This blog is written by Brian E. Barreira, an estate planning, probate and elder law attorney with offices at 18 Samoset Street, Plymouth, Massachusetts, and 175 Derby Street, Unit 18, Hingham, Massachusetts. Brian was named a Massachusetts Super Lawyer® in Boston Magazine in 2009 and 2010 and is listed in The Martindale-Hubbell Bar Register of Preeminent Lawyers in the fields of Elder Law and Trusts & Estates, Wills & Probate. Brian's biographical website can be found at www.elderlaw.info
Nothing on this blog should be considered to be legal advice or tax advice.
Why Is It Important that a Massachusetts Power of Attorney Be “Durable” and Detailed?
A power of attorney is a written document through which you authorize someone (usually known as your agent or attorney-in-fact) to take actions for you. The powers that are given can be limited or quite broad. Unfortunately, if your power of attorney is not “durable,” your agent or attorney-in-fact may find that the power of attorney is useless when you are incapacitated and it is needed most.
The Massachusetts “durable” power of attorney is similar to a power of attorney that is not durable, but there is one huge difference between the two types. The difference involves whether the agent or attorney-in-fact continues to be empowered to take action for you once you have become disabled. A power of attorney that is not durable is no longer effective if you become disabled, whereas a “durable” power of attorney continues to be effective even after your disability.
Under the English common law upon which Massachusetts law is based, if you signed a power of attorney naming someone to act on your behalf, the person would have authority only for as long as you remained competent. If you later became disabled or incompetent, the power of attorney became null and void. That would mean a court process would then be required for someone to be able to step in and handle your financial affairs upon your disability. To minimize the need for court involvement by allowing a power of attorney to remain effective after disability or incapacity, decades ago the Massachusetts legislature passed a law (Massachusetts General Laws, Chapter 201B) to allow for the creation of a “durable” power of attorney. The way to make a power of attorney become durable is to add a phrase that makes it clear that the powers detailed in it remain effective even after disability.
That Massachusetts durable power of attorney laws were changed when part of the Massachusetts Uniform Probate Code took effect on July 1, 2009, and, as I’ve reported in a previous post, Chapter 201B was repealed. (See Is Your Massachusetts Durable Power of Attorney Still Valid?) Unfortunately, when a law is replaced, actions taken under it are still effective, but when a law is repealed, those actions are treated as though the law was never there. Therefore, any durable power of attorney executed before July 1, 2009 may be invalid, especially if it makes specific reference to Chapter 201B.
The major problem with any durable power of attorney is that it is only as good as the respect it receives from a self-serving bureaucrat. (If you bring money to a bank using a durable power of attorney, you may be greeted with open arms; if you try to take money out of a bank using a durable power of attorney, often you’ll hear that it needs to be reviewed by the bank’s lawyer.) There is never any guarantee that third parties, such as banks or insurance companies, will honor a power of attorney even if it is durable. Such problems often arise when there has been a long passage of time since the power of attorney was executed and it is thought to be “stale.” Fortunately, the current Massachusetts law addresses this problem by stating that no durable power of attorney ever become stale, and that if you rely on a power of attorney in good faith, you will not incur any liability if you follow the instructions of the agent or attorney-in-fact.
Unfortunately, the other reason a durable power of attorney may be rejected is based on the specific powers granted to the agent or attorney-in-fact. While theoretically the document need only state that you want to give the power to do absolutely anything, many financial institutions want to see specific powers that pertain to them before they are willing to respect a durable power of attorney. Therefore, a well-drafted Massachusetts durable power of attorney is often several pages long.
To the extent that a power of attorney is not effective when needed, the only alternative would be to file for conservatorship under the Massachusetts Uniform Probate Code, and that process is time-consuming, detailed, subject to challenge by well-meaning and not-so-well-meaning relatives, and, as you might expect, expensive. For those reasons, a well-drafted durable power of attorney is often the most important document that a person could execute.
End-of-Life Care: Nursing Home Residents Rights
Approximately 20% of all persons who die every year are residents of nursing homes. Since a nursing home is the last place of residence for such a large percentage of our population, it is very important that all of the rights of nursing home residents be upheld.
A person who lives is a nursing home is known as a “resident,” not a patient, and it is important to note that the resident is in a nursing “home,” not a nursing “institution.” Federal law requires that a nursing facility provide “services and activities to attain or maintain the highest practicable physical, mental, and psychosocial well-being of each resident.” Federal law also requires that a facility must ensure that a resident’s “abilities in activities of daily living do not diminish unless circumstances of the individual’s clinical condition demonstrate that diminution was unavoidable.” Thus, maintaining a condition, or moderating the rate of decline, should always be a goal of therapy services, even if the resident is not making progress.
Federal Medicaid law requires that a nursing facility “must establish and maintain identical policies and practices regarding transfer, discharge, and the provision of services required under the state plan for all individuals regardless of source of payment.” Thus, a resident should never be denied the continuation of physical therapy based on the excuse that Medicare will no longer cover it.
Nursing facility residents often are susceptible to transfer trauma in being moved from place to place. Federal law gives every resident the right to veto any intra-facility transfer. Medicare certification of a room does not prevent that room from being used for the care of a resident who pays privately or has payment through the MassHealth (i.e., Medicaid) program.
Immediate family or other relatives are not subject to visiting hour limitations or other restrictions unless imposed by the resident. Federal law requires that a resident’s “immediate family or other relatives” have the right to visit at any time if the resident consents to the visit. Under federal law, non-family visitors must also be granted “immediate access” to the resident.
Federal law requires that a nursing facility must care for its residents in such a manner and in such an environment as will promote maintenance or enhancement of the quality of life of each resident.” Federal law also requires that a resident has the right “to reside and receive services with reasonable accommodation of individual needs and preferences, except where the health or safety of the individual or other residents would be endangered.” A resident has the right to choose activities, schedules, and health care consistent with his or her interests, assessments, and plans of care.
