Well, if you attempt to complete a legal transaction or act without the advice of an attorney who knows if you have done everything you need to do? A common example is formation of LLCs and other business entities. Many people filled out their generic forms to create their entity and thought that was all they needed to do.

Those people are going to find a surprise in their mailbox soon.

You see, LLCs and other entities have to pay a “Business Entity Tax” in Connecticut. The generic forms sold at Staples and office stores might not tell you that, but I hope a competent attorney would. The Connecticut Department of Revenue Services (DRS) is catching up with everyone that created a business entity but neglected to pay their business tax the last few years. The DRS is sending out 23,000 letters to notify people of their non-compliance.

The lesson for today is: if your goal is to achieve a certain legal result or status it is generally a good idea to obtain the opinion of someone licensed to practice law. Sometimes a fill in the blank form just doesn’t tell you everything you should know before signing it.

Additional information: fill in the blank forms gone wrong in Florida.

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Congress recently opened the door to allow a non-spouse beneficiary to rollover an IRA or 401(k) and stretch distributions over the beneficiary’s lifetime. 2007 was interesting because this new option was not required by all retirement plan administrators, it was optional. At the end of the day, there was confusion and to answer the question if it was even possible for a non-spouse beneficiary to qualify for a rollover you would have to check with each plan administrator.

In 2008 the IRS is attempting to put an end to the confusion and requiring that all plans provide the option for a non-spouse beneficiary to rollover an IRA. This is great news and a great opportunity for those families positioned to take advantage of it. For families that are not prepared, it is simply another sand-trap.

So what is the big sticking point?

Designated Beneficiary. Those two words are critical to how the IRS treats and taxes the transfer of an IRA or other qualified retirement account from the account holder to the beneficiary(ies). You may be thinking, well, as long as I have a beneficiary I am in good shape. That would be wrong, the IRS has dedicated volumes of paperwork to making it perfectly clear to those who are listening that not every beneficiary qualifies as a designated beneficiary.

The biggest example of a beneficiary that is not a designated beneficiary is if your IRA goes into your probate estate either on purpose or by accident. The IRS absolutely hates it when an IRA goes into a probate estate and will almost certainly treat the event as a transfer to a non designated beneficiary and your family would not be able to take advantage of the rollover option without jumping through a lot of costly hoops.

But I went to an attorney and setup a complete estate plan including a living trust etc.

That’s great. I’m glad you’ve embraced personal responsibility for your estate plan rather than run from it like a lot of people according the surveys over the last 10 years. However, all trusts are not the same. Some come from old books in a law library (I’ve seen trust documents reference King George in the Rule Against Perpetuities language. I don’t know if I’m more surprised that the attorney presented it to their client with a straight face or that the client did not think twice about who drafted the trust when they saw it.), some come from computer drafting assembly programs written in imprecise language by people that may or may not be experienced tax attorneys, and some are even drafted by competent attorneys that get it right. Simply having a trust or having an estate plan does not automatically mean your family will qualify for the new rollover benefits.

How can I qualify for rollover treatment?

The IRS has very specific rules for how a trust can qualify as a see through trust and treated as a designated beneficiary. The top level bullet point requirements are:

1. The trust must be valid under state law;
2. The trust must be irrevocable or become irrevocable when the IRA owner dies;
3. The trust beneficiaries must be identifiable from the trust instrument;
4. Proper documentation must be provided to the IRA custodian.

Seems simple enough right? Remember, this is the IRS we are dealing with and they take income tax deferral very seriously because they think they are losing money. They have regulations on top of regulations on top of Private Letter Rulings and court decisions defining each one of those bullets in extensive detail. There is enough material to write a book on those four issues, and people have. I can’t get into detail on all of them here because it would take forever.

The most common stumbling block for inexperienced drafters is the requirement that beneficiaries be identifiable from the trust document. Many trust documents I’ve seen coming in to my office do not contain adequate restrictive language to achieve compliance with this rule. If you don’t have this language or if the people administering your estate handle the IRA or retirement funds incorrectly you have a big flashing sign to the IRS saying your family does not qualify for rollover treatment.

Rollover treatment is a privilege, not a right. Your family will not qualify for rollover treatment if you do not follow the rules in your estate plan. Make sure you and your attorney understand the requirements and that your estate plan doesn’t fall apart on this critical issue.

