Twenty Questions About Elder Planning
How to Prepare for a Secure Financial Future

By Peter A. Karl III

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Elder planning is complex and emotional, with issues in the areas of estate taxes, IRAs and other retirement-based investments, long-term care insurance (LTCI), and the range of trust instruments available. Well-informed choices allow individuals to control their financial circumstances and fund them better than would otherwise be possible. The financial future of the growing number of seniors in the United States requires nothing less.

1. What determines whether an estate plan should encompass a revocable living trust (RLT) or a last will and testament (LWT)?

Using an RLT accomplishes “living probate” in which assets are retitled following the execution of the trust documentation. An RLT avoids the expense and delay associated with probate, which is the process of retitling assets from the name of the decedent to the beneficiaries named in the LWT. Consider the following when deciding which format to use:

  • When an individual owns real estate located in more than one state, usually an RLT can avoid ancillary or another probate procedure in the second state. The more varied and substantial the asset holdings, the more costly the estate administration will be (it can be completely avoided with an RLT).
  • If a will contest by a family member is anticipated, using an RLT is recommended because it does not provide heirs an opportunity to dispute the will through the probate process. The contesting party would have to file a lawsuit on the basis of contract law, which procedurally is a more difficult task than contesting an LWT. Additionally, there is a presumption of validity with respect to a trust; the person disputing the trust has the burden of rebutting its validity.
  • An RLT is not required to be filed in court (unless there is a rare judicial challenge). Consequently, the trust and its accompanying assets are not a matter of public record.

A “pour-over” will is always needed in conjunction with an RLT to address those assets that have not been previously retitled to the name of the trust (e.g., an inheritance received immediately prior to death).

2. When is an irrevocable living trust (ILT) useful in elder planning?

An ILT is an alternative to the outright distribution of property to a beneficiary for reasons such as—

  • a concern over the windfall nature of an outright transfer to the beneficiary who (because of age or other circumstances) warrants asset preservation through entity insulation and needs to have the future distribution of the ILT assets controlled;
  • a transfer of the income tax burden from the creator of the trust to its beneficiaries age 14 or older (provided student financial aid implications are reviewed). This assumes that the ILT is not an accumulation trust but a conduit one;
  • freezing the value of assets to save estate and generation-skipping taxes (e.g., by using a dynasty trust); or
  • elimination of estate taxation attributable to life insurance proceeds.

3. What is the benefit of using a split interest trust (SIT)?

The most widely used SITs (even by individuals in their 70s and 80s) are the grantor retained annuity trust (GRAT), the grantor retained unitrust (GRUT), the qualified personal residence trust (QPRT), and the personal residence trust (PRT).

A SIT provides benefits to the creators of the trust for a stated period of time. If the grantor lives beyond the designated term, none of the assets within the trust are included in the individual’s estate as long as the trust qualifies under IRC section 2702. The GRAT stipulates the right to receive a fixed payment of income, while the amount distributed by a GRUT is based on a fixed percentage of the trust’s value, determined annually. The QPRT retains occupancy of the principal residence for the trust grantor during a stated term. A second or vacation home can be used within a PRT with provisions addressing usage, expense sharing, and death of a beneficiary.

These irrevocable trusts are sometimes referred to as “marital deduction substitutes” because the effect of the split interest provisions is to leverage the unified credit. For example, they allow a widow to freeze the value of appreciating property by transferring it at a discount to a SIT. Because the gift is a future interest, the valuation is based on the present value of the remainder interest, under the principle that the longer the term of the donor’s retained interest, the lower the amount of the gift. This transfer could be valued at zero if the retained interest equals the value of the property gifted to the trust.