Minimum Monthly Maintenance Needs Allowance for Nursing Home Resident’s Spouse Increased to $1,839 during 7/1/2011-6/30/2012
When one spouse is living in a nursing home and the other spouse is living anywhere else, the spouse who is not living in the nursing home (known under Medicaid and MassHealth law as the “community spouse”) is allowed by Medicaid or MassHealth to keep some or all of the nursing home resident’s income through an income allowance known as the Minimum Monthly Maintenance Needs Allowance (MMMNA). Every July 1st, this figure changes based on federal poverty level guidelines, and the MMMNA will increase from $1,821 to $1,839 from July 1, 2011 through June 30, 2012.
If certain basic household expenses are more than 30% of the MMMNA, the community spouse is entitled to keep extra income, known as the Excess Shelter Amount (“ESA”). Between the MMMNA and the ESA, the community spouse can now be entitled to as keep as much as $2,841 of the married couple’s total income. If even more income is needed, such as where the community spouse is living in an assisted living facility, the community spouse can request a fair hearing and attempt to prove the need for more than $2,841 of the married couple’s total income. All of these figures remain unchanged through June 30, 2012.
Another option to retain greater income for the community spouse is a Probate Court procedure known as separate support. Since both spouses need legal representation in court, it is important that the institutionalized spouse have a durable power of attorney that allows the appointed person to hire a lawyer.
Utilizing the MMMNA provisions in Medicaid/MassHealth law is always better than purchasing an immediate annuity, since all payments from the annuity are treated as income, and taking that step ends up reducing the amount of the married couple’s retirement income that the community spouse could otherwise keep. Unfortunately, due to the asset rules under Medicaid/MassHealth, in many situations the community spouse has no choice but to purchase an immediate annuity with excess assets. See Preserving Assets and Maximum Income for the Healthier Spouse When the Other Spouse Enters a Nursing Home.
Effective April 7, 2011, there is a new law in Massachusetts that allows a person to set up a trust for the benefit of a pet. In the past, pet owners were limited under Massachusetts law to leaving funds to a person and hoping those funds would be used to take care of the pet as a moral obligation, but not a legal one. Under this new law, a trust can be set up with the pet as beneficiary, with the toughest legal issue appearing to be how to protect the trust from being attacked from disgruntled heirs on the grounds of excessive funding.
I have established a blog to deal solely with Massachusetts pet trust issues. You can find it at http://pettrust.info There are already several posts there about the basic components of an effective Massachusetts Pet Trust, including appointing Trustees, Caretakers (sometimes referred to by others as guardians or caregivers) and Monitors (sometimes referred to by others as pet panels), as well as other basic issues to consider.
Text of the New Massachusetts Law Allowing Establishment of Pet Trusts
Can You Leave a Sum of Money Directly to Your Pet in Your Will?
What Are the Reasons to Establish a Massachusetts Pet Trust?
What Are the Basic Components of a Massachusetts Pet Trust?
With Whom Should You Discuss Your Plans for Your Massachusetts Pet Trust?
What are the Key Issues to Consider When Appointing the Trustee of a Massachusetts Pet Trust?
Choosing a Caretaker for Your Pet in Your Massachusetts Pet Trust
Who Should Be the Monitor in Your Massachusetts Pet Trust?
When Can the Amount in a Massachusetts Pet Trust Be Reduced by the Court?
What Are the Income Tax Issues for Massachusetts Pet Trusts?
When a person who has a life estate wants to sell the real estate, the life tenant is legally entitled to a share of the proceeds. The amount of the proceeds the life tenant is supposed to receive is based on his/her life expectancy and interest rates at the time of sale.
To calculate the value of the life estate, you must first determine what the applicable interest rate is. The interest rate in the month of the sale can be found at http://www.tigertables.com/7520.htm. Once you have this figure, you then go to http://www.unclefed.com/IRS-Forms/2001/p1457.pdf and look in Table S for the page displaying tables with that interest rate. Looking up the life tenant’s age on that page will get you the breakdown between the life tenant’s percentage interest in the proceeds and the other parties, who on that page are referred to as the “Remainder.” For further explanation, including an example, see MassHealth Eligibility Operations Memo 07-18 .
The life tenant’s share of the proceeds can be eligible for the $250,000 capital gains exclusion under Internal Revenue Code Section 121, but often the persons receiving the remainder do not live there and their proceeds are subject to capital gains taxation without the ability to use that exclusion. Thus, it can often be advisable to wait until the life tenant’s death before selling real estate.
Note that the failure of the life tenant to receive the life tenant’s full share of the proceeds is considered a disqualifying transfer of assets under federal Medicaid law and MassHealth regulations, and is subject to the 5-year lookback period.
Form 8939 for estates and trusts of decedents who died during 2010 still hasn’t been finalized by the Internal Revenue Service. The last draft Form 8939 posted by the IRS was dated 12/16/2010.
It’s a good thing that the default provision for the estates of decedents who died during 2010 is the 2011 federal estate tax law, with its $5,000,000 exemption and automatic step-up in basis for assets includible in the federal gross estate. Many estates under $5,000,000 will probably not want to elect to be treated under 2010 law and deal with the uncertainties of what assets are entitled to a step-up in basis, so the unavailability of Form 8939 won’t matter to them. Unfortunately, estates that want to opt out of 2011 law and elect 2010 law still don’t have access to the form or instructions, or even an estimate from the IRS of when they will be completed.
It was once thought that Form 8939 would be due at the same time as the decedent’s 2010 federal income tax return. The IRS has recently announced, however, that Form 8939 should not be filed with the decedent’s final income tax return. Filers of Form 8939 will be given at least 90 days after the form is eventually finalized to file it, and will have access to information about the form and Internal Revenue Code Section 1022 through future Publication 4895, entitled “Tax Treatment of Property Acquired from a Decedent Dying 2010.”
Faced with the possibility of spending all of their savings on the costs of their long-term care, many elderly or aging persons recognize that covering the possible problem with long term care insurance is far and away their best choice, due to the changing nature of Medicare and Medicaid laws. With this problem hanging over their heads, elder law attorneys and other estate planning professionals are forced to consider long term care insurance first and foremost in long-range planning, and elderly or aging persons look to their advisors for creative ways to pay for the policy.
