Going Into Reverse - Coming Out Ahead

Reverse Mortgages. Persons 62 and older are eligible to take out a Reverse Mortgage on their residence. Read on to learn more about this strange animal called a Reverse Mortgage.

A Reverse Mortgage is a first lien on a residence that has no monthly payments. In many cases, the borrower withdraws all or part of the loan in monthly installments, thus the term "Reverse Mortgage". The lender pays the borrower monthly rather than vise versa.

The idea is to permit seniors to tap the equity in their residence, or pay off an existing home equity loan or mortgage, avoiding a monthly payment, and augmenting retirement income. The borrower has a choice of benefits, lump sum, monthly payment or a combination.

Example. Take the hypothetical case of a 76 year old widow with an $300,000 condo subject to a $80,000 home equity loan on which the monthly interest at 6% is $400 per month. The widow's retirement income (social security and pension) is $1,600 per month. She can hardly afford the monthly payment on the home equity loan and might not qualify for a regular mortgage because of her low income. Solution: A Reverse Mortgage which pays off the home equity loan and provides a monthly income of $350 per month for the widow's lifetime. Her monthly available cash, therefore, has improved by $750 per month, the $400 interest payment she saves, plus the monthly cash disbursement by the lender. The widow makes no monthly payments on the loan but still has to pay for insurance and taxes, which are expenses she had anyway.

How Does The Loan Work? Reverse Mortgages are guaranteed by the federal government so there is generally a saving in the interest rate. The lender's interest accrues, adding to the outstanding loan balance each month. Included in the interest accrual is an insurance premium. Also, included in the loan balance are the initial expenses for the lump sum payment to the government, the lender's origination fee, appraisal and closing costs. In my experience, these fees and costs generally run $9,000-$20,000, depending on the amount of the loan. Fees have often been cited as a strong negative to Reverse Mortgages, as they may reduce the amount of the equity in the property that is available to the borrower's heirs. However, the benefits outweigh the negatives for many seniors.

Ultimate Payoff. The lender has to get paid its principal and interest somewhere along the line. There is no free lunch. The typical Reverse Mortgage terms provide that the loan becomes due at the death of the borrower or if the borrower moves out, for example to go to a nursing home. The borrower, or the borrower's representative, has six months in which to sell the property and pay off the loan. Generally, an additional six months is granted to reflect market conditions. If the property is not sold, the lender takes over the property and has to sell it. Since the loan is guaranteed by the federal government, the lender can't lose on the deal. The lender has no claim against the borrower's estate.

Whether there is any equity in the property left for the borrower's heirs, will depend on how much money the borrower has drawn and how long the borrower lives or stays in the house. For this reason, an older borrower, with a shorter life expectancy, is permitted to withdraw more money from the Reverse Mortgage loan than a younger borrower with a longer life expectancy. The insurance premiums paid to the federal government are supposed to cover variations in market values and life expectancies.

The program is relatively new, but is gaining in popularity because of bad market conditions, outstanding loans, and the squeeze felt by many retirees in their pension and social security income. In some ways, the program can be looked upon as a government incentive to seniors for staying in their own homes.

Down Sizing. Another use for a Reverse Mortgage is in financing a new, smaller home. For example, a married couple want to down size and realize $400,000 from the sale of their primary residence. They want to buy a smaller condo in Florida for $200,000. Based on their ages, they may be able to borrow $100,000 on a Reverse Mortgage on the new Condo This reduces their out of pocket purchase costs to $100,000, and leaves investable funds of $300,000. They have no mortgage payments on the new house and have substantial liquid funds for investment, living costs, or assisting family members.

New Competition. As pointed out by a recent Wall Street Journal Article, competition is heating up the Reverse Mortgage market. Active lenders are Genworth Financial, Bank of America, Wells Fargo and Financial Freedom. Also, the Article points out that Met Life is also dropping its Reverse Mortgage origination fees and servicing charges. Because the Reverse Mortgage scene is constantly changing, clients are advised to do comparative shopping, which has potential to save thousands of dollars in origination fees and servicing charges.

