December Is A Time For Making Lists

December is a time for making lists – grocery lists for big family gatherings, shopping lists for gifts, and to-do lists as you try to get everything ready for the holidays.  So, in keeping with the spirit of the season, here are three lists you should create that will really help your family, if instead you decide to just hit the eject button from Santa’s flying sleigh … or, if Grandma gets run-over by a reindeer. Ho ho ho! 

1. Contact lists for professionals and advisors:  Agents under powers of attorney, executors, and trustees need access to information about your assets, your estate plan, and your end-of-life wishes.  Therefore, keep a list with contact information for your financial/investment advisor, accountant, insurance agents, estate planning attorney and other relevant legal advisors, doctors, and any other important people who might have information your fiduciaries need.

2. Assets:  Simply put, your fiduciaries need to know where your stuff is and what it is.  Talking to the professionals listed above and reviewing past income tax returns can help with that, but it’s a good idea to keep a list of your assets so that, when the time comes for your fiduciaries to step in and start managing assets, they aren’t flying blind or scrambling to understand your situation.  This can also trigger your fiduciaries to think about what payments need to be made during your incapacity to ensure policies do not lapse, real estate taxes are paid, etc.  Consider listing the following:

· insurance policies – including life insurance, disability insurance, medical insurance, long term care insurance, homeowner’s and auto policies, and any others.

· real estate – your fiduciaries may not be aware of investment or vacation property, or that lot you inherited in another state and haven’t decided whether to keep.

· securities – especially if you own certificated stock or other securities that are not managed by an investment advisor.

· cash – list your checking and savings accounts, CDs, and any safe deposit box in your name, making sure to identify the branch where the box is located.

3. Digital assets and accounts:  This is extremely important because you may have accounts and assets that you only manage online.  Your fiduciary does not have easy or automatic access to your email account, thus will not see your statements and notices.  In addition, state law on a fiduciary’s ability to access to digital assets is new and evolving, and it varies state by state. Without knowledge that these assets exist and access to those accounts, your fiduciaries have no way to gain control over them (or even realize they exist).  In addition, there is the concern that hiring a hacker to get into a computer to find this information violates the federal Computer Fraud and Abuse Act and similar acts under various state laws. We’ve known some people who keep detailed lists of each account and password; however, how do they keep up when so many institutions require frequent password changes?  At a minimum, you should make sure these assets are listed (with the assets in #2 above) or print statements from each such account.   If you think your fiduciary can just go onto the web and click the “Forgot Password” button to solve the problem, you’re wrong.  They don’t have access to the email account where that “Forgot Password?” email is sent.

We recommend that you keep these lists with your estate planning documents, but don’t forget to let your fiduciaries know where you keep them!  You should also update them as your situation changes – we recommend checking them twice (!) a year.  The more organized your records are, the easier time your fiduciaries will have implementing your estate plan.

As for digital assets, a thorough discussion would require a series of blog posts.  Perhaps we will put that on our 2018 New Year’s Resolution list.

Jennifer Schooley  |  Contact  |  Estate Planning

Jennifer Schooley Awarded Legal Elite 2017

Jennifer Schooley has been nominated by her legal peers in the commonwealth and awarded as a member of the Legal Elite 2017 by Virginia Business Magazine, in association with the Virginia Bar Association, for her work in the category of Taxes/Estates/Trusts/Elder Law.  

She is appreciative of the recognition and remains dedicated to understanding the legal industry in today's every-changing times, as well as passionate for helping people develop comprehensive plans and advice that supports their unique life needs.

As we look towards 2018, Schooley Law Firm can help you address changes in your circumstances — whether that be due to changes in the tax laws, new or deceased family members, or increases in the value of your estate.

Jennifer Schooley  |  Contact

Choosing the Right Fiduciary: Trustees

This the fifth and final segment of our Choosing the Right Fiduciary series where we cover trustees. 

Trustees are best saved for last because their duties often overlap with the duties of agents under powers of attorney and health care powers of attorney, as well as executors.  Yet, naming a trustee is unlike these other positions because a trust is an incredibly flexible document.  Before diving into the substance of this post, a few key terms to note:

            Grantor/Settlor:  The person who creates the trust.

            Beneficiary:  The person whom the trust assets are meant to serve.

Revocable vs. Irrevocable:  Trusts can be either revocable or irrevocable.  In a revocable trust, the grantor has full power to amend or revoke the trust during his or her lifetime.  An irrevocable trust, on the other hand, cannot be revoked or amended by the grantor once executed.  This distinction is important because the tax treatment of these two types of trusts can differ and, in some cases, only certain people can be named as trustee.

