R.C. Lim, Attorney and Counselor at Law

Elderly Gay Couple In Sonoma County Wrongfully Separated

For those gay couples looking for a cautionary tale of what can go wrong as you get older, the recent story of an elderly couple who were wrongfully separated and deprived of their assets is chilling. In brief, the fall of an eighty year old man led county employees to visit the home and admit the couple. The county employees admitted the couple to different nursing homes. In the case of the younger partner, it was entirely against his will. The older partner who had fallen spent the final two months of his life alone and away from his partner of twenty years. Despite the fact that documents had been prepared giving each other powers of attorney, healthcare directives, and wills, county officials went into court claiming that the two longtime partners were just roommates and asked for a court order to sell their stuff.

This couple evidently had already done the estate planning to prepare themselves for such an event. Worse still, these ugly acts were committed by county employees under the color of law. It shows in yet another glaring fashion why prohibiting gay marriage is wrong.

Inherited IRAs and Bankruptcy

IRAs benefit from a federal bankruptcy exemption on an amount something north of $1.1 million. (The previous amount should have had its 3-year inflation reset on April 1, 2010.) This is a touch more complicated, and “roll-over” IRAs, or IRAs that are funded from ERISA plans can potentially qualify for unlimited amounts although there is very little guidance right now on what happens once such plans become “mixed” when a roll-over plan is mixed with regular contributions. (See Natalie Choate at Morninstar.com).

Inherited IRAs have become a fairly common tax planning strategy for estate planners. If not planning is done, an IRA can trigger a whopping tax bill. Tax is immediately due on long-term and any short-term gains. The capital gains tax would be in addition to any estate taxes on the estate. However, the IRS permits a decedent to pass an IRA without triggering a distribution and a tax and most importantly to replace the new beneficiary’s age for the purpose of calculating the minimum withdrawal calculations. This permits a “stretch-out” of the IRA distributions over a potentially very long period, depending on the age of the beneficiary, thereby permitting the assets to continue to grow tax free for an even longer time.

However, a Texas case, In re Jarboe, 2007 WL 987314 (Bkrtcy. S.D. Tex. 2007),  suggests that these inherited IRAs are not entitled to the same $1.1 million plus protection that they would have had in the hands of their original holder. Although this case is merely persuasive in other jurisdictions, like our 9th Circuit, bankruptcy practitioners are probably simply steering clear of its seemingly solid reasoning by advising clients to pay the capital gains tax and then push the former IRA assets into other categories of clearly exempt assets, like a home. If the client is already using his or her full homestead exemption, the exemption planning might be a bit more challenging.

2010 Estate Tax 101

Okay, the really quite odd thing happened and Congress did not get around to changing the estate tax last year. Hence, there is no estate tax for those who die this year regardless of the size of the estate: millions, hundreds of millions, or even billions….

The complication comes in that the basis step-up that most receive on death is no longer available. This means that beneficiaries will usually inherit the tax basis of any asset they receive from a decedent. This further means that when and if they go to sell that asset, they will owe capital gains tax on any increase in value. Since the assets in questions — homes, IRA accounts, etcetera — that beneficiaries receive have usually appreciated over the decadent’s life, this means that taxes will be owed by most estates.

The net effect will be to increase the tax on the smaller to mid-size estate, while almost entirely removing the tax for large and exceptionally large estates, a truly perverse outcome. Worse still, it’s worth remembering that most brokerages do not keep or report records to the IRS on purchase prices of securities. In the absence of knowing a precise number, the IRS typically assumes the value to be zero and capital gains taxes are presumed to be owed on the entire amount from the sale of any securities. The problem here is that it is often the case that the executors and administrators who are rummaging through the old records cannot reconstruct the purchase prices either. This leaves those in charge with the difficult task of making up a number based on the surrounding or circumstances or simply paying the tax on the entire amount. Congress has certainly created a real mess by allowing the Bush’s repeal of the estate tax to go into effect.

California Homestead Exemption Increases By $25,000

The California homestead exemption protects a fixed amount of the equity in a person’s home from that person’s creditors. The means that judgement creditors cannot foreclosure on a property unless the person’s equity exceeds the amount permitted by state law. Under current California law, the base exemption is $50,000. If a person or a person’s s spouse resides in the home as a homestead, the amount rises to $75,000. For those over 65 years of age, disabled, or over 55 years of age with limited income, the amount jumps to $150,000.

On January 1, 2010, California will increase these amounts across the board by $25,000. (CA Assembly Bill 1046.) A client of mine mentioned that California to me in a hazy way, and I foolishly assumed that he was accidentally referring to the currently higher limit of $150,000 for the aged.  While this news did not pass unnoticed on the blogosphere, newspaper citations on the change are scant. I guess the newspapers assume (quite rightly) that their readership does not need to be reminded in any way of how much equity they’ve lost in their houses.

New Estate Tax Passes House

It seems that the House has already passed a bill that taxes estates over $3.5 million at 45%.

Point - Counterpoint

A NY Times Op-Ed piece by Ray Madoff argues that there needs to be an exemption to any new estate tax for family farmers and small business owners.

Others disagree stating that it’s money that can scarcely be lost from the Treasury and that the exceptional amounts involved only include families with very large farm or business operations.