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1. Another Lost Asset Protection Opportunity
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1) Using a Will as an instrument of significant distributions. This is not something I would recommend for someone in Leona Helmsley’s position, especially if this was taking place in Connecticut. First, as is obvious by now, Wills are public and everyone now knows she disinherited some grandchildren, left a very large sum to her dog, and imposed visitation requirements on other beneficiaries. Maybe it is just me, but I find it difficult to believe someone with Leona’s history in the news would invite public scrutiny of her last wishes.

Second, the Will creates several ongoing trusts. Maybe it is different in New York, but in Connecticut creating even one trust in a Will is synonymous with ongoing Probate Court involvement for years and years as well as the accompanying legal and accounting fees. Not exactly the model of efficiency and savings. If this was my client in Connecticut, I would recommend using inter-vivos trusts for ongoing matters rather than the testamentary trusts used by Leona Helmsley.

2) Article Four Section D of Leona Helmsley’s Will requires her grandchildren visit the grave of her son annually. Failure to comply with this provision will terminate their trust share. I bring this provision up to highlight the flexibility you have in structuring your estate plan. Within the bounds of the law, you are free to create any framework you like for the distribution of your assets; including steering your beneficiary’s behavior to continue personal values you believe are important.

3) Leona Helmsley took advantage of a Charitable Trust to provide a tax efficient legacy to her beneficiaries. There are different types of Charitable Trusts and the terms of Leona’s are private, so I can’t get into specifics on this one. In general terms, if Leona did not take advantage of a Charitable Trust the tax impact on her estate would have been significant. If setup properly, the Charitable Trust allowed her to re-structure some of her estate into a more tax efficient distribution to her own family as well as charitable organizations. As proof of what I described above, compare how much we know of Leona’s Will because it is public with what we know of her Charitable Trust, because it is private.

This is a good opportunity to clear up a popular misconception of Charitable Trusts. Sometimes when people first hear the words Charitable Trust offered as a suggestion for their own estate plan they think it means leaving everything to charity. Not true, you have a lot of flexibility for dividing the interests in the Charitable Trust between your own family and the charitable organization(s). In many cases where I recommend a Charitable Trust, the primary family beneficiaries will receive more after taxes than if the distributions did not use a Charitable Trust. So the next time someone mentions this opportunity, look at the numbers closely before thinking it is not for you.

Sometimes celebrity estate planning attorneys get it done right, and sometimes they get it done not so right. The general consensus is Anna Nicole Smith’s estate planning was a disaster. Leona Helmsley’s estate plan was a little better, if not more public than necessary.

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HR 3170 would continue to increase the estate tax exemption in smaller increments from the $3 million mark in 2009 up to $4.75 million in 2014. The rate of tax would be linked to the capital gains rate, 15% until 2010 and then 20%. The deduction for state death taxes paid would be eliminated in 2010. And in an interesting move, the Executor of the first spouse’s estate could “give” any unused estate tax exemption to the surviving spouse. This would have an interesting impact on families that for some reason would prefer to not equalize estate values for tax planning purposes.

Who knows how far this Bill will get. Hopefully some meaningful resolution on the estate tax is not far off, although it could easily go unresolved until after the next presidential election.

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• With some assets, designating a joint owner amounts to a present gift of a portion of the asset rather than only creating a survivorship interest. On the portion of the property that’s a gift, there’s no stepped-up basis. Your cost carries over to your beneficiary. When they sell, they pay capital gains taxes. But if they inherit the property directly from you or from your living trust at death, the capital gains are wiped out altogether.
• While the property is in joint names, your beneficiary might be sued, go bankrupt, get divorced, or have an accident that leaves them incapacitated. If so, the assets might become consumed by your beneficiary’s expenses and be unavailable to you, leaving you destitute.
• If your beneficiary has siblings to whom you expect the joint owner to divvy up the assets when you pass away, the transfers are gifts, subject to gift tax.
• You can have a falling out with your beneficiary and they can clean out an account they are listed as joint owner on.
• If your beneficiary dies before you, the IRS wants proof that the asset was bought by you. Otherwise, they’re taxable in your beneficiary’s estate.

You may notice the common issue with every case described above stems from giving someone else access to your assets during your lifetime. I am a firm advocate of protecting your own assets from all the risks out there. I am hard pressed to find a reason to justify taking on somebody else’s risks by naming a joint owner of an asset. It’s risky.

One way to avoid all of these problems is to not use lifetime ownership designations to accomplish property transfers you desire after you pass away. Use a Will or Trust to define your estate plan and coordinate your assets to be distributed according to your Will or Trust. You are not vulnerable to these joint ownership issues when you use a Will or a well designed Trust.

Ready to get started? Call (860) 593-0404 and schedule your consultation today.