Trusts may be created to achieve many different goals.  One of the most common trust arrangements is a revocable trust created by the grantor to serve as a will substitute.  The grantor serves as the trustee of his or her revocable trust during the grantor’s lifetime.  He or she may title assets in the name of the revocable trust and may name the revocable trust as the beneficiary of insurance policies or retirement assets.  If the grantor becomes mentally incapacitated, the successor trustee is authorized to step in and manage assets on behalf of the grantor.  Therefore it is desirable to name a trustee who will coordinate well with the agent named under the grantor’s power of attorney and the grantor’s health care agent.  Clients often name the same person to serve in all three roles, which creates efficiency.  However, be aware that the more “hats” a fiduciary is wearing, the less oversight there is over his or her actions.  As has been stated throughout the series, absolute confidence in the named trustee’s abilities and integrity is paramount.

At the grantor’s death, the trust becomes irrevocable and functions like a will – it directs assets to the grantor’s desired beneficiaries, often outright.  In this scenario, the clients frequently name the same person to serve as executor and trustee because the primary purpose of the trust is to direct assets at the grantor’s death.  The trustee’s responsibilities – locating heirs, distributing assets, etc. – are often very similar to the duties of an executor, but without the government oversight and reporting requirements. 

If assets are directed to be held in continued trust, the trustee’s role more closely resembles that of a guardian of property.  The trustee manages assets for the beneficiary, according to prescribed terms in the trust about how the assets should be used and when distributions should be made or withheld.  In this case, the right person to serve as trustee would be familiar with the beneficiary’s potential needs and obstacles.  Clients often name a guardian or other close relative to serve in this role because he or she is in a strong position to observe and interact with the beneficiary.  A trustee who is named to serve for a trust with multiple beneficiaries has the special challenge of weighing each beneficiary’s needs and avoiding preferential treatment of current beneficiaries over remainder beneficiaries (unless the trustee is specifically directed otherwise by the terms of the trust).  Trustees should also be strong decision makers, because beneficiaries may have opinions about the desired frequency and amount of distributions that the trustee considers inappropriate or ill-advised.  Many clients also prefer to name trustees who share the clients’ values (particularly if assets are held in trust for their children) so that those values may be passed on in the clients’ absence.

Though great consideration must be given to a trustee’s relationship with beneficiaries and ability to understand the grantor’s intent while also weighing the beneficiaries’ needs, the trustee role also requires proficiency in managing assets.  Beneficiaries are entitled to annual accountings of trust activity, so it is best to name trustees who are reasonably savvy when it comes to finances and record-keeping.  One way to accomplish both goals is to name co-trustees with different strengths who can work together, including professionals or individuals with a financial background.  The trustee is responsible for filing tax returns on behalf of the trust, which can be complicated and time consuming depending on the nature and purpose of the trust itself.  Finally, keep in mind that for some types of irrevocable trusts the class of people who may serve as trustee is limited if the desired tax result is to be achieved.

When the right person is serving as trustee, trusts are incredibly useful tools that can accomplish a wide variety of objectives.  The best choice of trustee will depend upon the goals of the grantor, the potential needs of the beneficiaries, the assets to be managed, and other circumstances particular to each trust.

We hope you have enjoyed the Choosing the Right Fiduciary Series.  Contact us today to learn more about creating an estate plan and selecting the best people to manage it.

Below are links to the four earlier articles in our Choosing The Right Fiduciary Series, if you missed them:

1. CHOOSING THE RIGHT FIDUCIARY

2. CHOOSING THE RIGHT FIDUCIARY: FINANCIAL POWERS OF ATTORNEY

3. CHOOSING THE RIGHT FIDUCIARY: HEALTH CARE POWERS OF ATTORNEY

4. Choosing The Right Fiduciary: Executors

Jennifer Schooley  |  Contact  |  Estate Planning

Choosing the Right Fiduciary: Executors

Pick me! Pick me? Pick…ugh, her?

This is the fourth installment in our blog series on Choosing the Right Fiduciary, discussing how to select the best executors for your will and asset distribution, among other things.

Many people have the impression that being chosen as the executor is being chosen as the anointed one, rather than viewing it as the job that it actually is.  According to Webster’s, an executor is “a person or institution appointed by a testator [that is, the person making the will] to execute a will.”  This sounds pretty straightforward.  In reality, an executor’s duties can be complicated.  The actions of executors are governed by extensive state law and are overseen by various government authorities.  Below are just a few of their obligations:

• qualifying before the circuit court probate division
• gathering assets of the deceased person, including tangible personal property (things you can touch or move) and intangible property (accounts, etc.)
• locating and notifying heirs and/or beneficiaries
• filing an inventory with the Commissioner of Accounts detailing every asset of the deceased person’s estate
• keeping detailed records of income and expenses of the estate (including paying final debts and taxes)
• filing accountings with the Commissioner of Accounts showing income received, expenses paid, and distributions made to beneficiaries
• filing the decedent’s final tax return (and any prior years the decedent failed to file)
• filing the estate’s tax return

Executors can be exposed to personal liability if they make mistakes during the course of estate administration, and can even be sent to jail for failing to fulfill their responsibilities.  It is not a task to be assigned or undertaken lightly. Many people who have experience as executors are less than eager to go through it again, so it is extremely important to use care in choosing the best person for the job.  However, with proper planning, it is possible to create a smooth process for your executor and even minimize his or her obligations.