4. Why are testamentary trusts useful in elder planning?

Using a testamentary trust within the language of a LWT or RLT funded with assets after the death of an individual can provide the following benefits to the designated beneficiaries:

  • n Providing for the continuity of ownership and postmortem control of particular assets, such as shares of a closely held corporation.
  • Establishing at the death of the first spouse a unified credit trust (UCT), which is ineligible for the marital deduction. The UCT provides income to the surviving spouse along with principal distributions pursuant to ascertainable standards under IRC section 2041 (i.e., the health, education, support, and maintenance of the beneficiary). This arrangement should be particularly considered when the combined assets of the two spouses are estimated to exceed the amount of the unified credit available upon the death of the second spouse (or if there is concern regarding the status of the estate tax law after 2010). An additional benefit is that the trust assets will be sheltered in the event of a creditor’s claim against the surviving spouse (such as from a nursing home).
  • Preventing a premature windfall to a younger beneficiary by providing a testamentary trust with sprinkling provisions of income and principal at the sole discretion of the trustee to a certain age (e.g., age 25). This may also protect the trust’s income and assets from being included in the calculation for student financial aid qualification.
  • Disbursing income (and optional principal distributions) to the spouse from a second marriage in order to preserve assets for the decedent’s children. In this situation, the need for a waiver should be considered with respect to the right of election that the surviving spouse would have against the estate of the deceased spouse.

5. What tax complications exist in using testamentary trusts?

The highly compressed tax brackets applicable to taxable trusts should mandate to the document drafter that income be set aside on behalf of any beneficiary under, for example, age 25, or distributed outright in order to avoid taxation at the entity level.

If Subchapter S stock will be an estate asset, the testamentary trust should be drafted to qualify as an eligible shareholder in order to avoid revocation of the S election after the two-year grace period afforded to estates.

Any trust (including a testamentary one) that is a beneficiary of an IRA or a qualified plan must meet certain requirements in order to qualify the recipients named within the document as designated beneficiaries. This means that the trust (which becomes irrevocable as of the IRA owner’s death) lists all of the beneficiaries as identifiable individuals. In addition, a copy of the trust instrument must be provided to the IRA plan administrator.

6. What benefits are available under Medicare for an individual residing in a skilled nursing facility (SNF)?

Qualification for Medicare is based on attaining age 65 and being eligible for Social Security. Part A, which covers inpatient hospital expenses, is automatic; Part B, for outpatient health-care expenses, is optional. The latter coverage should be compared by any nonretiree to a health-care policy being provided by an employer. Provided that an individual has been hospitalized for at least three days, Medicare’s Part A will pay for the first 20 days in an SNF for acute medical or rehabilitation care. The succeeding 80 days in a SNF will be covered after payment of a deductible.

7. What are the rules with respect to the required “spend-down” of personal assets and income in order to qualify for Medicaid?

Medicaid eligibility is based on an individual’s financial ability as of the date of application in terms of both income and assets. New York State allows a single individual in an SNF to retain $50 in monthly income as a personal needs allowance, and $3,950 of assets, a lifetime savings allowance.

For married couples, regardless of which spouse has title to the family assets, New York State permits the noninstitutionalized spouse (the community spouse) to retain up to $92,760 in assets in 2004, which is the community spousal resource allowance (CSRA). In New York, certain assets are exempt, and allowed to be retained above and beyond the CSRA:

  • Real estate used as a personal residence by the community spouse
  • An automobile
  • Burial and prepaid funeral funds
  • A family business
  • Investment real estate generating less than a 6% net return on its equity value
  • Insurance, both whole life (up to $1,500 in cash value) and term.

A community spouse is able to retain income officially known in New York State as the community spouse minimum monthly maintenance needs allowances, which is also called the community spouse income allowance (CSIA). This CSIA in 2004 is $2,319 monthly with the expectation by Medicaid that 25% of any income in excess of this amount will be contributed toward the institutionalized spouse’s long-term care; the cost of any health insurance premiums is allowable as an offset to the monthly gross figure. As a result, a determination must be made as to whether a person’s income is derived from the fruits of labor (FOL) or the fruits of capital (FOC). The former includes pension income; the latter is earned from investments. FOL income cannot be separated from the individual and is counted as an available resource. In contrast, the transfer of the underlying capital (e.g., stocks or bank accounts) results in the associated FOC income being shifted to the new payee under the “name on the check” rule. This calculation will reflect the extent of income exposure to nursing home and Medicaid claims.