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The Minimum Monthly Needs Allowance (MMNA) refers to the monthly income that the community spouse is allowed to retain while a spouse living in a nursing home can qualify for Medicaid benefits. The “community spouse” refers to the spouse remaining in the home that is not receiving Medicaid benefits. The starting point to determine the MMNA is a minimum MMNA adjusted annually. For fiscal year 2006-2007 the minimum MMNA is $1,650.00 per month.

This starting point is then adjusted by a separate calculation to determine the “excess shelter allowance.” The excess shelter allowance totals the following expenses:

Rent, mortgage, or condo fees for a primary residence;
Property taxes;
Homeowner’s insurance; and
Standard utility allowance of $517.00.

From the total of those expenses, the Department of Social Services subtracts a predetermined standard shelter allowance. This is currently $495.00. The remaining balance is then added to the minimum MMNA ($1,650.00) to determine the community spouse’s actual Minimum Monthly Needs Allowance. Your attorney can then discuss strategies to protect assets based on this calculation. Note, the Case Worker does not have authority to approve an actual MMNA that exceeds $2,541.00 (adjusted annually). You should consider a Fair Hearing to pursue the maximum MMNA if you are in this category.

Why is this important? The MMNA plays a significant role in determining what spousal assets (in the form of the CSPA) the community spouse will be allowed to retain in order to create sufficient income to achieve his or her Minimum Monthly Needs Allowance. The MMNA is one of the items you will focus on if your spouse needs to qualify for Connecticut Medicaid and alternative asset protection strategies are not available. Make sure your team is prepared to protect your rights if you find yourself in a Medicaid situation.

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Section 101(a)(2) is an exception to the general rule of Section 101(a)(1) that gross income does not include amounts received under a life insurance contract if such amounts are paid by reason of the death of the insured. Under Section 101(a)(2), if a life insurance contract, or any interest therein, is transferred for a valuable consideration, the exclusion from gross income provided by section 101(a)(1) is limited to an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee.

Although, under applicable Treasury regulations, a transfer-for-value generally includes “any absolute transfer for value of a right to receive all or part of the proceeds of a life insurance policy,” an exception applies when a life insurance contract is transferred to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer.

Citing Rev. Rul. 85-13, 1985-1 C.B. 184, which provides that a transaction between a grantor of a trust that is treated as owned by the grantor for Federal income tax purposes is disregarded, the Revenue Service ruled that, in Situation 1, the transfer of the policy from Trust 1 to Trust 2 while both are grantor trusts is not a transfer for a valuable consideration within the meaning of Section 101(a)(2) of the Revenue Code. (For rulings on similar transactions, see PLRs 200636086, 200120007 and 200228019.) In effect, for federal income tax purposes, Grantor is treated as the owner of all the assets of both trusts, including both the life insurance contract and the cash received for it, both before and after the exchange. Accordingly, in Situation 1 there has been no transfer of the contract within the meaning of Section 101(a)(2), i.e., the entire transaction is disregarded.

In Situation 2, Trust 1 (the purchaser) is a grantor trust, but Trust 2 (the seller) is not a grantor trust. Therefore, Grantor is treated as the owner of the cash (but not the life insurance contract) before the exchange, and as the owner of the life insurance contract (but not the cash) after the exchange. However, although there has been a transfer for a valuable consideration in Situation 2, the transfer for value limitations of the general rule of Section 101(a)(2) do not apply because the transfer to Trust 1 is treated as a transfer to Grantor, who is the insured.

Note that, under Rev. Proc. 2007-3, 2007-1 I.R.B. 108, §§ 3.01(7) and 3.01(47), the IRS stated that it will not issue an advance ruling on the following questions:

1. Whether there has been a transfer for value for purposes of § 101(a) in situations involving a grantor and a trust when (i) substantially all of the trust corpus consists or will consist of insurance policies on the life of the grantor or the grantor’s spouse, (ii) the trustee or any other person has a power to apply the trust’s income or corpus to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse, (iii) the trustee or any other person has a power to use the trust’s assets to make loans to the grantor’s estate or to purchase assets from the grantor’s estate, and (iv) there is a right or power in any person that would cause the grantor to be treated as the owner of all or a portion of the trust under §§ 673 to 677 (See, e.g., PLR 9413045, in which the IRS implied — but would not rule — that the sale of two second-to-die polices, one of which was held by a trust of which the wife was the grantor, and the other of which was held by a trust of which the husband was the grantor, to a new trust that was intentionally designed to qualify as a “grantor trust” with respect to the husband and wife would not be a transfer-for-value with respect to either of them); and

2. Whether the grantor will be considered the owner of any portion of a trust when (i) substantially all of the trust corpus consists or will consist of insurance policies on the life of the grantor or the grantor’s spouse, (ii) the trustee or any other person has a power to apply the trust’s income or corpus to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse, (iii) the trustee or any other person has a power to use the trust’s assets to make loans to the grantor’s estate or to purchase assets from the grantor’s estate, and (iv) there is a right or power in any person that would cause the grantor to be treated as the owner of all or a portion of the trust under §§ 673 to 677.