Conclusion. Reverse Mortgages can be a useful tool for financial planners, seniors and estate planning advisors. We have had several clients tap their home equity with a Reverse Mortgage, enabling them to stay in their homes, augment their income and improve their standard of living. We suggest that an interested borrower get quotes from several lenders. A Reverse Mortgage generally involves modifications of a client's Will or Trust, as well. If you, friends or relatives want to consider a Reverse Mortgage and discuss its impact on overall estate planning, please call James R. Modrall III or Thomas A. Pezzetti, Jr. or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau, David H. Rowe and 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.

Tax Impact - New Health Care Bill

Keebler Analysis. Credit for this summary alert goes to Bob Keebler, a Wisconsin CPA who advises affluent clients throughout the country. Bob has analyzed the important income tax provisions of the 2010 Health Care Bill and has posted his narrative on our Leimberg estate planning listserve. This is a synopsis of his presentation. I have to confess that I have not read the new health care bill. As passed, it will have an impact on affluent clients, meaning singles with income over $200,000 and married couples with income over $250,000, the "Threshold" amounts.

Medicare Surtax. The 2010 Bill establishes a 3.8% Medicare Tax on passive net investment income in excess of the threshold amounts. This newsletter will attempt to summarize Bob Keebler's analysis of the new Surtax.

The 2010 Health Care Bill establishes a third tier of income tax calculations. We are familiar with the first two tiers, the regular tax calculation and the AMT (Alternative Minimum Tax). We now have a third tier, Surtax calculation, for higher income tax payers. Also, it is important to remember that the Bush tax cuts expire in 2010. Therefore, the highest marginal effective tax rates are likely to increase from 35% to 43.4%, effective January, 2013.

Investment income would normally be royalties, dividends, interest, and capital gains. The new tax will be levied on "passive" investment income as opposed to "active" investment income, a distinction which has been present in the Code for many years. An example of this distinction would be a landlord who actively manages rental properties vs. rental income from partnerships, or income from oil and gas investments, where the taxpayer is not "active" in management.
Modified Adjusted Gross Income. The measuring rod for the Surtax will be Modified Adjusted Gross Income ("MAGI"). MAGI will include capital gains and all other income, including pensions, deferred compensation, etc.

It is important to note that distributions from qualified retirement plans are not subject to the Surtax. However, taxable distributions will push up MAGI so that other passive investment income, becomes subject to the tax.

Two Important Points. With increasing rates ahead for high income taxpayers, Keebler makes two important points for them and their counselors:

1. Death in 2010. For taxpayers dying in 2010, prior to November 30, representatives should choose a fiscal year ended November 30 to achieve maximum avoidance of increased tax rates, particularly the Surtax. Under special provisions of the Internal Revenue Code, estates and revocable trusts can elect fiscal years other than the year ended December 31. This is a commonly used tax deferral technique, which will now help avoid some of the rate increases and Surtax.

2. Roth Conversions. We have written previously about the advantages of Roth conversions in 2010. We see increased publicity for this technique in the financial press. The new Surtax makes Roth conversions in 2010 look even more attractive. The distribution from a regular retirement plan will be taxable in 2010. However, the 2010 tax rate appears to be much lower than affluent taxpayers will face in future years, especially those higher income taxpayers who will be facing the large increase in the top bracket.

Conclusion. Many professionals have not yet had an opportunity to analyze the impact of the new Health Care Bill on client taxes. Suffice it to say that if you advise higher income clients or if any reader fits this category, be alert to these changes. Make sure that you, or your client, sit down with a financial planner or CPA, to analyze the potential impact that the bill will have after 2010 and consider what steps you can take this year to minimize your potential tax exposure in the future.

We get involved with estate and trust administration which will have potential impacts under the new legislation. Roth conversions also impact estate planning by beneficiary designations, etc. If you have questions regarding any of the above, please contact James R. Modrall III or Thomas A. Pezzetti, Jr. or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau, David H. Rowe and 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.