The best choice for an executor will be scrupulous, organized, and tactful in moderating potential conflict between heirs.  Many executors struggle with the reporting requirements to the Commissioner of Accounts, so it can also be helpful to name someone with financial experience and/or familiarity with your assets.  Your executor will have complete control over your “probate” estate (some assets pass outside probate by beneficiary designation, deed, or title – these assets are not subject to your executor’s control).  This creates an opportunity for theft and can also create tension between your named executor and any beneficiaries of your estate who are not serving as co-executors.  Another challenge is that out-of-state executors are often required to post a bond with the Circuit Court, an expense that must be paid out of pocket by the executor (although he or she can be reimbursed once the estate is open).  In order to qualify for a bond, the executor must have good credit and a clean financial record.  It is possible to name more than one person to serve together as co-executors, so naming a professional and/or Virginia resident to serve as a co-executor is one way to mitigate these concerns.

Making a strong choice of executor is a major step toward a smooth administration process, but you should also provide clear instructions for your executor about where to find your will and assets, particularly when you no longer have paper statements.  Remember that your named executor is under no obligation to accept, so the more orderly your affairs are, the more likely it is that your desired executor will take on the responsibility.  If chosen correctly, the executor will understand exactly what they are getting into, with no illusions of glory or prestige, leading to a greater likelihood of acceptance and a smoother administration process.  Contact us for more information about wills, executors, and creating an orderly estate plan.

October is for pumpkins, ghosts and IRS estate + gift tax updates

It's that time of year again...

Not for ghosts and pumpkins (well, those too) - this month, the IRS published the new estate and gift tax exclusion amounts, along with various other tax rate tables.  These numbers may or may not vary from year to year, but estate and tax planners are always interested.  Minimizing estate and gift taxes can be an important component of a complete estate plan and clients who may make large gifts or whose net worth approaches the estate tax exclusion amount should stay abreast of these changes.

The highlights:

The unified credit against estate tax increases to $5,600,000 per individual in 2018 ($11,200,000 for a married couple utilizing portability).  This is a notably steeper climb than in recent years – in 2017, the unified credit was $5,490,000, in 2016, the amount was $5,450,000, and in 2015, the amount was $5,430,000.

The gift tax annual exclusion increases to $15,000 in 2018.  This is even more noteworthy because the annual exclusion amount has not changed in recent years – it has stayed at $14,000 since 2013.

Other values of interest include:

For gifts to a non-US citizen spouse, the first $152,000 given in each tax year is non-taxable.

Beginning in 2018, gifts received by US citizens from certain foreign persons must be reported if the aggregate value received in the tax year exceeds $16,111.

Irrevocable trusts and estates reach the top income tax rate of 39.6% on income exceeding $12,700.

The official IRS update documentation can be found here, if you want some light bedtime reading. 

But if you are concerned about reducing estate taxes or making annual gifts greater in value than $15,000, contact our firm today.  We can help create an estate plan or gifting strategy to achieve your goals without the headache.

Jennifer Schooley  |  Contact  |  Estate Planning

Choosing the Right Fiduciary: Health Care Powers of Attorney

This is the third installment in our blog series on Choosing the Right Fiduciary, discussing how to select the best agents under a health care power of attorney.

The people you name to act as your agent under a health care power of attorney are responsible for making your medical decisions if you are incapacitated and unable to do so for yourself.  In the absence of a health care power of attorney, Virginia law identifies the people who are authorized to make those choices; however, clients generally prefer to be more specific about who will manage their health care and treatment.

It can be helpful to name a friend or family member with a medical background.  Clients with a nurse or doctor in the family often name that person as their health care agent because he or she will have a better understanding of the client’s condition and the decisions that should be made.  Your health care agent should also be familiar with your personal values – for example, knowing your end of life wishes and whether your religious beliefs would affect your treatment plan. 