Currently, many elderly or aging persons do not buy long term care insurance because they feel that they cannot afford it. Some of them feel that way because they consider their principal to be untouchable, and are concerned whenever any plan causes them to invade it. A deeper inquiry into their finances often shows that much of their principal would not be needed for anything except paying for the costs of their long-term care. (They could therefore be considered to be gambling with their principal by going without long term care insurance.)
Some elderly or aging persons would consider purchasing long term care insurance but want to evaluate its cost in today’s dollars. Such clients would prefer to be shown a single premium long term care insurance policy. For the many insurance companies that do not offer such a product, the use of an immediate annuity with a lifetime payout (or term certain payout equal to or exceeding the client’s life expectancy) to pay for the premium is one way to approximate such a policy.
Some elderly or aging persons would consider purchasing long term care insurance but feel that their principal is untouchable because it includes appreciated assets that would result in substantial capital gains taxes if sold. They may view the appreciated asset as merely a stream of income that they receive. Unlocking the equity in these appreciated assets can often provide the funds necessary to pay the premiums for long term care insurance. Selling these assets, however, usually results in substantial capital gains taxes, thus reducing the amount remaining to pay for the insurance. It is this author’s opinion that elder law attorneys and other estate planning professionals should be exploring with these clients the possible uses of a charitable remainder annuity trust (CRAT).
A CRAT is an irrevocable trust established pursuant to Internal Revenue Code section 664 that provides a payout to one or more individuals for their lives or a period of up to 20 years. The payout must be at least 5%, and is based on the initial fair market value of the trust. The payout that is selected by the client is payable each year without regard to the actual income of the trust.
The primary reason to consider the use of a CRAT in long-term care planning is that when a CRAT sells appreciated assets that had been donated to it, no capital gains taxes are immediately payable. The CRAT can then invest the full amount of the proceeds in order to provide the payout, which in turn can be used to pay the long term care insurance premium.
The payout from the CRAT generally represents taxable income to the client. If the payout exceeds the current and accrued income of the trust, capital gain will be received by the client. The type of taxable income should not be of much concern to the client, since these taxes do not cause the principal of the CRAT to be diminished. In fact, any long-term capital gain received from the CRAT could end up being taxed on the client’s income tax returns at a lower percentage than the trust’s income.
At the end of the payout period, any amount left in the CRAT must be paid to a charity selected by the client that is described in Internal Revenue Code section 170(c). When establishing the CRAT, the client need not make an irrevocable decision about which charity will eventually benefit, as the client can reserve a special power of appointment and thereby preserve the right to change the charity receiving the remainder of the trust at the end of the payout period.
Although the remainder of the CRAT would be inherited by a charity instead of the client’s intended heirs, the existence of the long term care insurance would presumably ensure that the client’s other assets would be left behind as an inheritance to them.
A charitable remainder unitrust (CRUT), the other basic type of charitable remainder trust, is not as good a choice for this type of planning. First, the amount received from a CRUT is determined on an annual basis, and is dependent on the income generated by the CRUT’s investments. If the investment performance in a CRUT were poor for a substantial period of time, the client would be required to invade the client’s remaining principal to pay the long term care insurance premiums. Thus, the use of a CRUT is often rejected here because it does not provide the certain payout that a client would be looking for in order to pay the annual long term care insurance premium, which should remain level.
The client establishing the CRAT would be entitled to a charitable deduction on the client’s income tax return based on the present value of the charitable remainder. It is assumed here, however, that the client would be focused primarily on eliminating capital gains taxes on the sale of appreciated assets and receiving the highest feasible payout in order to pay the long term care insurance premium rather than leaving a large amount to charity and receiving a large income tax deduction.
The difficult choice that a client must make on a CRAT is whether to establish a term certain payout or a lifetime payout. It is this author’s experience that many elderly or aging persons do not wish to enter into a financial gamble that is based on their meeting or exceeding their life expectancy under an actuarial table. They are concerned about having lost money if they die earlier than their projected life expectancy, and would prefer a payout for a term certain. Upon the client’s death prior to the end of the term certain, the remaining payout would go to a beneficiary designated by the client.
Another argument in favor of a term certain payout in a CRAT is that the calculations to meet IRS scrutiny are simpler. With a lifetime payout and a high payout percentage, the IRS could disqualify the CRAT if statistically there could possibly be no remainder to be left to charity. The IRS therefore requires that with a lifetime payout there be no greater than a 5% chance that the CRAT could be exhausted by the payout. The result of the required calculation often is that for a lifetime payout the payout percentage must be smaller than the payout percentage on a term certain. To pay for the client’s long term care insurance premium with a lifetime payout, then, the CRAT would require a greater initial fair market value via more assets to make up for the lowered percentage payout. Faced with these figures, the likelihood of needing a payout period of greater than 20 years should be considered.
Statatistically, a 20-year payout may be sufficient for most clients. Under HCFA Transmittal No. 64 (November 1994), a female who is 64 years of age or older or a male who is 58 years of age or older has a life expectancy of less than 20 years. Thus, for most clients purchasing long term care insurance a CRAT for a term certain of 20 years would be longer than needed. (If the client wished to cover long term care insurance premiums only for the client’s average life expectancy, persons over these ages would require a shorter term certain for their CRAT, and it would therefore require a lower initial fair market value.)
Since the client’s taxable income will be increased by the CRAT, the client may wish to increase the initial funding and receive a payout in excess of the long term care insurance premium in order to help pay the increased income taxes. The ability of many clients to deduct the premium as an itemized medical expense on Schedule A of their federal income tax return, however, could in many cases offset the taxable income caused by the CRAT.
Using Reserved Special Powers of Appointment in Medicaid Planning
(Note: this is an update of an article of mine published in NAELA Quarterly in 1992.)
Due to their concerns about possible impact of nursing home costs (and the Medicaid disqualification period) on their assets, many aging clients feel under pressure to make transfers of their assets earlier than may otherwise be advisable. One relatively simple way to make such a transfer more palatable to a client is to suggest that the client reserve a power which is known as a non-general power of appointment or a “special power of appointment” (SPA).