Taxpayer Wins Uncapping Case

Joint Tenants Are Happy. Property owners are universally unhappy that the taxable value of their property gets "uncapped" at death. In the case of a married couple, the property gets uncapped at the second death, with taxable value rising to fair market value for the year after the second death.
A popular tactic in the circumstances has been for a husband and wife to execute a deed transferring the property to husband, wife and child, as joint tenants with full rights of survivorship. Alternatively, if husband dies first, wife can do the same thing, transferring the property to herself and son, as joint tenants.
The Michigan Department of Treasury has taken the position that in the circumstances described above, the property is uncapped when wife dies (the second death), unless the son was a joint owner in 1994, when the new property tax laws were enacted.

New Case. These were essentially the facts in a recent decision by the Michigan Court of Appeals in Klooster v. City of Charlevoix, decided December 15, 2009.
In Klooster, husband and wife, James and Donna Klooster, owned property as tenants by the entireties. In August, 2004, Donna quit claimed her interest to James. On the same day, James, the sole owner, quit claimed his property to himself and their son, Nathan Klooster, as joint tenants, with rights of survivorship.
James died in January, 2005. Then in September, 2005, Nathan executed a quit claim deed, creating a joint tenancy with rights of survivorship with his brother, Charles Klooster. The City of Charlevoix asserted in 2006 that the property had become uncapped at the death of James in 2005 and that the taxable value was to be uncapped, approximately doubling.
The Michigan Tax Tribunal affirmed the decision by the Assessor and the Board of Review that uncapping had occurred.
The question before the Court of Appeals was whether James' death was a "transfer of ownership", as defined by the Michigan statutes. Unfortunately, the specific sections of the statute are ambiguous.
Many practitioners throughout Michigan have observed this ambiguity and have assisted in the creation of joint tenancies, usually between parents and children, in the hope of avoiding an uncapping when the last parent dies.
Without getting into the technicalities of the Court's analysis of the statutory language, we would note that the analysis by the Court of Appeals will probably be challenged on appeal to the Michigan Supreme Court.

Trustworthy Decision? At this point, it is too early to say what the Michigan Supreme Court will decide and whether the Michigan legislature will address this potential loophole and clarify the language of the statute.
If the Klooster decision is upheld by the Supreme Court, taxpayers are faced with the further questions whether any legislative fix could be retroactive to joint tenancies created prior to a statutory change.
We have employed this strategy for clients on occasion, with the caveat that the Michigan Department of Treasury has consistently taken the position, in the facts outlined above, that the property gets uncapped at the parent's death.
Should clients rush out and attempt to do the same thing to forestall uncapping? That raises another question, "what is the downside of trying?" Depending on the facts involved, there may not be much downside from clients trying to get in under the wire, where the facts are clear and where the creation of a joint tenancy fits in with the overall estate plan.

Stay Tuned. To paraphrase Yogi Berra, "it ain't over till it's over."
If you have questions concerning uncapping, joint tenancy and integration with your overall estate plan, please call Jim Modrall or Tom Pezzetti or any of the attorneys listed below.
Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau, David H. Rowe and 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.

WHAT A MESS!

The Unthinkable. At the date of this writing, it appears that Congress will adjourn before December 31, 2009 without any action to fix the estate tax. Almost no one in the estate planning profession would have dreamed that this would be possible.

To refresh your memory, the 2001 Bush Tax Bill reduced rates and increased the exemption so that in 2009 the exemption became $3.5 million per person with a fixed rate of 45% on the amount of the taxable estate in excess of that amount. For a married couple, thus a total of $7.0 million could be protected from the federal estate tax.

But apparently, the unthinkable has happened. Congress has not taken any action to delay, prevent or terminate the Sunset Provisions in current law. In other words, 2010 will bring a complete lapse of estate taxes and a return to the $1.0 million individual exemption in 2011.