Since one of the complaints of the estate tax is that it distorts wealth distribution and encourages individuals to pursue diseconomy, this can scarcely be called a cure. Would Sam Walton’s children be permitted to take free of tax as heirs to a “family business”? On the other hand, what of a family farm in California that gainfully employs four or more heirs in comfortable but not extravagant lives? This is the complicated debate that awaits Congress after they finish bickering about Afghanistan, health care, and the environment.

The Big Question: Will the Estate Tax Disappear?

Now that it’s November and Congress is still putzing around in committee, the question of whether Congress will find enough time to pass a new estate tax bill is an open question.

As I have pointed out, failing to act will create a perverse incentive to die in 2010 so that an estate can pass tax free. Perhaps the legislators have a hard time grasping that tax policy could affect such an important decision, but I have had heard enough sick and elderly joke about this to know that it is only some people peoples’ minds.

Failing to act will also make hay of the current system that balances the bite of a steep estate tax (45%) with the benefit of a stepped-up basis. Property received at death prior to 2010 will receive the basis step up, while property received in 2010 will not. On the other hand, the accounting burden here is no different than what the service and people routinely already choose to accept when they create GRATs, QPRTs, and FLPs.  Still, there is an important difference when a person chooses, or can choose this benefit, versus cases where it is not chosen. Under current law, a family must balance the benefit of locking in the value of the asset versus the benefit of date-of-death step-up in tax basis. The decision is either made or not made.

My concern and belief is that most will attempt to wait out the uncertainty and only later will discover that many vehicles that might have saved their heirs from a big, nasty, and resurgent estate tax. In a recent WSJ article, another estate planner shares the same concern, stating simply “I would advise anyone who wants to do a GRAT or Family Limited Partnership to do it soon, like yesterday.” There are two simple reasons for this. The first is that the country is unlikely to forgo tax revenues in a time of growing deficits.  The second is that the populist sentiment in this country that should arise as a backlash from the economic crisis has only just started to be felt. The political climate will soon change to disfavor the wealthy, and there is no more glaring symbol of Bush’s Gilded Age than the nonexistent estate tax.

Qualified Personal Residence Trusts - their time is now!

What is it?

• A qualified personal residence trust, or QPRT, is an irrevocable trust set up to hold your house for a specified number of years. By transferring your house today, you can freeze the value of your home at today’s real estate prices for estate tax planning purposes. The transfer will be deemed a “gift” and will count against your gift exemption.  During the trust term, you will live in your house as before. By living in the home for that specified time, you will further reduce the amount of the gift. At the end of the term, the house will be legal property of your heirs.

An Example:

• Let’s say that I own a house worth $1 million with no mortgage.  At the peak of the market it had been worth $1.5 million, but the price has fallen back by 33%. Following the recommendation my estate planner, I transfer my house to a QPRT, naming my daughter as the sole heir and setting the term of the trust at 20 years. The value of my gift will be the $1 million the house is worth today, reduced by the amount that the enjoyment of my home for twenty subtracts from its current value. To keep the math simple, let’s say it makes the present value of my gift $666,666. This amount will count against my lifetime gift tax credit but is easily covered by that amount and so there will be no tax due at the time of the transfer. Now if I can live longer than the 20 year term, the QPRT will succeed and the house could appreciate to any amount and no additional gift or estate tax will ever be due at my death.

Factors:

• As the example hopefully makes clear, the very best time to set up a QPRT is when real estate prices and interest rates are both low. These factors ensure that the value of the gift is at its lowest.
• You need to outlive the trust term for the QPRT to succeed as a tax strategy. That is, you outlive the term. At the end of the term, you can remain in the house, but you will need to pay rent to your heir. Bear in mind that this is often a way to further reduce the estate tax burden.
• In the case of the transfer of a single family to one individual, this plan can prevent what might otherwise require your heir to sell the family home to pay the estate tax bill.
• In the case where someone has a serious illness and is facing huge hospital bills, a QPRT can help to keep the house out of reach from the hospital.

The Debt Collectors’ Latest Hustle

As this article from yesterday’s New York Times demonstrates, the credit card companies facing declining payments from creditors are going after the recently dead’s next of kin.

Comment: You do not know owe the debts of your parents.  While your parents estate might owe money against these debts, if your parent dies penniless, do not let some smooth-talking, seemingly kind-hearted, or threatening debt collector talk his or her way into your pocket book.

Moreover, you should be sure to take notes on any conversation that you have and later consult a lawyer to see if you have a case against the debt collector.  The debt collectors are under very strict obligations not to mislead or threaten you.

Estate Planning for These Crazy Times

On December 16th, 2008, the FOMC set the Fed Funds rate at 0-0.25. For anyone who still has a taxable estate left this leaves two salient features that favor estate planning right now. First, asset prices have collapsed. Hence gifting now occurs at greatly depressed level. Second, interest rates, which are used and which determine the size of the tax avoidance value of some strategies, can be locked in at what will clearly be the floor. Specifically, planning that involves grantor retained annuity trusts (GRATs), charitable lead trusts (CLTs), and sales to intentionally defector grantor trusts (IDGTs) are particularly effective in this economic environment.

No one feels flush in these time. But if your estate is likely to exceed tax-free amount on your death, you might consider taking advantage of the financial zaniness of the moment.