What is an SPA?
An SPA is a power which allows someone at a later date to alter the disposition planned under the original instrument of conveyance. This power can be reserved by the client in the original instrument making the transfer.
By virtue of the existence of the SPA, the disposition planned in the original instrument of conveyance amounts to nothing more than a vested or contingent interest subject to divestment. If the SPA is never exercised, however, the property will eventually be inherited by the persons or entities (and in the proportions) originally planned.
The possible alternate recipients of the property named or described in the SPA can be any person or entity. For tax reasons, it seems advisable that the SPA exclude the client, the client’s creditors, the client’s estate, and the creditors of the client’s estate. A power which includes any of this group could be treated as a general power of appointment under Internal Revenue Code sections 2041 and 2514 and saddle the holder of the power with unintended tax consequences. For Medicaid purposes, this group should be excluded, as well as the client’s spouse.
Why does a reserved SPA work?
Two key elements in Medicaid planning are that the property not be reachable by a creditor (such as the state Medicaid program), either (1) during the client’s lifetime or (2) after the client’s death. A transfer which is subject to a reserved SPA can meet both of these tests. As long as the property is vested, albeit defeasibly, in entities or persons other than the client and his spouse, and as long as neither of them have any power to revest the property in themselves, the property should be deemed transferred for purposes of beginning the running of the Medicaid disqualification period. If nursing home care is not needed during the disqualification period, the property is protected in case the need for nursing home care should subsequently arise (unless, of course, Medicaid laws change retroactively, an occurrence which is always a risk in Medicaid planning).
Since the Medicaid disqualification period would begin to run upon the original transfer, any later exercise of the SPA should not cause any additional period of Medicaid disqualification.
Non-tax benefits of reserved SPA to client.
One key benefit of a reserved SPA is that a client who holds such a power maintains a great deal of control over the asset despite the conveyance. An SPA reserved in a deed can amount to a power to change who will eventually inherit the real estate. An SPA reserved in an irrevocable trust can amount to a power not only to change who will eventually inherit the remaining assets of the trust fund, but also to make gifts out of the trust.
A reserved SPA in a deed or irrevocable trust allows an appreciative client the later opportunity to compensate or reward the members of his family who take care of the client and keep the client out of or postpone entry into a nursing home. For example, part or all of the assets of an irrevocable trust with a reserved SPA could be used to build an addition or otherwise revamp the caring child’s home.
If the reserved SPA were banned in the Medicaid planning context, clients would probably resort to making outright gifts, and would have no flexibility to deal with future changes in circumstances. A caring child could then be left in a much worse financial position than another child who takes a share of the client’s assets and later bears no responsibility for the client’s continuing care.
Tax benefits of reserved SPA to client.
The control afforded by the SPA has tax ramifications. For deaths before 2010 and after 2010, at the client’s death, Internal Revenue Code section 2038 will treat the transferred assets as if they had not been transferred, and the full fair market value of the assets as of the client’s date of death will be includible in his federal gross estate. If the assets had appreciated in value during the time of the client’s ownership, this result will often be advantageous to the transferees, as Internal Revenue Code section 1014 then gives each asset a “stepped-up basis.” This means that the value at which each asset is includible in the client’s federal gross estate will then become the asset’s new basis (i.e., the figure above which federal capital gains taxes would later be assessed upon a sale of the asset).
For deaths that occurred during 2010, there are two choices of law, with the default provision being 2011 law, so powers of appointment would receive the treatment described above. If 2010 law is elected by the executor of the estate, the tax law is unclear, but my opinion is that a reserved power of appointment receives similar tax treatment. See my blog post Which Powers of Appointment Are Eligible for a Step-up in Basis in 2010 under the Modified Carryover Basis Rules?
In a Medicaid trust, a reserved SPA which allows the client and/or the client’s spouse to make lifetime gifts out of the trust fund invokes the grantor trust rules (found in Internal Revenue Code sections 671 through 678). Upon a future sale of the home, the use of the client’s $250,000.00 capital gains exclusion under Internal Revenue Code section 121 may thus be preserved.
Example of use of reserved SPA in deed.
Consider the following use of a reserved SPA in a deed: “John Smith hereby grants to his daughters, Mary Smith, Jeanne Smith, and Cheryl Jones, as joint tenants with right of survivorship, the following premises……John Smith reserves the power, exercisable as often as he may choose, by an instrument recorded at this registry of deeds during his lifetime, to appoint these premises, outright or upon trusts, conditions or limitations, to any one or more of his issue or their then current or surviving spouses.”
If Mary, Jeanne or Cheryl are sued, file for bankruptcy, file for divorce, marry a man for whom John feels little affection, become disabled or incompetent, have a falling out with John, or undergo some other change in circumstances or character, John can eliminate the daughter’s interest, can set it up in trust for the daughter and/or her husband, widower or issue, or can make it subject to a right of first refusal.
The SPA may also be of great utility if a daughter predeceases John. By exercising the SPA he could eliminate her interest and the need for probate of her estate. If in the absence of the exercise of the SPA he were to inherit her share of the home, however, a new Medicaid disqualification period may thus begin to run. If this gift had been made to the daughters as tenants in common, upon a daughter’s death John could be revested with the daughter’s share, and an exercise of the SPA could thus begin the running of a new Medicaid disqualification period.
In the above example of a gift to Mary, Jeanne or Cheryl as joint tenants with a reserved SPA in John, the deed could be recorded and the running of the Medicaid disqualification period could begin without time being spent in reviewing or altering the estate plans of John’s daughters. Upon a daughter’s death where the daughters hold title as joint tenants, and upon John’s later exercise of his SPA, he would not begin the running of a new Medicaid disqualification period because he would not have inherited any interest. (If his testamentary wish were per stirpes, however, the possibility of his later becoming incompetent to exercise the SPA makes this maneuver risky, even if it were meant to be temporary.)
Example of use of reserved SPA in irrevocable trust.
