionals and the family. Generally, clients who want to make anatomical gifts have strong feelings on the subject. Those intentions may or may not be made known to spouses, children or other friends and relatives.
　
Medical Power of Attorney. It appears, therefore, that clients who have a serious intent for anatomical donations at death should:

1) Make a notation on their drivers license.

2) Register with the Secretary of State.

3) Alternatively, or including any of the above, make a specific provision in his or her Will.

4) Finally, if the only action taken is a provision in a Will or Codicil, we recommend a provision in the Medical Power of Attorney (Patient Advocate Designation) making known that there is an anatomical gift provision in the patient’s Will. Typically, if there is a hospital stay, the Patient Advocate Designation is available and referred to.

Recommendation. Refer to your Medical Power of Attorney, whether the printed form such as Five Wishes or the document drafted by us. If you have a serious intent to make an anatomical gift, in the event of death, make sure your MPOA has a reference to your intention and your Will, if you have made provisions there of your intentions to make an anatomical gift.

Decisions by Relatives. The new Michigan statute has an expanded list of individuals who are authorized to make anatomical gifts at death, provided there is no clear intention that a decedent has refused to make such gifts or has issued instructions barring any anatomical gifts, whether for transplants or research. Similarly, the new law contains provisions for oral instruction, positive or negative, and the revocation of previous instruction.

　
Moreover, the new law contains provisions for reconciling any differences that might occur between the administration of care and potential medical treatments.

Gruesome Subject. We realize that this is not a typical subject for dinner table conversation. However, it is receiving increasing attention as a result of medical advances. If your feelings are strong one way or the other about organ donations, we suggest we make your wishes known in your Will or Codicil and in your Medical Power of Attorney. For many people, this is not a subject of concern and debate. However, if this is a matter of concern to you and you wish to add an anatomical provisions to your Will and/or to your Medical Power of Attorney, we will be happy to assist you and prepare the necessary documentation for nominal fee of $50 for simple provisions.

If you have any other matters of concern concerning your existing estate planning documents, please contact Jim Modrall or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660

©BRANDT, FISHER, ALWARD & PEZZETTI, P.C.
*These articles are meant strictly for informational purposes. Nothing contained therein should be construed as legal advice.

All In The Family

Introduction. The purpose of our newsletter is to inform readers of what we think are interesting developments in the estate planning and elder law areas. Occasionally, related income tax developments come to our attention which we think some readers might find interesting.

What is a "Family"? A recent decision of the Tax Court in the Leonard case involves an interesting court decision on what constitutes a family for income tax purposes. We are all aware of the dependency deduction. The dependent deduction shows up boldly on the income tax return. However, there are other income tax issues that are directly affected by the financial arrangements involving a group of individuals, related or not, residing in a common residence.
While this may not affect our readers directly, you may be aware of friends or other members of your family who may have similar circumstances.

Danita Leonard Facts. Danita Leonard was an unmarried individual with full time employment. She provided 80% of the household expenses for her roommate, her roommate’s two grandchildren, and herself.

On her federal income tax return for 2005 she claimed:

1) head of household status;
2) adjusted gross income under $30,000;
3) a dependency deduction for her roommate and her roommate’s grandchildren;
4) child care credit;
5) child tax credit;
6) unearned income credit.

(She also claimed an education credit for college courses she took in connection with her employment, an issue not germane to our discussion here.)

The IRS challenged all of the items for which Danita claimed eligibility. It is of great interest that Danita represented herself all the way to the Tax Court, which ruled that Danita was:

1)entitled to head of household status;
2)entitled to claim a dependency exemption for her roommate;
3)entitled to claim dependency exemptions for the grandchildren of the roommate, because each was qualified as a qualifying relative;
4) not entitled to a child tax credit;
5) not eligible for the earned income credit;
6) eligible the education tax credit.

Comments We credit Attorney Marc Soss, a contributor to our estate planning newsletter from Leimburg Services with bringing this case to our attention. The case was entered under Section 7463(b), which means that it cannot be claimed as a precedent in other cases. However, practitioners in family law and estate planning may well use the principles enunciated in this case in advising people about the income tax benefits of various living and expense sharing arrangements.

Brief Review. To qualify for "Head of Household" treatment, a taxpayer must not be married or a surviving spouse at the close the taxable year. Moreover, the taxpayer has to have a dependent living in the home as the dependent’s "principal place of abode". Without getting into specifics and technicalities, the Tax Court found that one or more of the persons living in Danita Leonard’s house, for which she was providing the principal support, qualified as dependents under IRC Section 152. In fact, the Court determined that Leonard’s roommate and the roommates two minor grandchildren were dependents.

Conclusion. The purpose of highlighting the Leonard decision is to point out that there are many living arrangements involving individuals related or unrelated who care for minor children. While many such living arrangements involve taxpayers at or near the poverty level, often individuals with more substantial incomes provide such support. All "these un-conventional families" need to study the possible tax benefits of "head of household" status.