Consequences. Remember that the gift tax is still effect. If nothing is done to restore the estate tax, persons dying in 2010 will have a completely different legal matrix applicable to their estate. The good news is that there will be no estate tax.

The bad news is that there will be what is called carry-over basis, which is intended to impose a capital gain tax on assets when they are sold, based on historical costs.

There are exemptions for carry over basis, in particular as to assets allocated to a spouse. The purpose of this newsletter is not to go into detail about the technicalities of this law. Congress tried carry over basis years ago and found it to be unworkable.

What About My Estate Plan? Most traditional Wills and Revocable Trusts have some division of the Trust at death, usually called an A/B Trust formula. The interpretation of these formulas, if someone dies in 2010 without an applicable estate tax, will be up in the air.

Without changes, it is probably that there will be a great many petitions to probate courts for interpretation of trusts which became irrevocable at death in 2010.

(We avoided this interpretation question in recent years where nuclear marriages were involved by providing for a single trust for the benefit of the surviving spouse, at the first death.)

Horns of a Dilemma. Clients are thus faced with a dilemma, modify older A/B Trusts formulas in existing Revocable Trusts, or wait to see if Congress reinstates the estate tax in early 2010.

Our recommendation would be to wait until the end of February to see if Congress takes action, retroactive or not. Clients with imminent health issues may wish to modify their A/B Trust provisions promptly in January, but otherwise we think it is prudent for clients to wait and see if Congress acts.

If Congress does not act in reasonable haste, then we would recommend clients with A/B Trust formulas in their trust documents set up appointments right away to make changes, which will eliminate ambiguities in the event of death in a period when there is no tax and carry over basis applies.

The dilemma can certainly be solved. The timing is an issue. Please call Jim Modrall, Tom Pezzetti if you wish to schedule an appointment to discuss this matter and the status of your current documents. Alternatively, contact any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, Susan Jill Rice, Gary D. Popovits, H. Douglas Shepherd, Laura E. Garneau, David H. Rowe and 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.

Gifting - Who Gives and Who Gets?

Who Gives? Increasingly, clients are interested in gifting assets, usually to children and grandchildren. This is part of the normal transfer of wealth from one generation to the next generation. Parents and grandparents make continual and regular gifts to children and grandchildren, generally as holiday presents or to meet special needs such as medical bills or college expenses.

Sometimes large gifts are contemplated as part of estate planning. This month we will touch on some of the motivations and rationale for gifting - usually larger amounts than a normal Christmas gift.

Estate and Gift Taxes. Clients typically make annual gifts to take advantage of the annual gift tax exclusion, now $13,000 per donee per year. In addition, an individual is allowed to make a $1.0 million lifetime gift, free of gift tax. Gifts in excess of that amount are subject to gift taxes and, in our experience, are almost never done. Lifetime taxable gifts (part of the $1.0 million) are deducted from the $3.5 million per person federal estate tax exemption, in calculating whether a federal estate tax is due on death.

As part of overall estate and tax planing for clients with individual net worth in excess of $3.5 million, or married couples with combined net worth in excess of $7.0 million, we urge clients to take advantage of the $1.0 million gift tax exemption with gifts outright or in trust of assets that are likely to appreciate or to take advantage of current low values. Often we recommend and analyze more exotic techniques such as a Qualified Personal Residence Trust (QPRT), Charitable Trusts or Grantor Retained Annuity Trusts (GRATS), which are beyond the scope of this summary. Suffice it to say that where preservation of wealth is concerned and federal estate taxes are a likely possibility based on total net worth, we urge clients to consider employing some of these strategies to transfer wealth at little or no transfer tax (gift or estate).

Transfers to Spouses. Transfers to spouses are not subject to gift or estate tax, the theory being that those assets may be subject to estate tax at the spouse�s death. However, many times where there is substantial disparity in wealth between spouses, we can arrange special spousal trust gifts so that the donor can retain an element of control and that there is no tax when the trust is created or when the spouse dies. Lifetime planning is not a function of age. Married couples of any age should investigate these possibilities.