Personality can be a major factor as well.  Look for someone who stays calm in emergencies, is able to make quick decisions, and can communicate those decisions clearly to the rest of your loved ones.  Situations where you are abruptly incapacitated because of a medical problem can be very high stress for the people who care about you.  Another factor to consider is that a person’s incapacity may not be temporary, or short-lived.  Health care agents can become overwhelmed when they become responsible for the long-term care of someone who is incapacitated, so it can be a good idea to choose someone who is conveniently located and has a flexible lifestyle.  Complex family dynamics can add to that stress for the person you have entrusted with this responsibility. Naming a strong decision-maker whose choices will be trusted by others can help minimize disagreements surrounding your medical care.

Another way to reduce conflict about your health care is to include an advance directive (sometimes called a “living will”) with your health care power of attorney.  This is your declaration to your doctor that you wish to be removed from artificial life support if your doctor has determined you are terminally ill or in a persistent coma and unlikely to recover.  This can be a powerful tool to effectuate your wishes and to release your loved ones from the burden of making that final decision.

Keep in mind that you can name anyone to act as your health care agent, whether that is a family member, a friend, or a trusted employee or neighbor.  We can help you identify your options, but ultimately you are in the best position to determine who should be named to act in this capacity.

Jennifer Schooley  |  Contact  |  Estate Planning

Choosing the Right Fiduciary: Financial Powers of Attorney

This is the second installment in our blog series on Choosing the Right Fiduciary.  This week, we discuss how to select the best agents under a power of attorney.

An agent under a durable general power of attorney is empowered to carry out almost any action you (called the ‘principal’) could take for yourself with regard to your assets and finances.  Many clients choose to name their spouse as their agent, which can make sense because a spouse is often well-positioned to be familiar with financial affairs and can be one of the most trusted individuals in a person’s life.

Clients who are unmarried or for whom it is not desirable to name a spouse sometimes struggle with this decision, however, and married clients can have similar trouble choosing back-up agents to serve if their spouse is unable to act.  Your choice may be guided by several factors, but the most paramount is trust.  The power granted under these documents makes abuse relatively easy and difficult to detect.  Consider naming family members or close friends who merit a high level of trust and do not have financial, addiction, or other troubles in their past that might render them vulnerable to temptation. 

Another factor to consider when choosing your agent is the relative complexity of your financial situation.  Agents under a power of attorney are typically called upon to pay your obligations and manage your affairs.  If your major assets are cash accounts, retirement assets, and a primary residence, the skills required for your agent to effectively handle your finances are substantially different from someone with interests in small business entities, investment real estate, or securities that are not professionally-managed.

Finally, consider naming someone you believe can be ‘neutral’ in exercising the authority granted under a power of attorney.  Agents have fiduciary duties to avoid conflicts of interest when acting on your behalf, but when family issues between siblings or step-relations arise, it can be difficult for someone who is emotionally invested to remain objective.  One might question how often an agent under a power of attorney could become entangled in such disagreements, but consider a child approaching the agent for an extension of an existing loan, or a second spouse requesting the agent’s cooperation in purchasing a marital residence or funding the spouse's long term care using the principal’s separate assets.  An emotionally-invested agent might even reconfigure beneficiary designations and transfer on death arrangements made by the principal to secure an estate outcome which he or she considers more just.  Another problem might arise if an agent (intentionally or otherwise) sells property that is given by specific bequest to a beneficiary under the principal’s estate planning documents to provide for the principal's support, rather than choosing a different asset to sell.  Naming agents who are suitably loyal to your own interests and values reduces the likelihood of these kinds of conflicts producing undesirable results.

Depending on the level of complexity your agent will be dealing with (whether that means financial or family complexity), it can be worthwhile to name a professional such as an accountant, attorney, or someone else with special skills that will increase the agent’s effectiveness.  Although this option can be more expensive, it might make sense if there is substantial risk in naming a family member or friend who may not be up to the task.  Agents who are already acting under a power of attorney can also benefit from engaging professional services to supplement the agents’ own knowledge and skill.

In case you missed the first part, Choosing the Right Fiduciary. And look for next week’s installment in our blog series on Choosing the Right Fiduciary – Health Care Powers of Attorney.

Jennifer Schooley  |  Contact  |  Estate Planning

Choosing the Right Fiduciary

The importance of choosing the right people to fill fiduciary roles cannot be overstated.  The word “fiduciary” derives from the Latin verb fidere – to trust – and it is true that individuals named to these roles should have the highest level of trustworthiness.  Ideally, however, the people serving as fiduciaries should also possess the necessary skillset to successfully perform the tasks required.  Because the responsibilities in each role are somewhat different from the others, taking the time to think through whether a potential fiduciary’s skillset and personality are compatible with the role is well worth the effort.  Here is an overview of each role, which will be followed in subsequent posts with more detail about each particular one.