8. What look-back periods are applicable to the transfer of assets under Medicaid?

When applying for Medicaid, outright transfers of assets for inadequate consideration to third parties within the look-back period of 36 months preceding the application will trigger an ineligibility period that begins in the month of the gift. The time period for Medicaid ineligibility (which can be more or even less than the look-back period of 36 months) is calculated by dividing the average monthly cost of the regional nursing home care into the amount of the impermissible transfers that occurred during the look-back period.

For example, if the monthly regional rate (MRR) for nursing homes is $5,000 and a $500,000 outright gift occurs during the 36 months before the Medicaid application, the look-back is triggered and the ineligibility period for Medicaid is 100 months from the date of transfer (actual 2004 MRRs range from $9,296 in Long Island to $5,842 in Central New York). Once this financial snapshot has been taken, assets or transfers by the community spouse are not considered; resource eligibility occurs only at the time of application. This would permit, for example, the sale of the principal residence after Medicaid qualification, if necessary.

The rules regarding Medicaid and asset transfers (including spousal impoverishment) do not apply to home health care. Consequently, transfers can be made immediately prior to applying for this care, which can provide, if physician ordered, up to 28 hours per week (and in certain situations more) as long as the homebound individual is receiving designated therapy.

9. What type of trusts can protect family assets?

The creator of a trust can retain the income and life use of assets contributed to an irrevocable living trust (ILT). Assets transferred to an ILT are subject to a 60-month look-back rule under Medicaid. Because of the retained life interest under IRC section 2036, the trust property will receive a stepped-up income tax basis upon the death of the creator.

The 60-month look-back period applies to assets transferred to and from any type of trust. An individual with a revocable grantor trust should first transfer assets from this entity to her name before making gifts in order to have the shorter 36-month rule apply. With respect to trust disbursements of income or principal, any creditor “steps in the shoes” of a beneficiary (i.e., to the extent that this individual is entitled to receive any benefits, so would the creditor). The Exhibit summarizes when income and principal from a trust can be considered as an available resource for Medicaid. This chart reflects that the look-back rules are not applicable to testamentary trusts, although a provision should be included that no benefits are payable to any beneficiary who otherwise would qualify for governmental benefits.

10. What strategies are available for an individual with a “foot in the door” at a nursing home?
While planning should occur years before entering a nursing home, such individuals do have some options with respect to available assets (i.e., those exceeding the CSRA and applicable exemptions; see Question 7):