Consider the following use of a reserved SPA in an irrevocable trust: “John Smith reserves the power, exercisable during his lifetime as often as he may choose, to appoint any part or all of the principal and income of the trust fund, outright or upon trusts, conditions, or limitations, to any one or more of his issue or their then current or surviving spouses, or to charitable organizations.”
Much of the above discussion regarding deeds also applies here, except that in a trust the remainder interest would not become vested until John’s death, so that a per stirpes testamentary disposition can be initially established without concern for any daughter’s estate plan, or lack thereof.
If changes in the law adversely affect the trust, it may then be advisable to place all of its assets directly into the hands of the daughters. To get assets out of the trust and into their hands, he could use the gifting aspect of the SPA to make outright gifts to them. The SPA thus can amount to a power to terminate the trust.
Can an SPA be used less aggressively?
Clients and their advisors may feel that a reserved SPA in an irrevocable trust as described above may be too aggressive an approach and may someday be deemed to cause Medicaid disqualification on the grounds of excessive control or indirect access to the trust fund. One less aggressive approach would be to eliminate the aspect of the reserved SPA which would allow the client to make lifetime gifts from the trust to other persons. Since a gifting aspect of the SPA may be required in order to activate the grantor trust rules as to principal, the client could instead reserve an SPA which allows him to make unlimited lifetime gifts to charitable organizations. Under this approach the client could not be deemed to have indirect access to the trust fund. In order to maintain the flexibility to terminate the trust in light of future changes in the law, someone other than the client and his/her spouse could be given an SPA under this less aggressive approach.
A future complication could be caused by use of a simple SPA, for a meticulous conveyancing lawyer may require proof that the SPA was not exercised by will. In such a case the transferor’s will may have to be probated, perhaps solely for this reason. This complication can be eliminated by language in the deed which causes a conclusion presumption of the failure to exercise the power by will or codicil if notice of the establishment of probate proceedings is not recorded in the chain of title within a certain time frame after the transferor’s death.
At the same time at which any such deed is executed, the transferor may also wish to execute a durable power of attorney under which one or more of the transferees could release the transferor’s life estate or SPA. Such a power would allow a transferee whom the transferor does not wish to favor financially, but upon whose judgment the transferor feels secure, to later step into the transferor’s shoes and take corrective action if necessary or desirable under future changes in family circumstances or in federal or state law.
By use of the SPA, each remainderperson would have a vested remainder subject to divestment. If a sibling has such an interest and lives in the home for one (1) year, it is possible that one of the permissible transfers under federal Medicaid law could be utilized. Thus, the transferor may wish to give a partial remainder interest to a sibling who could later be persuaded, if feasible, to live in the home for one year prior to the transferor’s institutionalization in order to preserve it for the transferor’s family. At the same time the deed is executed, or thereafter, the transferor could execute a will which exercises the SPA to remove the sibling’s interest; since such a testamentary exercise of the SPA would not be effective until the transferor’s death, the sibling’s “equity interest” would thus remain part of the record title and intact during the transferor’s lifetime.
It should be noted here that, despite the opinion of one legal commentator, any transfer described herein does not necessarily allow the transferor to make full use of the transferor’s $250,000.00 capital gains exclusion under Internal Revenue Code section 121. If the transferor wishes to move in the future to a smaller, less expensive home, the lawyer should consider placing the home into an irrevocable grantor trust in order to preserve this exclusion.
Life Estate Can Be “Retained” for Estate Tax Purposes under Internal Revenue Code Section 2036 without Being Reserved in Deed
NOTE: This article reflects the current 2011 law, and also reflects pre-2010 law. It also is the default provision for decedents who died during 2010 unless the executor chooses to have 2011 law apply.
For many elderly persons in the middle class, a key tax goal is to keep the home includible in the person’s gross estate for federal estate tax purposes. Doing so results in a step-up in the basis of the home under Internal Revenue Code Section 1014, and the persons inheriting the home essentially receive, free of any capital gains tax, the appreciation in value from the time of the initial purchase of the home.
For example, suppose a person who paid $10,000.00 for a home dies when it is worth $200,000.00. The appreciation of $190,000.00 escapes capital gains tax if the home is includible in the person’s gross estate for federal estate tax purposes.
For a person who wishes to give away the home, the most common method of doing so may be to give away the remainder interest while reserving a life estate. Internal Revenue Code Section 2036 states that “the gross estate shall include the value of all property… of which the decedent has at any time made a transfer… under which he has retained for his life… the possession or enjoyment, or the right to the income from, the property.” Thus, if the person deeds the home to others, yet explicitly reserves a life estate, the full fair market value of the home is includible in the client’s gross estate for federal estate tax purposes and the transferees thereby receive the desired step-up in basis.
Unfortunately, some persons deed away their homes without reserving a life estate. Arguably, the federal estate tax inclusion ends up being lost by such a maneuver, but the literal language of Section 2036 quoted above can salvage the step-up in basis: note that the word “retained” is used. The Internal Revenue Service has successfully argued in the past that a right can be retained without having been reserved, and that the continued occupancy of the home after the transfer of title, without paying fair market rent, is evidence of an implicit agreement, understanding or assumption of the parties of the transaction. (See Estate of Linderme v. Commissioner, 52 T.C. 305 (1969).)
For example, if a person deeds the same home described above but reserves a life estate, upon the person’s death the home is includible on the Federal Estate Tax Return and the transferees receive a stepped-up basis of $200,000.00. If the person making the transfer had not reserved the life estate, but continued to live there rent-free or for less than fair market rent, the home should be included on the Federal Estate Tax Return as a “retained life estate” if a step-up in basis is desired.
One final note: under Internal Revenue Code Section 2035, a release of a life estate is ineffective for federal estate tax purposes for three (3) years. This means that a life estate that is released within three (3) years of death is included in the gross estate and results in the desired step-up in basis. Thus, if a person insists on making an outright transfer (perhaps due to Medicaid estate recovery concerns), it may be better to structure the transaction as a deed with a reserved life estate, then have the person release the life estate at a later time.