• An agent under a power of attorney may manage your finances on your behalf during your lifetime.  Agents are often granted nearly unlimited powers to carry out any action you might undertake for yourself.  Unfortunately, this broad power is sometimes abused, so trustworthiness is the absolute guiding star when choosing an agent.  Another important factor is attention to detail.  Investment, banking, bill payment, and other records of actions should be maintained.  This person may also be tasked with voting on (or otherwise controlling) your business affairs.  Thus, it may be easier for an agent who lives locally and has intimate knowledge of your affairs to act on your behalf.
• By contrast, an agent under a health care power of attorney is empowered to make decisions about your body.   If you are unable to make or communicate a decision about your own medical care, your agent is named to make those decisions.  Thus, this person becomes your advocate.  The person named should be familiar with your values and your wishes, and if necessary, be assertive enough to ask the right questions of medical professionals.  Finally, it is helpful (but not essential) to name someone with medical experience and who is local.  If you are in an assisted living or a nursing care facility, your agent is the facility’s main point of contact.
• An executor is appointed to wrap up your affairs after your death.  This begins by qualifying before the circuit court clerk and may include preparing an inventory of your assets at your death and an accounting showing payment of your debts, receipts by your estate, and distributions to your beneficiaries.  Your executor is also obligated to file your final income tax return.  Strong organizational skills are critical to this position because record-keeping, meeting probate deadlines, and making tax elections and filings are key aspects of the job.  Weeding through and selling, distributing, or donating household contents is also a major function of the job, and it’s no small task.  If the executor is not a resident of the state, this task is more cumbersome.  In addition, the court may require that the executor be bonded. 
• A trustee is put in place to manage money for the long-term benefit of the trust’s beneficiaries.  The person in this position must be prepared for a commitment and possess either a talent for asset management or the ability to assess information provided by a competent professional who is hired.   Consider naming someone who has a sense of your values and the beneficiaries’ needs, so that if the trustee is called upon to make discretionary distributions, he or she has a solid foundation from which to consider the issues.  Often the interests of beneficiaries conflict, so your trustee may be tasked with making difficult choices.

Naming the wrong people to these fiduciary roles can cause even a well-constructed estate plan to fall apart.  Your attorney can help you identify individuals in your life who would be a good fit for each role, but your knowledge of both the character and judgment of the people you choose is paramount.  If you lack confidence that people in your life have the talent or character required of the job, choosing a professional trustee may be the better course.

Jennifer Schooley  |  Contact  |  Estate Planning

Power Of Attorney Pitfalls

In one sense, being named to act as someone’s agent under a power of attorney should be considered an honor – clients are encouraged by their lawyers to choose agents who are highly trustworthy and competent.  Even well-meaning agents, however, can make mistakes, either from simple human error or from a misunderstanding of an agent’s obligations and responsibilities under Virginia law.  Here are just a few of the issues we see giving agents trouble.

Record-Keeping

Agents are obligated by statute to keep records of every transaction they undertake in their principal’s name.  Depending on the individual situation, this could mean keeping many years of records of deposits, withdrawals, expenses paid, reimbursements made to the agent, purchases, and sales.  This can be a lot to undertake while also trying to run your own, busy life, and many agents therefore let their records slip.  The pitfall?  If these records are requested by certain individuals listed in the statute, the agent is obligated to hand them over within thirty days.  Recreating these records (up to five years’ worth) may be impossible at the point the request is received, so it is critically important to maintain the records from the start.

Unauthorized Actions

Although powers of attorney often grant agents broad powers to undertake any action the principal could take with regard to his or her finances, certain powers are considered special and require an express grant of authority to be stated in the document.  If those powers are not specifically listed, the agent is not authorized to exercise them.  These “special powers” include:

• Creating, revoking, or amending the principal’s revocable trust;

• Making gifts of the principal’s property;

• Creating or changing rights of survivorship or beneficiary designations;

• Delegating the agent’s authority to someone else;

• Waiving the principal’s right as a beneficiary of a joint and survivor annuity (including a survivor benefit under a retirement plan); and

• Exercising fiduciary powers that the principal has authority to delegate.

Agents should read the power of attorney granting them authority carefully to determine exactly which powers are granted to them and which are withheld.  In addition, certain powers, even if expressly granted, are further limited by statute depending on the agent’s familial relationship to the principal.

Conflicts of Interest and Good Faith

An agent is obligated to act on the principal’s behalf in accordance with the principal’s best interest, in good faith, and free from conflicts of interest.  Although these may seem like straightforward conditions, in practice they can be more complicated.  An agent can run afoul of these fiduciary responsibilities even when he or she has no intention to act against the principal’s best interest or otherwise cause harm to the principal. 

The bottom line? For violating these duties, agents can be held personally liable for any actual loss to the principal, as well as the attorneys’ fees and costs of a party who raises the issue.  Thus, the best practice is always to get legal advice before taking any action that raises the slightest question mark or causes you to hesitate for any reason.  If you are already acting as agent under a power of attorney and have questions about transactions you have already entered into, it may not be too late to “right the ship” and get back into compliance with your legal responsibilities.