  • The “rule of halves” (or “half a loaf” strategy) allows an individual to transfer approximately one-half of available assets above the CSRA (see Question 7) to a third party while using the other half (along with any income earned during the period) to privately pay for nursing home care. For example, consider an individual with $100,000 of available assets about to be confined to a nursing home in a locale where the MRR is $5,000. Prior to entering, he transfers $50,000 to family members, which renders him ineligible (see Question 8) for 10 months, during which period he privately pays the nursing home using the retained $50,000 (with eligibility for Medicaid in month 11).
  • An alternative to the “rule of halves” should be considered when available assets are, for example, in excess of approximately $216,000 for a married couple in Central New York; the actual amount depends on the cumulative 36-month MRR (see Question 8). This would be the retention of assets (along with the income generated from these during the ensuing 36-month period) sufficient to privately pay the nursing home over the next three years. The balance of the assets could be immediately transferred outright to the children. Structured properly, there may be tax benefits to the payor-child of the nursing home costs for the institutionalized parent: a dependency exemption and a medical expense itemized deduction. The latter can be obtained provided that the medical nature can be substantiated by a doctor’s statement, even if the dependency exemption is unavailable because the parent had 2003 gross income in excess of $3,050. This strategy of gifting all assets (except those being used to privately pay over the 36-month period) results in none of the transferred property being counted as available resources if the Medicaid application is made in the thirty-seventh month following the last transfer. The 60-month look-back period would apply to transfers to an ILT. An individual desiring to have an ILT should consider having it established by a third party, such as an adult child, who has been previously gifted the property. This reduces the look-back period by from 60 months to 36 months, although this two-step transfer also has double–gift tax implications.
  • Nonexempt assets under Medicaid can be converted to exempt assets, such as the community spouse buying a larger personal residence or adding capital improvements.
  • An immediate annuity that is irrevocable and nonassignable, having no cash or surrender value (i.e., permitting no withdrawals of principal) can be purchased. The annuity contract should provide a monthly income for a period no longer than the actuarial life expectancy of the annuitant-owner. In the event the annuitant dies before the end of the annuity payout period, the policy’s successor beneficiary would receive the remaining installments. This strategy can convert a nonexempt excess asset into a revenue stream that is subject to the more liberal income rules of what the community spouse can retain under Medicaid. An annuity with a term exceeding the annuitant’s life expectancy may be
    considered a transfer affecting Medicaid eligibility.
  • Liquid resources should be used to pay off consumer debts and prepay for burial plots and funeral expenses (including a family crypt).
  • Children can be compensated for documented household and care services as long as the amount is reasonable. An independent estimate should be obtained before determining the amount of remuneration, and the family should have a written agreement with the family members providing care.
  • All joint and individual assets that are in the name of the institutionalized spouse should be transferred to the community spouse (after which asset protection planning should be immediately undertaken for the latter individual).
  • In New York, one can pursue a fair hearing (800-342-3334) under Medicaid (because of “undue hardship”) after an initial determination of ineligibility by a Social Services caseworker. A hearing can address the retention of assets in excess of the CSRA that are needed to generate the minimum amount allowable under the CSIA. Similarly, a spousal refusal of contribution may be successful in certain circumstances, such as a second marriage in which assets and income have remained separate between the spouses.

These strategies should be evaluated on a local basis because their validity will depend upon the latest interpretation. Reform proposals currently being considered in New York State would change the look-back period for outright gifts from 36 to 60 months and calculate this timeframe from entry into the nursing home (as opposed to when the Medicaid application is subsequently submitted).

11. What options exist for long-term care insurance (LTCI)?

Several states, including New York, offer an LTCI partnership option from the Robert Woods Johnson Foundation that involves three parties: the insured, the state, and the insurance company.

With an LTCI partnership policy in New York, the insured is required to purchase a contract having a minimum benefit period of three years. Upon entering a nursing home, the insurance company covers expenses pursuant to the contract’s limitations. If the insured is still in the nursing home after three years, the state does not require any forfeiture of family assets, although 25% of income in excess of the 2004 monthly CSIA ($2,319) would be expected as a contribution. If the individual is single, only $50 per month can be retained.

A nonpartnership, or regular, LTCI policy provides the stated benefit for the period purchased. Nursing home expenditures incurred when there is a shortfall or the benefit period expires will have a required contribution (see Question 7).

12. What are the relevant considerations when reviewing a LTCI policy?

Besides the company’s rating, the cost of the policy must be weighed against the following typical features:

  • Daily nursing home benefit (compared to the rate in the individual’s locale)
  • Number of years over which benefits are payable or the maximum total benefits
  • Percentage of the daily benefit that may be used toward home health care
  • Initial waiting or elimination period before eligibility for benefits
  • Specific coverage for Alzheimer’s and related diseases
  • Inflation adjustments to the daily benefit (simple or compound interest calculation)
  • Discounts for joint spousal policies
  • Waiver of premium feature.

Given the probabilities of eventual long-term illness among the elderly, LTCI should be considered by everyone except those on either extreme of the economic scale (after taking into consideration the potential asset and income exposure in the event of one or both spouses being institutionalized).