Internal Revenue Service Releases 12/16/2010 Advance Proof Copy of Form 8939 Required for Step-up in Basis for 2010 Deaths
Attached is the 12/16/2010 advance proof copy from the Internal Revenue Service of Form 8939, entitled “Allocation of Increase in Basis for Property Received from a Decedent.” This form is necessary for the estates of many 2010 decedents to achieve a step-up in basis. It reputedly is required to be filed with the decedent’s final income tax return, and is believed to be necessary only for estates in excess of $1,300,000. Until we see specific instructions from the Internal Revenue Service, however, it is my belief that all estates should consider filing this form.
Schedule A pertains only to surviving spouses. For assets inherited by persons other than surviving spouses, Schedule B would be required. Note that on both of these schedules, the date that the decedent acquired the property is required, along with the decedent’s adjusted basis in the asset. While that information may be easy to determine for real estate, it may not be easy to determine for securities and mutual funds held in book entry for many years. Further, taxpayers and their accountants may find that attempting to list the separate purchases made in dividend reinvestment plans to achieve a step-up in basis on each investment may not be worth the time and effort.
A positive note for taxpayers is that this latest draft of the form still does not require an explanation of why the Executor of the estate believes the asset would be entitled to a step-up in basis under Internal Revenue Code Section 1022. Thus, technical issues as to whether life estates, reserved powers of appointment or irrevocable trusts are “owned by the decedent” and “received from the decedent” under Internal Revenue Code Section 1022 are not flagged on the form except, perhaps, where an “[a]ccurate description of the property” is required. For my previous posts on Internal Revenue Code Section 1022, see http://elderlawblog.info/category/internal-revenue-code-section-1022-2
Traps for the Unwary Regarding the Modified Carryover Basis Rules for 2010 Deaths
Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue
Code Section 1022?
More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010
Are All Revocable Trusts Eligible for a Step-up in Basis under the Modified
Carryover Basis Rules?
When Is an Asset Considered “Acquired from the Decedent” under Internal Revenue Code
Section 1022?
It still looks like we’re stuck with Internal Revenue Code Section 1022 being the tax law for estates of decedents who die during 2010. Here are a few traps for the unwary regarding this law:
(1) The law allows $1,300,000 of basis increase, plus an additional $3,000,000 for a surviving spouse. Increasing the decedent’s basis means somebody has to figure out the decedent’s exact basis in his/her assets. Old deeds and purchase-and-sale agreements may need to be tracked down, and a lot of tedious, time-consuming work will have to be put in on mutual funds and dividend reinvestment plans.
(2) In addition to the $1,300,000 or $4,300,000 basis increase, additional increases are allowed if the decedent had capital loss carryovers or net operating loss carryovers. That means in some cases the decedent’s final income tax return will need to be prepared first.
(3) Assets with unrecognized capital losses as of the time of the decedent’s death cause the decedent’s estate to have additional basis increases equal to the amount of the unrecognized capital losses. There is no requirement in Section 1022 that this additional basis adjustment be utilized on the asset with the unrecognized capital loss.
(4) Internal Revenue Code Section 121(d)(11) allows the decedent’s estate, the decedent’s qualified revocable trust or the decedent’s beneficiary (as defined under Section 1022) to utilize the decedent’s $250,000 capital gains exclusion on a sale of the decedent’s principal residence. There does not appear to be any time limitation on the usage of this exclusion, so in some many cases it could be wasteful (and legally actionable) to use the Section 1022 basis increase on the decedent’s principal residence without taking Section 121 into account. This means that the basis adjustment for many estates without surviving spouses under 2010 law can effectively be $1,550,000.
(5) Under Internal Revenue Code Section 6716, there is a $10,000 penalty for failure to file Form 8939 on a timely basis.
(6) Form 8939 is due at the time of the decedent’s final income tax return, so in many cases placing Form 1040 on extension may be advisable to give the Executor more time to gather all the necessary information for Form 8939.
(7) Beneficiaries are required to be sent information about the basis increase within 30 days after Form 8939 is filed. Failure to do so can result in a $50 penalty per beneficiary.
(8) Only an “executor” can allocate the basis increase, and that term is not defined within Section 1022, but under Treasury Regulation 20.2203-1, the term “executor” includes an executor or administrator, but if there is no executor or administrator, the term means “any person in actual or constructive possession of any property of the decedent, ” and the term can actually include “the decedent’s agents and representatives; safe-deposit companies, warehouse companies, and other custodians of property in this country; brokers holding, as collateral, securities belonging to the decedent; and debtors of the decedent in this country.” Thus, the lack of an executor or administrator being appointed for a decedent’s estate can mean the possibility exists for different persons or entities to file competing Forms 8939 with different basis adjustments (and perhaps the first one filed wins).
(9) It is possible that the Executor’s basis allocation decisions on a timely-filed Form 8939 may be final, binding and unamendable even if self-serving, biased or irrational.
(10) Where the date that the decedent acquired the property is required, Executors and their accountants may find that attempting to list the separate purchases made in dividend reinvestment plans to achieve a step-up in basis on each investment may not be worth the time and effort.
(11) The first version of Form 8939 withdrawn by the IRS did not require an explanation of why the Executor of the estate believes the asset would be entitled to a step-up in basis under Internal Revenue Code Section 1022. Thus, technical issues as to whether life estates, reserved powers of appointment or irrevocable trusts are “owned by the decedent” and “received from the decedent” under Internal Revenue Code Section 1022 may not be flagged except, perhaps, where an “[a]ccurate description of the property” is required. Even though the basis of an asset is a question of fact that the IRS can later bring up, a decision will have to be made as to how much information to include on Form 8939.
(12) Filing Form 8939 may make sense even for smaller estates, to help the beneficiary prove to the IRS (when selling the asset received from the decedent) that the estate did not exceed $1,300,000.
(13) It is possible, but not certain, that filing Form 8939 will begin the 3-year clock against the IRS on valuation issues.
(14) Internal Revenue Code Section 1022 has specific safe harbor provision for qualified revocable trusts but not for revocable trusts. (A qualified revocable trust is simply a revocable trust that is elected to be treated as part of the decedent’s estate for income tax purposes under Section 645(b)(1).) To be conservative and assure the possibility of a step-up in basis for assets held in a revocable trust for someone who dies during 2010, it seems that the Executor of the decedent’s probate estate and the Trustee of the decedent’s revocable trust should make the election under Section 645(b)(1) to treat the trust as a qualified revocable trust for income tax purposes.