Learn More About

Estate Law  |  Jennifer Schooley

2016 Inflation-Adjusted Amounts for Trust and Estate Tax Brackets

Each year the trusts and estates tax lawyers eagerly await the new exemption amounts and tax brackets to see if there is any change due to upticks in the Consumer Price Index.  Ok...maybe we don't hold our breath, but we do pay attention.  It's vital information for a client meeting and fodder for conversation at the next cocktail party, where inevitably, the question "what do you do" comes up and one prepares to either enlighten or bore the other person with a font of tax knowledge.  Cue the sports conversation, "Hey, how about those Bears???"

Here are the highlights:

• The new estate tax exemption equivalent is $5,450,000, up from $5,430,000.
• The new generation-skipping transfer tax exemption is $5,450,000, up from $5,430,000.
• The gift tax annual exclusion remains at $14,000.
• The annual exclusion for gifts to noncitizen spouses increases to $148,000.
• The reporting threshold for foreign gifts received by a U.S. person from a nonresident alien individual or estate is $100,000 in the aggregate for the year and is $15,671 (increased from $15,601) if received from a foreign corporation or partnership.
• Irrevocable trusts and estates reach the top income tax rate of 39.6% on income over $12,400.

In other news, the Bears defense will face a tough test on Sunday when the Raiders come to play at Soldier Field.

"Give A Little Respect...Just A Little Bit?" (When a handwritten note is just not enough.)

People often hold the mistaken belief that their family and their financial institutions will respect their wishes, even if they do not dot all their "i's" and cross all of their "t's."  Admittedly, following rules and procedures and dealing with paperwork can be dull, but don't let your failure to do so take your intended beneficiaries by surprise.  In a recent 8th Circuit case, Hearing v. Minnesota Life Insurance Company, the Court determined a handwritten note apparently intended to effect a change of beneficiary did not satisfy a life insurance policy’s contractual requirement that the policy owner file a beneficiary change with the insurance company prior to death.  The policy owner, Jon Holloway, wrote a note to his daughter, Nikki, directing her to “sell everything you don’t want and bank it.”  The policy number for Holloway’s Minnesota Life Insurance policy was listed at the bottom, along with contact information for the insurance agent.

The beneficiary of Holloway’s life insurance policy, however, was Holloway’s sister, Joetta Hearing.  Holloway made Hearing his beneficiary when, following his divorce, he did not want his ex-wife to control the proceeds on behalf of Nikki in the event of his death.  In fact, on his insurance application he wrote “[n]aming sister as beneficiary so ex-wife can’t control the death proceeds.”  So, it could be inferred that Holloway really intended for his daughter (a minor) to be his beneficiary but named his sister instead in an attempt to safeguard his death proceeds from his ex-wife.  The Court, however, was not willing to make such an inference, even given the existence of a handwritten note, signed and dated by Holloway, designating Nikki the recipient of the proceeds.

Minors cannot legally own property, and Holloway may have been advised of this when he decided to make his sister the beneficiary. However, a better way for Holloway to have approached this situation would have been to create a trust with Nikki as beneficiary and name the trust to receive the life insuranace proceeds.  Trusts allow a greater degree of control and management over ones wealth, even after death. If Holloway had made a trust agreement naming a competent adult as trustee, he could have outlined precisely when, after reaching the age of majority, his various assets (including policy proceeds) would pass to Nikki.

Deciding who will be the beneficiary of your insurance policy is not always easy.  But it is always a good idea to keep abreast of your policy’s requirements for changing beneficiaries.  Check with your insurance agent to ensure your policy is up-to-date regarding the direction of your assets, and consult an estate planning attorney if your primary or contingent beneficiary would be one or more minors.  Furthermore, it may be a good idea to create a trust agreement.  After all, having your proceeds go to someone unintended really may be the last thing you want.

Same Sex Marriage in Virginia

In October, the U.S. Supreme Court declined to hear appeals from five states, including Virginia, that sought to prohibit same sex marriage. Critics of the rejection have argued that the Court should have engaged the issue in order to set a national standard. But regardless of whether the Court should have reached further by ruling on the appeals, the refusal to hear the cases effectively legalizes same sex marriage in the appellant states.

This means that weddings between same sex couples began immediately in the Commonwealth.  In addition, same sex couples currently residing in Virginia who were married in states where such marriages were already legal will now be subject to all Virginia state laws governing marriage, including divorce, estate, and tax law.  