13. What elder-planning issues exist with respect to IRAs?

An IRA (along with any pension plan) of a community spouse is an exempt asset not requiring liquidation toward the costs of the institutionalized spouse; however, the amount exempted counts toward the CSRA and, because the account must be in a periodic pay status in order to qualify for this exemption, the income will be factored into the calculation of the CSIA.

Retaining the account owner’s name on the IRA after death in order to create an “inherited IRA” (stretch IRA) should be considered. Unlike a surviving spouse, a nonspouse IRA beneficiary does not qualify for a rollover. Consequently, the account title for a child beneficiary needs to reference the deceased IRA owner such as “X Financial Institution as Custodian for Y, deceased for the benefit of Z, beneficiary.” This will allow for maximum deferral, if desired, because annual withdrawals will be based on the beneficiary’s life expectancy using the applicable divisor in the uniform tables from the regulations under IRC section 401(a)(9). Upon this individual’s death, the deferral can be continued by designating a successor recipient of the IRA who retains the aforementioned account titling using the applicable divisor in each successive year as the deceased beneficiary would have used.

An IRA that has several beneficiaries can be divided into separate accounts for each individual either during the owner’s lifetime or by December 31 of the year following death. This will result in the tax deferral of the payouts based on each recipient’s life expectancy. Similarly, in lieu of having one trust with multiple beneficiaries of various ages, separate trusts qualifying the respective recipient as a designated beneficiary should be used so that each individual can defer his allocable share of the decedent’s IRA over his own life expectancy (instead of being required to use the oldest recipient’s age).

There must be verification that the withdrawal of an individual’s Required Minimum Distribution has occurred, particularly when the individual has a terminal illness.

14. What are the tax traps in the gifting of assets to third parties?

For the transfer of an asset, such as an IRA or annuity with built-in gain that will be recognized upon transfer, the income tax implications must be reviewed. In every situation (including lifetime transfers of property to irrevocable trust and charities), the issue of “liability over basis” should be reviewed. If the property transferred has a mortgage with a principal balance in excess of its adjusted tax basis (ATB), the transfer will result in a deemed sale to the extent of the difference.

Despite the desire of elder individuals to undertake outright transfers to their children, transferring property that will result in a deemed sale requires additional consideration. These assets (such as appreciating stock) are best retained or given to charity; assets having a nominal difference between the FMV and ATB (e.g., cash) are preferred for lifetime transfers to family members. Appreciated assets that are retained for subsequent distribution through an estate are entitled, under current laws, to a stepped-up income tax basis.

The transfer of a principal residence to children will result in the resident parents losing the IRC section 121 gain exclusion and applicable property tax exemptions (such as New York’s STAR Program).

15. What problems are associated with having all of a family’s assets titled jointly by a husband and wife?

Having all of the assets titled jointly between spouses (sometimes known as the “poor man’s will”) is sometimes acceptable for smaller estates, but this co-ownership arrangement does not address circumstances such as the simultaneous death of a husband and wife.

For individuals potentially facing an eventual estate tax burden, joint titling does not take advantage of the unified credit in the estate of the first spouse to die (besides providing no asset protection to the surviving spouse). In addition, when established between spouses involved in a second marriage, these arrangements result in the surviving spouse having full control of asset disposition at death, which may not be the intention of both parties while alive. Circumstances such as these dictate establishing and funding a testamentary trust, as discussed in Question 4.