Medicaid Qualification. Gifting of assets has been a common technique in Medicaid planning where there is a possibility or likelihood that a person, parent or spouse may require nursing home care. Medicaid rules and regulations became much more strict with the Deficit Reduction Act of 2005. Therefore, for most people, we organize asset gifts at the time a donor is admitted to a nursing home, in order to protect as much wealth as possible and still qualify for Medicaid. Generally, advance gifts are not recommended. (As a side note, we can still protect assets of a married couple in Michigan.) Caution: All gifts are now taken into account in creating Medicaid penalties (delay in eligibility), unless the donor can prove that the gifts were not made for Medicaid planning. This proof is fact dependent and is an additional obstacle to overcome for annual gifts, payments for college expenses, etc.

Medicaid Exception. Where a considerable amount of wealth is involved and nursing home care is forecasted, we do intricate asset planning and often employ irrevocable trusts (which I call ProTec Trusts) in order to get past the Medicaid five year look back for gifts.

Veterans Assistance. Direct gifts or gifts in trust can be made for purposes of qualifying a Veteran for Aid and Assistance pension benefits. We are seeing more WWII Veterans and Korean Veterans over 65 requiring Assisted Living or Adult Foster Care assistance. There is no comparable look back provision for veterans benefits as there is in the case of Medicaid. Trusts are generally the most common and effective way to protect assets where pension benefits for a Veteran or spouse or widow of a Veteran is involved.

Asset Protection. There is increasing interest in asset protection against creditors claims. Asset protection sometimes takes the form of special trusts, which requires sophisticated planning.

An overriding concern in asset protection planning is the possibility that the transfer will be deemed a fraudulent conveyance. Under the laws of most states, including Michigan, a fraudulent conveyance, a gift or transfer designed to defraud creditors, can be avoided and the assets reclaimed from a transferee by a judgment creditor.

Many states have adopted favorable laws to protect trust assets from creditors so long as the creation of the trust is not deemed to be a fraudulent conveyance.

Asset Protection Trusts, in states with favorable laws, are becoming increasingly popular for individuals with substantial wealth. In most cases, these individuals no longer have to look to off shore trusts in exotic spots such as the Cook Islands.

Gifting may not be required for asset protection. Assets held jointly with a spouse as tenants by the entireties are protected in Michigan from the creditors of one spouse alone. Often times, therefore, no transfers or gifts are required to protect assets.

Conclusion. Transfer of wealth to the next generation or generations is part of normal human desire, and a foundation of estate planning and planning for wealth preservation. If you or a friend a facing any of the above situations where gifting or transfer of assets is considered, please contact Jim Modrall, Tom Pezzetti, Jr., or any of the attorneys listed below.

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

© 2009 BRANDT, FISHER, ALWARD & PEZZETTI, P.C.This newsletter is provided for informational purposes and should not be acted upon without professional advice.

Trusts - New Michigan Rules

This will no doubt not be the last newsletter about the new Michigan trust rules which go into effect April 1, 2010. The new trust statutes were enacted this summer after many years of debate. A special panel of Michigan attorneys and bankers has been working on a local adaptation of the Uniform Trust Code (UTC).

The UTC has been adopted with some local modifications by over 20 states, and the number is growing . The attempt in Michigan has been to codify many rules involving trust execution and administration that were part of normal practice and case law. The drafters attempted to clarify various uncertainties and to spell out in greater detail certain issues that have arisen.

Effective Date. As noted above, the effective date of the statute is April 1, 2010. The statute will be effective for trusts created on or after that date. As to trusts created prior to that date, the terms of the trust will control except that "any rule of construction or presumption" in the new statute will apply to trusts executed before the effective date, "unless there is a clear indication of a contrary intent in the terms of the trust."

A Few Important Observations. Obviously, there will be questions of interpretation of the new statute where disputes involving trusts arise, especially trusts that are not modified after April 1, 2010. Three points of concern may be of interest:

1) Jurisdiction - what court hears trust disputes.
2) Registration of a trust.
3) Should a trust have a trust protector?