We would also express respect and admiration for the taxpayer, Danita Leonard, who pursued and argued her own case in front of the Court. For the more specific references for readers, friends or advisors, we refer them to Leonard v. Commissioner, TC Summary Opinion, 2008-141.

We hope you find this comment of interest and further hope that it may find applicability among the members of your family, friends or acquaintances.

If you have questions concerning estate planning matters, including elder law or medicaid eligibility, please contact Jim Modrall or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660
©BRANDT, FISHER, ALWARD & PEZZETTI, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional advice.

Gifts - To Report Or Not To Report

Introduction. Gifting is a fundamental part of our culture. Gifts to charitable organizations are typically reported on income tax returns where itemized deductions are claimed. Reporting on charitable gifts, especially of property other than cash, is a separate subject not covered by this newsletter.

Other the other hand, gifts for the benefit of family members are part of our culture and a key component of estate planning recommendations.

Quick Review. The annual gift tax exclusion is now $13,000 per year per donee. In other words, a single person can gift $13,000 to each of two children, for a total $26,000 in 2009. If each child is married and the spouse appears on the check, annual exclusion gifts would double to $52,000.

Present Interest. In order to qualify for the annual exclusion, the gift has to be a present interest such as cash or property. Gifts in trust typically do not qualify for the annual exclusion because full enjoyment is delayed by the terms of the trust. An exception to this rule would be trusts for minors under section 2503(c) of the IRC, or gifts under UTMA - the Uniform Transfers to Minors Act. In each of these cases,enjoyment of the property has to be transferred to the donee by age 21. The minor’s social security number is typically used on the account and any taxable income on the principal of the gift has to be reported on the minor’s income tax return.

When Should Annual Exclusion Gifts Be Reported on a Form 709 - Federal Gift Tax Return? If a spouse consents to treat half of the gift as being made by the non-donating spouse, the split gift with the consent of the non-donating spouse has to be reported on a Form 709, even if the gifts are annual exclusion gifts. Often this requirement is ignored because these are tax-free gifts, and the taxpayers expect that there is no penalty for failure to report. Moreover, taxpayers generally do not like to pay for filing tax returns that they consider unnecessary.

Potentially Taxable Estates. Who’s to know whether there will be a federal estate tax at death or at the death of a surviving spouse? The estate tax exemption is $3.5 million per person for 2009. Under current law, the estate tax goes away in 2010 and returns with the vengeance 2011. As we have indicated in other newsletters, our expectation is that exemption will continue at $3.5 million per person after 2009 (or possibly higher) when Congress addresses these tax issues in their overall review of tax legislation that is expected this year under the new administration.

Therefore, we advise higher net worth clients, with total marital assets in excess of $7.0 million, or $3.5 million for single individuals, to conduct their affairs and file information returns with the IRS to avoid future controversies and unnecessary taxes in the future. This especially means filing Form 709 for purposes of making disclosure to the IRS and starting the three year statute of limitations running so that gifting will not be challenged by the IRS many years in the future in connection with estate tax audits.

Lifetime Exemption. The lifetime exemption for tax-free gifts is currently $1.0 million per person (in addition to qualified annual exclusion gifts). Many higher net worth clients are taking advantage of this exemption by making gifts of appreciating property usually in trust. These gifts should always be reported on Form 709, along with proper appraisals if the property is other than cash or listed securities.

Section 529 Plans. Establishing qualified tuition plans (QTP or Section 529 Plans) offers the possibility of pre-funding annual exclusion gifts for five years. Thus, $65,000 can be contributed to a Section 529 Plan for each beneficiary. The contribution is allocated rateably over the five years and should be reported on a Form 709 Gift Tax Return. If a donor dies within the five year period, any unabsorbed portion of the exclusion is brought back to the taxable estate of the donor, if any. Despite this boomerang provision, we recommend pre-funding Section 529 Education Plans for grandchildren or great grandchildren as an essential and valuable part of estate planning techniques.

Crummey Withdrawals. A familiar technique for gifts in trust, especially life insurance trusts, is to give a potential beneficiary a limited right to withdraw a portion of the annual contribution so that such withdrawal amount can be counted against the annual exclusion gift for that donor and donee. Crummey Withdrawal provisions are another important weapon in the estate planner’s arsenal and can accomplish substantial estate tax reductions, assuming that a donor’s net worth puts him, her or them in the position of potential estate tax in the future. As with other types of specially qualified gifts, we recommend that Crummey Gifts be disclosed on Form 709, even though no tax is due, to prevent future attacks by the IRS.

Conclusion. If you have questions concerning gifting as part of tax saving strategies, or strategies for transferring wealth to future generations, please call Jim Modrall or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Thomas A. Pezzetti, Jr., Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau and David H. Rowe at (231) 941-9660
©BRANDT, FISHER, ALWARD & PEZZETTI, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional advice.