16. How often should the beneficiary designations of nonprobate assets be reviewed?

The beneficiary designations of all nonprobate assets should be periodically reviewed in order to update the designations and evaluate the need for the use of a testamentary trust for protecting assets. This is particularly appropriate after the death of the primary beneficiary or following a divorce. Nonprobate assets include IRAs, life insurance, annuities, and pension plans for which both the primary and contingent beneficiaries should be checked for the following reasons:

  • The possibility that children could receive outright distributions that would be a windfall in their minds or that of a student financial aid department.
  • The surviving spouse may need asset protection because of the possibility of subsequent institutionalization in a nursing home.
  • Preserving assets for the children of an earlier marriage.
  • Subjecting a nonprobate asset to probate because the estate is the contingent beneficiary by default when no secondary recipient has been designated.
  • The estate plan may reflect an overqualification for the marital deduction if the spouse is named as the beneficiary of the nonprobate assets to the exclusion of using the unified credit. This premortem determination is preferable to subsequently using a postmortem disclaimer.

17. Why should disclaimers be factored into elder-planning recommendations?

A qualified disclaimer or renunciation filed within nine months of an individual’s death is a refusal to receive assets left under an LWT or an RLT, as if the disclaiming beneficiary had predeceased the decedent. This can be a total or partial election and, to the extent elected, is not deemed a transfer for tax purposes by the disclaiming party. This individual is usually the surviving spouse, with the assets then directed to the next generation of the family in order to prevent the unified credit from being underused. Alternatively, the recipient could be a testamentary trust (of which the spouse is a beneficiary) contained within the language of an LWT or an RLT, such as a UCT. This document could be drafted to be a “disclaimer trust,” to take advantage of the increasing unified credit over the decade and uncertainty of the estate tax laws after that time. The UCT, as a testamentary trust, can also protect the assets that are funded within it from creditors, such as a nursing home.

In addition to being used for property subject to probate, a disclaimer can be filed against nonprobate assets, including real estate held as joint tenants or life insurance proceeds; assets that would have been received under intestacy (i.e., in the absence of the decedent leaving a will) can also be disclaimed. It should be noted, however, that a disclaimer by a surviving spouse could be deemed an impermissible transfer if this individual submits an application for Medicaid within 36 months of the renunciation. Similarly, a spouse receiving Medicaid benefits may be required to file a spousal right of election against the estate of the deceased spouse whose testamentary plan directs all of the assets to the children.

18. What elder-planning considerations are applicable to life insurance?

Life insurance can be used as a capital-shifting device as long as underwriting standards do not make the cost prohibitive. For example, when a taxpayer is receiving taxable distributions from an IRA, a portion of the withdrawals could be put toward life insurance premiums (such as for a second-to-die contract) owned by a third party or an ILT. The result is that the proceeds, when received, are not taxable for income or estate purposes and act as a kind of wealth replacement device (for the taxes incurred by the estate attributable to the IRA). This strategy is also applicable to distributions from any other tax-deferred account, such as an annuity or a 401(k) plan, in light of the substantial dilution in value due to eventual taxes. The result, with certain substantial account accumulations, is that only 25 cents of every IRA dollar would remain for the nonspousal beneficiaries after the payment of the associated estate and income taxes. For example, a widower who is over age 70As will be obligated to commence required minimum distributions (RMD) from his IRA. If these RMD proceeds are not needed for daily cash flow, these annual distributions, after taxes, could be applied toward premiums for a life insurance policy (owned by an ILT or his adult children) with guaranteed level premiums until death.

For a widower or widow, the ownership of an insurance policy should follow the beneficiary designation (or be in the name of an ILT if there is a need for the proceeds to be held in trust because of the recipient’s age or marital situation). This will remove the death benefit from the taxable estate of the decedent. If this is not accomplished when the policy is applied for and issued, any subsequent transfer is subject to the “in contemplation of death” rule, which results in the inclusion of the death benefit in the taxable estate during the three years following the change of ownership.

Even when a spouse is the beneficiary of an insurance policy, a life insurance trust should be considered, subject to the three-year contemplation of death rule. This is a form of ILT in order to “carve out” the face value from any estate taxation while not using any of the unified credit. In addition, the ILT can control the disposition of the proceeds following the death of the insured.