Internal Revenue Service Has Gone Back to the Drawing Board on Form 8939
The Internal Revenue Service has withdrawn its drafts of new Form 8939, entitled “Allocation of Increase in Basis for Property Acquired From a Decedent.” http://www.irs.gov/pub/irs-dft/f8939–dft.pdf
Hopefully, The Internal Revenue Service will complete its work soon, since the form will be due with the decedent’s final federal income tax return on April 15, 2011. Once a new version of Form 8939 is made available, I’ll post it here.
12/16/2010 UPDATE: SEE Internal Revenue Service Releases 12/16/2010 Advance Proof Copy of Form 8939 Required for Step-up in Basis for 2010 Deaths
New Form 8939 Required to Be Filed with the Internal Revenue Service for Step-up in Basis for Estates of Persons Who Die During 2010
Attached is an early draft by the Internal Revenue Service of Form 8939, entitled “Allocation of Increase in Basis for Property Received from a Decedent.” This form is necessary for the estates of 2010 decedents to achieve a step-up in basis. It reputedly is required to be filed with the decedent’s final income tax return, and is believed to be necessary only for estates in excess of $1,300,000. Until we see specific instructions from the Internal Revenue Service, however, it is my belief that all estates should consider filing this form.
Schedule A pertains only to surviving spouses. For assets inherited by persons other than surviving spouses, Schedule B would be required. Note that on both of these schedules, the date that the decedent acquired the property is required. While that information may be easy to determine for real estate, it may not be easy to determine for securities and mutual funds held in book entry for many years. Further, taxpayers and their accountants may find that attempting to list the separate purchases made in dividend reinvestment plans to achieve a step-up in basis on each investment may not be worth the time and effort.
A positive note for taxpayers is that this draft of the form does not require an explanation of why the Executor of the estate believes the asset would be entitled to a step-up in basis under Internal Revenue Code Section 1022. Thus, technical issues as to whether life estates, reserved powers of appointment or irrevocable trusts are “owned by the decedent” and “received from the decedent” under Internal Revenue Code Section 1022 are not flagged on the form except, perhaps, where an “[a]ccurate description of the property” is required. For my previous posts on what types of assets may be entitled to a step-up in basis, see http://elderlawblog.info/category/internal-revenue-code-section-1022-2
12/16/2010 EDIT: Internal Revenue Service Releases 12/16/2010 Advance Proof Copy of Form 8939 Required for Step-up in Basis for 2010 Deaths
Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue Code Section 1022?
More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010
Are All Revocable Trusts Eligible for a Step-up in Basis under the Modified
Carryover Basis Rules?
When Is an Asset Considered “Acquired from the Decedent” under Internal Revenue Code
Section 1022?
Massachusetts Supreme Judicial Court Rules Favorably on Validity of Postnuptial Agreements
In the 2010 Massachusetts case of Ansin v. Craven-Ansin, the Supreme Judicial Court ruled that postnuptial agreements can be valid under certain conditions. This case was brought by a disgruntled wife who had signed an agreement during the marriage on how the couple’s assets would be distributed upon a divorce, but the case has far-reaching ramifications and can be useful in the estate planning context.
A postnuptial agreement is essentially a prenuptial agreement that is entered into after the marriage has taken place. Either of these agreements can completely ignore divorce and child support issues and be limited solely to estate planning issues. Where many married couples (especially those with children from prior marriages) are concerned about what might be done with their inheritance by the surviving spouse, this case makes it clear that under Massachusetts law they can enter into a limited postnuptial agreement, which I refer to as an Estate Planning Agreement, to prevent the surviving spouse from later disinheriting the family of the first spouse to die.
There are other ways to protect the children from the previous marriage, but those other ways have limitations. For example, under Massachusetts law, a will contract can be entered into by a married couple to prevent the surviving spouse from changing his/her will; unfortunately, a will contract would only cover assets passing through probate, yet many assets pass free of probate. Further, some spouses establish a so-called QTIP trust to provide income for life to the surviving spouse, with the eventual inheritance going to the previous family; unfortunately, the surviving spouse would have the right to make a statutory election against the decedent’s will and trust and could end up with a lot more assets than was planned.
A limited postnuptial agreement that covers estate planning issues is a document that more and more married couples may be entering into in future years, due to the great increase in blended families.
Can a “Retained” Life Estate Be Eligible for a Step-up in Basis under Internal Revenue Code Section 1022?
Some tax professionals are trying to find an argument that a retained (as opposed to reserved) life estate can obtain a step-up in basis under the modified carryover basis rules in effect for estates of decedents who die during 2010. I have already covered whether an explicitly reserved life estate is eligible for a step-up in basis during 2010 under Internal Revenue Code Section 1022, and concluded that the possibility exists. (See Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue Code Section 1022? and More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010) The deeper question that is now being posed by some tax professionals is whether a life estate that was not reserved can nevertheless be considered “retained” by the conduct of the parties after the gift, and thereby be eligible for a step-up in basis under the modified carryover basis rules. Based on the language in Section 1022, I do not believe such a retained life estate has any chance whatsoever of being eligible for a step-up in basis.
Under pre-2010 law, an asset that was includible in the decedent’s gross estate for federal estate tax purposes always received a step-up in basis. A retained life estate, includible under Internal Revenue Code Section 2036, was one of those assets, and a line of tax cases developed that defined the word “retained” as including not only a life estate that was explicitly reserved, but also life estates that were retained by agreement, understanding, assumption or conduct of the parties. That meant that under Internal Revenue Code Section 2036, the real estate of someone who had completely given it away could be pulled back into the decedent’s gross estate. For pre-2010 deaths, Section 1014 allowed a step-up in basis for assets pulled back into the gross estate under section 2036, but, unfortunately, neither of those laws are in effect for decedents who die during 2010.