The Court’s 2013 decision in U.S. v. Windsor extended federal protection and recognition to same sex marriage, with the result that same sex couples became subject to all federal tax law. (For more details, see the post of September 25, 2013.) Although this pair of decisions inarguably expands same sex rights, it also requires the same sex married couples to navigate and comply with all laws and regulations, both federal and state, that previously just applied to heterosexual married couples.

These changes should prompt all same sex married couples to consider contacting an attorney to review their estate plans and update them, if necessary.

Clark v. Rameker: Inherited IRAs Are Not Protected from Creditors

Clients who have named a child or spouse with financial problems as the direct beneficiary of an IRA should reconsider their beneficiary designation. In June, the Supreme Court unanimously held that IRAs inherited from the original owner are not exempt from the bankruptcy estate. This means that if a holder of an inherited IRA files for bankruptcy, funds from the IRA will be accessible by a bankruptcy trustee to satisfy unpaid debts.

Section 522 of the Bankruptcy Code states that “an individual debtor may exempt from property of the estate [. . .] retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code.” This includes both traditional IRAs (section 408) and Roth IRAs (section 408A). Thus, when Heidi Heffron-Clark filed for Chapter 7 bankruptcy, she listed an IRA inherited from her mother as exempt property. The bankruptcy trustee disagreed, as did the Seventh Circuit. This case, Clark v. Rameker, affirmed the Seventh Circuit’s holding and resolved a conflict with the Fifth Circuit’s decision in In re Chilton, which had held that inherited IRAs did constitute exempt retirement funds.

The Court distinguished inherited IRAs from traditional and Roth IRAs in three ways. First, the holder of an inherited IRA cannot invest additional money in the account. Second, holders of inherited IRAs MUST withdraw from the accounts, regardless of proximity to retirement. Last, a person who holds an inherited IRA may withdraw all the funds at any time, without penalty.

The Court explained that the purpose of exempting retirement funds from the bankruptcy estate is to allow the debtor to meet his or her essential needs during retirement. Because funds in a traditional or Roth IRA are only accessible without penalty when the account holder reaches approximate retirement age, exempting these accounts comports with that goal. On the other hand, the holder of an inherited IRA can (and in fact, must) withdraw the funds over a prescribed time period, even if the person is many years away from retirement. As Justice Sotomayor pointed out,

“nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete. Allowing that kind of exemption would convert the Bankruptcy Code’s purposes of preserving debtors’ ability to meet their basic needs and ensuring that they have a ‘fresh start,’ into a ‘free pass.’”

This ruling means that inherited IRA funds are accessible by creditors in the bankruptcy context. Therefore, estate planners should counsel their clients with substantial retirement accounts not to name individuals with a history of insolvency in their beneficiary designations. A better option is to create a trust, which can be impenetrable to most types of creditors. Trusts can hold a variety of assets and can be designated as IRA beneficiaries. In addition, distributions to beneficiaries can be limited to prevent trust assets from being consumed by the creditors of an insolvent trust beneficiary. 

New IRS Regs: Thanks a "Bundle"

At long last, the IRS finalized regulations that were initially proposed in 2007. Treas. Reg. §1.67-4 clarifies which estate and non-grantor trust costs are fully deductible for income tax purposes and which are only allowed to the extent that they exceed 2% of the estate’s or trust’s adjusted gross income as set out in §67(a). Section 67(a) “miscellaneous itemized deductions” are generally subject to this 2% floor for individuals, but §67(e)(1) provides an exception for costs paid or incurred by an estate or trust if an individual who held the property outright would not have paid them. In essence, costs incurred by an estate or non-grantor trust as a direct result of the form of ownership are fully deductible.

The standard under the regulations tracks the Supreme Court’s decision in Knight v. Commissioner, 552 U.S. 181 (2008). If an individual who held the same property outside of a trust would “customarily” or “commonly” incur the expense at issue, it is subject to the 2% floor. Using this inquiry, the Court determined that investment advisory fees would generally be subject to the 2% floor, and the finalized regulations reflect that holding. But if an investment advisory fee incurred by an estate or trust is higher than what would normally be charged to an individual investor, then the portion of the fee that exceeds a ‘normal’ charge is considered a special cost, particular to the estate or trust context and therefore not subject to the 2% floor. This also means that normal “ownership costs,” defined in §1.67-4(b)(2), such as condominium fees or insurance premiums, are subject to the 2% floor, but only if they are costs properly analyzed under §67. (Business costs, for example, would be fully deductible under §162.) On the other hand, some tax preparation fees and appraisal fees are not subject to the 2% floor because they arise out of the form of ownership. This includes estate and generation-skipping transfer tax returns and the appraisals required for preparation of those returns. Likewise, certain fiduciary expenses are fully deductible, a non-exhaustive list of which is provided in the regulations. This all seems fairly consistent with Knight and the Code.