A determination should be made as to whether or not an IRC section 1035 rollover is appropriate. A tax-free exchange of one whole life insurance policy for another (or one annuity for another) may be beneficial if the product is producing a low rate of return. Alternatively, an older universal life insurance (ULI) policy may be imploding as a result of unrealistic interest-rate assumptions made at the time the policy was issued. Last, an IRC section 1035 rollover of a policy’s accumulated cash values to a different policy could, where the need might now exist, provide additional insurance protection with a higher face value as a result of a lower allocation to the investment portion of the policy.

In a distressed financial situation involving an individual whose life expectancy is less than 15 years (due to age or illness), a predeath appraisal of the contract might be warranted to determine if a sale by the policy-owner or insured is appropriate. The premortem life settlement proceeds will not be taxed to the extent of the owner’s cost basis (i.e., accumulated premiums paid to date); there would be ordinary income to the extent of the difference between the cost basis and the cash surrender value. For example, if a term life policy having a face value of $500,000 is sold for $300,000 and $50,000 in premiums has been paid to date, the first $50,000 would be tax-free and $250,000 would be taxed as capital gains. This strategy would be appropriate only in unique circumstances, because the transaction converts what would have been a nontaxable event at the time of death to a taxable event in the present.

19. Why is a family limited partnership beneficial?

A family limited partnership (FLP) is the only type of legal entity in which individuals can hold a superminority interest (e.g., the elder parents as general partners with a 2% interest) while having supermajority control (98% interest held by the children) over the limited partners. This entity can be useful in certain situations:

  • It can reduce the value of the estate through the use of valuation discounts as a result of the principle that the sum of the FLP interests is less than the value of the underlying assets held by the entity because of a lack of control, marketability, and liquidity of the ownership units. As a result, the Medicaid ineligibility period (per the calculation in Question 8) may be reduced by discounting this entity’s underlying assets.
  • Where there are asset protection concerns of the younger generation due to potential divorce or lawsuits, any creditor would be required to obtain a charging order in order to obtain benefits from the attachment of the limited partner’s interest. Property that is retitled to the FLP will also have its accompanying income and other distributions controlled by the general partners, the parents.
  • When out-of-state real property is held by the FLP, the FLP may eliminate future probate costs (and possible nonresident estate taxation) because the real estate will be converted to intangible personal property.
  • Cash flow emanating from the underlying assets (and the accompanying income tax burden) can be shifted to the younger generation.

Taxpayers should be aware of the IRS’ negative stance on FLPs, as demonstrated by its decision in the recent case Strangi v. IRS (TC-Memo 2003-145). (Additional information regarding the use of FLPs can be found “Twenty Questions on Selection of a Legal Entity,” The CPA Journal, August 1999, and “Twenty Questions on Protecting Business and Family Assets,” The CPA Journal, February 2000.)

20. What strategies can be considered nearly universal in elder planning?

A life estate arrangement for a personal residence is preferable to an outright transfer or bargain sale to family members. The elder parents retain the lifetime use of the property and the children receive the remainder interest. The use of a life estate generally preserves the availability of the existing real property tax exemptions and a portion of the principal residence gain exclusion under IRC section 121. The life estate strategy also currently provides a stepped-up income tax basis of the residence to the remaindermen at the death of the life tenants. This strategy prevents any portion of the remainder interest from being factored into Medicaid consideration after the 36-month look-back period has elapsed.

Parents who anticipate family battles regarding disposition of personal property with sentimental value should draft a letter of instruction to the attorney, the executor, or the successor trustee of an RLT, that names the recipients of specific property.

The LWT or RLT of an elder client’s parents should be reviewed when an anticipated inheritance must be factored into the estate plan by determining whether these assets should be subsequently partially or totally disclaimed. Alternatively, the parents’ documents can be revised to provide the benefits in trust in a sprinkling format for their children or grandchildren (after reviewing any generation-skipping tax implications) in order to protect these family assets from creditors or estate taxation.