For 2010 deaths, Section 1022 requires that assets be owned by the decedent at the time of death and received from the decedent at that time, and those are much stricter standards than were required under Sections 2036 and 1014 in previous years. Tax positions formerly available utilizing Section 2036 are irrelevant in 2010, as there is no language in Internal Revenue Code Section 1022 that would allow an argument that the conduct of the parties after the gift would be equivalent to the retention of ownership. The retained life estate argument is an extreme stretch on the “owned by the decedent” test, but even if that argument were to pass muster, the argument in favor of the step-up would still fail on the “received from the decedent” requirement of the statute. If full legal title to the real estate was already given away, at the time of death the donees of the lifetime gift cannot possibly receive from the decedent what they have already completely owned.
Claiming that assets that were given away during lifetime were nevertheless owned by the decedent and received from the decedent at the time of death, and receive a step-up in basis under Internal Reveue Code Section 1022, seems to me to be a frivolous tax argument. We’ll know better how much leeway tax professionals will have to take such a position when we finally see the new tax return that is in the process of being created by the Internal Revenue Service for allocation of increased basis for 2010 deaths.
New HUD Counseling Rules Take Effect on Reverse Mortgages
On September 11, 2010, the U.S. Department of Housing and Urban Development (“HUD”) put into effect new procedures for counseling elders for reverse mortgages. These new procedures require that more detailed information be provided to the prospective borrower in advance of the counseling session, and specify what must be covered, who must attend and the issues the counselor should and shouldn’t discuss with the prospective borrower. These new HECM Counseling Protocols can be found here.
Before the counseling meeting, the elder must be sent an information packet that includes detailed loan information with comparisons, a document entitled Preparing for Your Counseling Session, and a 28-page booklet entitled Use Your Home to Stay at Home – A Guide for Older Homeowners Who Need Help Now.
During the processing counselors must now gather information from the prospective reverse mortgage borrower to examine the elder’s ability to maintain the reverse mortgage, including taxes and insurance premiums. The point there is to attempt to prevent foreseeable foreclosures due to cash flow problems.
As part of the process, counselors must ask 10 questions to ensure that the elder understands the reverse mortgage’s key elements. If the elder fails to give the correct answer at least 5 of the questions, or appears to be coerced or a possible victim of fraud, the counselor may withhold the counseling certificate. Thereafter, if the elder is insistent on proceeding, HUD states that “the counselor will issue a certificate and will flag the certificate in FHA Connection so the lender is aware that the client’s level of understanding of reverse mortgages is minimal.” Once that occurs, presumably it will be up to the lender and the lender’s counsel to decide whether to give the loan to the elder, especially where mental incapacity would then appear to be a possible problem.
More about the Mechanics of Obtaining a Step-up in Basis in 2010 under Internal Revenue Code Section 1022
The Internal Revenue Service has not yet published the form necessary to obtain a step-up in basis for 2010 deaths, but it has published FAQs about the New Tax Rules for Executors for 2010 .
It appears from the tax law that a tax return (which as of now doesn’t even have a number assigned to it) would be due at the same time as the decedent’s final income tax return (April 15, 2010, unless extended) and would only be required if the estate exceeded $1,300,000 in value or if the decedent received property via gift in the 3 years before death. The recipients of property to which the step-up in basis is allocated would receive written proof of the step-up within 30 days after the return is filed (which may be too late for some early filers, and cause the need for amended returns.)
It appears that an automatic basis increase would occur for smaller estates, but the question remains whether estates of less than $1,300,000 should also file the return. My opinion is that the return should be filed, for how else would the IRS, many years down the road, be able to determine whether a legitimate step-up in basis is being claimed? If the burden is someday placed back on the taxpayer to prove that the estate was less than $1,300,000, how would the taxpayer be able to prove that point? In addition, it may make sense to file the return for smaller estates if attempting to achieve a step-up in basis on questionable items under Internal Revenue Code Section 1022, such as reserved life estates (see http://wp.me/pRFoy-8k), reserved powers of appointment (see http://wp.me/pRFoy-90) and irrevocable grantor trusts (see http://wp.me/pRFoy-fW).
Rumors abound that a political compromise may allow taxpayers have the option of using 2009 tax law for 2010 estates. If such a law change doesn’t occur soon, the executors, personal representatives and trustees of larger estates should soon begin the process of determining the adjusted basis in the 2010 decedent’s assets. Busy accountants often have an available window of time from October 16 on through the end of the year, and larger estates should use that availability to begin dealing with this 2010 tax mess dumped on us all by the 2001 Republican Congress.
Are You Personally Responsible for Your Spouse’s Nursing Home Bills in Massachusetts?
It may come as a surprise to some people, but you can be held personally responsible for your spouse’s bills if they are for payment of necessaries. In the case of East Longmeadow Management Systems v. Wilson, the nursing home resident’s wife, Judith Wilson, was successfully sued for $45,243.24 in unpaid nursing home bills of her husband, Robert Wilson. This case serves as a stern warning to older married persons that they need to obtain legal advice from an elder law attorney when their spouse enters a nursing home. If she had done so, all of her husband’s nursing home bills could have been covered.
Even though Robert had no assets and even though Judith had not signed any contract or agreement accepting financial responsibility for his nursing home bills, she was successfully sued because she did not file for and obtain MassHealth (i.e. Medicaid) benefits for him on a timely basis. On a motion for summary judgment, the Court found that under Massachusetts General Laws, Chapter 209, Section 1, she was liable as his wife for the full cost of necessaries furnished to Robert during his life.
This case highlights why anybody concerned about the costs of nursing home care should be sure to obtain legal advice about MassHealth. If Judith had obtained legal advice from a Certified Elder Law Attorney promptly after Robert entered a nursing home, she would have learned how to apply for MassHealth for him on a timely basis. MassHealth coverage could have been applied for as long as three months after his health insurance had stopped paying for his care.
For some basic information about the at-home spouse’s ability to retain assets under MassHealth (i.e., Medicaid) law, see http://elderlawblog.info/2010/04/05/preserving-all-assets-and-maximum-income-for-the-community-spouse-when-the-other-spouse-enters-a-nursing-home/