Jurisdiction. All trusts should be reviewed to ascertain whether there are provisions concerning a designation of a court to hear disputes is either necessary or proper. One example in my practice recently brings this issue to the fore. A Settlor in Grand Traverse County dies. No beneficiary resides in Grand Traverse County. Under the probate statute, the decedent's Will would be filed in Grand Traverse County, regardless of the identification of location of the Personal Representative and beneficiaries.

The decedent's trust, on the other hand, appointed a relative as Successor Trustee who resided on the East Coast. Typically, jurisdiction over a trust is determined by "place of administration". Does this mean that any issues concerning the trust, administration or interpretation, have to be brought in a different state because the trust is supposed to be administered there, even though Michigan law applies?

Proper jurisdiction to hear disputes about trust administration and interpretation, which can arise long after death, will become a very important issue under the UTC. You can imagine the added expense if the decedent's trust had to be interpreted and applied in a Massachusetts or New York court, while a probate matter would clearly stay in Michigan.

Registration. The registration of a living trust has been something that has typically been avoided by attorneys and clients alike. The process is simple. It involves filing a short form with the Register of Probate of the Settlor's county of residence. The terms of the trust do not have to be included, but the form identifies the Settlor, the Trustee and the Successor Trustee. Trust registration was typically regarded as a nuisance and an unnecessary detail.

However, trust registration may take on a new importance under the UTC as a means to establish jurisdiction for possible disputes.

Trust Protector. The UTC has extensive provisions regarding the duties, responsibilities and powers of a Trust Protector. A Trust Protector is an individual or entity identified in a trust whose duties are stipulated, generally in detail. Sometimes the Trust Protector's duties are to stay in touch with the family situation and advise the trustee about the needs of beneficiaries. Sometimes a trust protector is given authority to change the trustee, direct withholding of distributions, if appropriate, and to change the situs of the trust and the applicable law.
A Trust Protector is generally desirable to introduce an element of flexibility in a trust which may last for many years.

A Trust Protector can also introduce a personal element in trust administration where the trustee is either a corporate trustee, without particular personal contact with the Settlor and the Settlor's family, or to provide a mechanism for changing trustees. The ability to change trustees can be especially important where trusts are designed to last for many years.

Another concern would be the desirability of "forum shopping" for administration of the trust. For example, the law of one state may be more favorable in permitting premature termination of a trust than another.

For example, in a "dynasty trust" intended to last for lifetime of each child beneficiary, should the children, by unanimous agreement, be able to terminate the trust early and get their hands on the trust assets directly? The laws of various states and application by their judges could differ radically in this respect and thus frustrate the intent of the Settlor who may have really intended the trust to benefit grandchildren and/or future generations.

Conclusion. These are some of the issues that concern trust drafters. We will devote future newsletters to other issues which may impact clients thinking about their trust instruments. We always recommend review of estate planning documents every five years for people over 65 and every ten years for younger clients.

However, the UTC (and possibly a new estate tax law) will no doubt be an encouragement to all clients and attorneys to review trust documents to determine whether amendments should be made before April 1, 2010, to take advantage of present law, or whether any changes should take place after that date, and subject the trust to the UTC in its entirety.

For a review of your trust and other estate planning matters, please contact Jim Modrall, Tom Pezzetti, or any of the attorneys listed below.

Donald A. Brandt, Joseph C. Fisher, Thomas R. Alward, Matthew D. Vermetten, 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.

2010 - Your IRS Get Out Of Jail Free Card

Converting Your IRA to a Roth. Many financial advisors over the years have recommended converting your traditional IRA into a Roth IRA so that future withdrawals from the Roth would be free of income tax, whether for you or your heirs.