A qualified terminable interest property trust (QTIP) should be used when the assets of the decedent are placed into a testamentary trust for the benefit of a surviving (second) spouse while preserving the underlying principal for the children. Besides providing mandatory life income (or use of the QTIP trust’s assets), an optional provision can be included for the distribution of principal at the trustee’s discretion under an ascertainable standard (the health, education, support, and maintenance of the beneficiary). An important consideration is the choice of the QTIP trustee in order to avoid conflicts between the surviving spouse and the stepchildren. Using an independent and professional trustee, either as the sole fiduciary or in the role of a third co-trustee in addition to one from each family, may be necessary. Also, a spousal waiver of the right of election should be executed at the time the LWT or RLT is signed.

Addressing the valuation and method of payment for the family business prior to the death of the parents is extremely important, especially when there are other children not involved in the enterprise.

Consideration should be given to using an IRC section 1031 exchange or a CRT to increase the cash flow generated from the real estate portion of the taxpayer’s investment portfolio (see “Twenty Questions About Deferred Realty Exchanges Under IRC Section 1031,” The CPA Journal, May 2003). Alternatively, any C corporation (facing significant gain from the asset sale of its underlying business, real estate, or marketable securities such as in the case of a personal holding company) could use a “hybrid bailout” strategy. This involves an asset sale to a third-party buyer and a subsequently executed stock purchase agreement with a second corporate entity (such as one in the asset recovery business having substantial accumulated losses) seeking to buy a corporation at a premium that has gain to be recognized.

Because some retirees are undertaking a more active role in managing their investments, there may be an interest in converting an IRA to a self-directed account that would be permitted to buy and sell (under its tax-free umbrella) such nontraditional holdings as private mortgages and investment real estate.

For nonresident taxpayers retaining realty in New York, consideration should be given to using an entity (other than a C corporation) as the titleholder for the real estate in order to determine whether potential income and estate tax savings are available. This conversion results in the real estate being treated as intangible personal property (i.e., the associated ownership interest in the entity) for the nonresident. This distinction is important because the real property will be deemed located in the state where the real estate is located, while intangible personal property is treated as being located in the state in which the owner is a resident.

The 5% capital gain rate can be utilized by any family member whose ordinary income tax bracket does not exceed 15% (i.e., 2003 taxable income under $28,400 for single filers, $56,800 for joint filers). Consequently, consideration could be given to gifting an asset (or partial interest) to a child or grandchild over age 13 (after taking into consideration student financial aid implications). Second, for every $2 of earned income in excess of $11,640, Social Security recipients under age 65 will see their 2004 benefits reduced by $1. Last, Social Security recipients of any age should be aware of the income level at which the percentage of benefits included in taxable income increases from 50% to 85%: $34,000 for single taxpayers and $44,000 for joint filers in 2003.

Realize that as elderly individuals advance in age, they become more susceptible to con artists, particularly those representing charities. An annual publication from the New York State Attorney General’s Office ( titled “Pennies for Charities” outlines the portion of every dollar being directed to charitable organizations in New York State. Additional information concerning many charities is available online at

While the federal estate tax burden is being reduced over the decade, taxpayers in states such as New York must be mindful of the potential for state taxes being assessed for estates over $1 million as a result of the recent change to the state death tax credit under IRC section 2011. For example, in 2004 and 2005, for a taxable estate of $1,500,000 there would be no federal estate taxes but a New York State assessment of $64,400.

Besides the execution of a durable Power of Attorney, one should also consider adding language to a separate Health Care Proxy that would allow the health care agent to receive private medical information that might otherwise be unavailable under the Health Insurance Portability and Accountability Act (HIPAA).

Peter A. Karl III, JD, CPA, is a partner with the law firm of Paravati, Karl, Green & DeBella in Utica, N.Y., and a professor of law and taxation at the State University of New York—Institute of Technology (Utica-Rome). He is also the author of




















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©2009 The New York State Society of CPAs. Legal Notices


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