The real head-scratcher appears in subsection (c). If an estate or non-grantor trust pays a single fee (for example, to an attorney or accountant or as a fiduciary commission) attributable to both kinds of costs, this so-called “bundled fee” must be allocated between the portion that is subject to the 2% floor and the portion that is not. Practitioners objected to this allocation requirement during notice and comment, arguing that it would drastically increase administration costs. The IRS disagreed, pointing out that the new regulations allow “any reasonable method” to be used in allocating bundled fees. However, a vague standard is no one’s friend, and this one is unlikely to comfort planners. In addition, unscrupulous professionals could choose to collude with their estate and trust clients by itemizing their “bundled fees” but allocating a minimal portion to costs subject to the 2% floor.

The Service’s position on bundled fees in the finalized regulations is a departure from the temporary guidance it issued in 2008, which had stated that the portion of a bundled fee subject to 2% floor costs did not have to be determined. Hence the bottom line is that estates and non-grantor trusts incurring these types of fees will no longer enjoy a complete deduction, and will have to develop a “reasonable” method of determining how they break them down. This means increased costs, both in taxes paid and in administration.

Lessons Learned, From Someone Else's Mistake

Tax Court Memorandum 2014-15, issued on January 27, 2014, is another example of a taxpayers falling far short of the requirements to substantiate a charitable income tax deduction resulting in the deduction for their contribution of a 34 unit apartment building to charity being denied.  The taxpayers, a doctor and his wife, provided false information and submitted appraisals that did not meet the substantive requirements of Code section 170 for submitting a “qualified appraisal,” hiring a qualified appraiser, and the appraisal summary requirements.  The result….well,  the judge absolutely denied their claim for a deduction, and that, readers, is the loss of real money.

When making large donations, failing to meet these requirements (which often occurs by failing to invest the time and money in hiring appropriate appraisers and advisors) can result in the loss of major dollars!  Unless a donation can be readily valued, such as donations of cash and marketable securities, it’s important to know the type of documentation you need.

Under Treasury Regulation 1.170A-13(c)(2), a taxpayer who claims a charitable deduction in excess of $5,000 must (1) obtain a qualified appraisal for the property contributed; (2) attach a fully completed appraisal summary to his tax return; and (3) maintain records containing certain information (as required by paragraph (b)(2)(ii) 13 of this section).

So, what is a qualified appraisal?  Under the regulations, a qualified appraisal must be made not more than 60 days before the gift and no later than the due date of the income tax return, it must be signed by a “qualified appraiser” (more on that later), must not involved a prohibited appraisal fee, and must include the following information:

1. A description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed;

2.  In the case of tangible property, the physical condition of the property;

3. The date (or expected date) of contribution to the charity;

4. The terms of any agreement or understanding entered into that relates to the use, sale, or other disposition of the property contributed;

5. The name, address, and the identifying number of the qualified appraiser;

6. The qualifications of the qualified appraiser who signs the appraisal, including the appraiser's background, experience, education, and membership, if any, in professional appraisal associations;

7.  A statement that the appraisal was prepared for income tax purposes;

8. The date (or dates) on which the property was appraised;

9. The appraised fair market value of the property on the date (or expected date) of contribution;

10. The method of valuation used to determine the fair market value; and

11. The specific basis for the valuation. (See Regulation §1.170A-13(c)(3)(ii))

A “qualified appraiser” is an individual who (1) “has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations….; (2) “regularly performs appraisals for which the individual receives compensation”; and (3) “meets such other requirements as may be prescribed by the [Treasury] Secretary in regulations or other guidance.”  Additionally, the individual must demonstrate verifiable education and experience in valuing the type of property subject to the appraisal and not be prohibited from practicing before the IRS.  (See IRC § 170(f)(11)(E)(ii) & (iii)).

Under the regulations, a qualified appraiser is an individual who includes on the appraisal summary a declaration that: (1) the individual either holds himself out to the public as an appraiser or performs appraisals regularly; (2) the appraiser is qualified to make appraisals of the type of property being valued; (3) the appraiser is not excluded from qualifying as a qualified appraiser under section 1.170A-13(c)(5)(iv), Income Tax Regs.; 21 and (4) the appraiser understands that an intentionally false or fraudulent overstatement of the value of the property described in the qualified appraisal or appraisal summary may subject the appraiser to a civil penalty under section 6701 for aiding and abetting an understatement of tax liability.  (See Regulation  § 1.170A-13(c)(5)(i)).

The rules surrounding charitable contributions and the required receipts and verifications needed for different types of property are complex.  It is important to discuss these issues with your CPA (because I assure you, they are not all covered here!) and ensure you take the steps necessary to protect the deduction you wish to take in April!