Rev. Rul. 2007-13 would appear to offer a favorable response to the first of these questions (although it is not clear if the assets of Trust 1 and Trust 2 consisted solely or substantially of life insurance) — the transfer for value question — because the “grantor” status of the trust has been stipulated by the taxpayer who then has the responsibility on audit of establishing the accuracy of that stipulation and thus confirming the favorable nature of the response. In contrast, the revenue ruling does not favorably answer the second of the revenue procedure questions — the grantor trust question — since Rev. Rul. 2007-13 does not discuss the reason why Trust 1 or Trust 2 were in fact treated as owned or not owned by the Grantor for Federal income tax purposes.

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Myth: A revocable trust can shelter my assets if I need Medicaid benefits.

Many people think that if they place their assets in a trust, they can protect those assets and create eligibility for Medicaid benefits because the assets are owned by the trust and not the individual. This is not true in the case of revocable trusts because the person creating the trust has the ability to revoke or dissolve the trust and have the property returned to them at any time. Assets owned by a trust that you can revoke or dissolve, or have other certain powers over, will not be protected from long term care expenses.

Truth: A revocable trust can cost less to administer than most other alternatives.

A revocable trust is commonly used to take certain administrative procedures that ordinarily are carried out in the court system and transfer responsibility for those procedures to a Trustee who is either a family member or a professional. Some of these procedures are distribution of property upon death, management of property upon disability, and management of property for beneficiaries under age 18. When these steps are supervised by the courts, there are accompanying costs. When these steps can be handled by a Trustee, there can be significant savings in many cases.

Myth: Only wealthy families can benefit by using a revocable trust.

An estate of $1 million or more is not required to benefit from the streamlined administration of a revocable trust. It is not uncommon for attorney fees alone to be in range of 3% of the estate in probate administration cases. With this in mind, people with an estate of $200,000 or more should compare the potential administration costs of using a revocable trust and not using a revocable trust before making a decision.

Truth: If I have real estate in two different states, I should consider a revocable trust.

Real estate in two different states opens a person up to administration in two different states which increases the administration costs. In order to avoid two administrations while at the same time retaining control over your real estate, a revocable trust is a common recommendation.

Myth: A revocable trust can avoid all administration procedures and costs.

A revocable trust moves the administration process out from the supervision of the probate court, it does not eliminate the administration process. The Trustee has the obligation to inventory or gather the assets, file and pay any required inheritance or estate taxes, account for financial transactions during the administration period, and then distribute the assets according to the terms of the trust instrument.

Truth: I can change the terms of the trust if I choose to.

A revocable trust is not etched in stone. It is a flexible document that the creator can change at any time with one exception, the creator cannot increase the duties of the acting Trustee without the Trustee’s consent. In the majority of cases, the creator of the trust is also the Trustee so this is not a significant concern.

Myth: Everyone should have a revocable trust.

A revocable trust is not a universal estate planning solution. It does provide certain advantages, but it can have disadvantages if used in the wrong situation. You should be confident you understand the advantages and disadvantages of using a revocable trust in your personal situation before making a decision.

Truth: A revocable trust offers more privacy than a Will.

Probate administration is a very open process because it is a judicial process. If you are uncomfortable with the public nature of probate administration, then you can secure more privacy by using a revocable trust rather than a Will.

If you think a Connecticut Living Trust may be right for you, visit CTLivingTrust.com

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Liability. Let’s assume you’ve made your children owner of your home. Part of what you have done is put your residence within the reach of your children’s creditors. If they are ever in an accident, get into financial trouble, or get divorced, your house is now in jeopardy.

Taxes. Under the current estate and income tax rules, when your children inherit your residence they will receive a step-up in basis that serves to eliminate the capital gain built into your house. If you gift your house to your children, they will not get the full benefit of this step-up in basis and will almost certainly be subject to capital gains tax on a portion of the sale when they sell the property.

Should you give your house to your children? I don’t know enough about you. Should you carefully consider the ramifications of such a significant step? Absolutely.

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