We all know that withdrawals from a traditional IRA are subject to tax, whether mandatory or voluntary. We are also aware that withdrawals from a Roth IRA, voluntary during the owner’s life and mandatory after death, are not subject to income tax. Trading a taxable account for a non-taxable account seems like a no-brainer. However, there have been two obstacles:

(1) Payment of the income tax on the IRA withdrawal;

(2) Income limitations on taxpayers eligible to make the switch. Taxpayers with adjusted gross incomes of more than $100,000, were not able to make the conversion. However, the 2006 Tax Bill eliminated this limitation for 2010 and beyond. Obstacle #2 is therefore eliminated beginning 2010!

It Gets Better. For 2010 only, taxpayers can elect to defer recognition of taxable income on the conversion. They can report the taxable income in 2011 and 2012, spreading out the taxes that are due. As I understand the new 2010 rules, a taxpayer making an IRA conversion can recognize all the income in 2010 or spread it equally between 2011 and 2012. If the deferral is elected, the last payment of the tax bite can be deferred until 2013.

After 2010, the Roth Conversation can still be made, regardless of income level, but the deferral of income recognition and tax payment will not be available.

What is the Downside of the New Rule? The basic downside of the new rule is the same as before, i.e. paying income tax on the monies withdrawn and rolled into the Roth. Anyway you look at it, you’re paying income taxes sooner than would otherwise be required. This is the price one pays for a permanent avoidance of income tax on Roth withdrawals. Remember that your heirs will be paying income taxes on monies remaining the IRA account at your death, at whatever their personal income tax brackets might be.

To Defer or Not to Defer. If your financial and tax advisors recommend an IRA Conversion, or recommend analyzing the consequences, one of the hookers will be the possibility that income tax rates might change in 2011 and 2012. For that matter, there is always the possibility, even though remote, that Congress might retroactively change tax brackets for 2010. All of these factors need to be taken into account. Individual taxpayers need to assess whether their taxable income is likely to increase or decrease in the future and determine what, if any, offsetting deductions they might claim against a big lump sum of taxable income. High net worth clients should also take into account that paying income tax on IRA’s now gets that money out of the taxable estate, a further saving to the family down the road. While the balance in a Roth IRA account at death might be subject to estate tax if not payable to a surviving spouse, there won’t be the feared double hit: payment of income taxes on monies withdrawn from a traditional IRA to pay estate tax.

Further Complications. Advance income tax planning might be more complicated for some taxpayers who have both after tax and before tax IRA’s. In our experience that is relatively rare, but nonetheless when that situation exists, more involved consultations with your income tax advisors will be necessary to make sure that the IRS rules on withdrawals for rollover purposes are observed.

Estate Tax Considerations. We still don’t know where the estate tax revision and/or extension is going to land. According our sources, the debate appears to be what the future tax rate will be and whether the exemption is going to $3.5 million per person or $5.0 million per person. In any event, there are high net worth clients that will have to continue estate and financial planning on the basis that a portion of their estates are likely to be subject to estate tax at some point. IRA planning is important in minimizing the estate tax bite, as well as income taxes. It is human nature not to realize taxable income any sooner than is absolutely necessary. Moreover, the volatility of the stock market has made advance planning much more challenging. In some respects, taxable withdrawals from IRA’s for Roth Conversions, can be considered a bargain at depressed asset values. All of this, however, is tempered by the need to use outside resources to pay the income tax liability.

Another facet of IRA planning is the ability to use your IRA accounts for charitable contributions without recognizing taxable income. This is particularly advantageous in Michigan. Taxpayers with charitable pledges or serious charitable intentions should explore this opportunity to maximize the tax effectiveness of their gifts, by reducing IRA balances.

Conclusion. The purpose of this newsletter is to highlight a special benefit for 2010 IRA-Roth Conversions. This opportunity is too good to ignore. Moreover, higher income taxpayers that have not considered IRA Rollovers should consult their tax and investment advisors to analyze how this conversation can help preserve wealth for the family. For your estate planning needs and IRA consultations, as they relate to Trusts, Wills and beneficiary designations, 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, 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.