Questions About Elder Planning
How to Prepare for a Secure Financial
Peter A. Karl III
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.
What determines whether an estate plan should encompass
a revocable living trust (RLT) or a last will and testament
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
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
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
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).
When is an irrevocable living trust (ILT) useful in elder
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
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
What is the benefit of using a split interest trust (SIT)?
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
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.
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.
Why are testamentary trusts useful in elder planning?
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:
Providing for the continuity of ownership and postmortem
control of particular assets, such as shares of a closely
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
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.
What tax complications exist in using testamentary trusts?
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.
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.
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.
What benefits are available under Medicare for an individual
residing in a skilled nursing facility (SNF)?
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.
What are the rules with respect to the required “spend-down”
of personal assets and income in order to qualify for 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.
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
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)
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.
What look-back periods are applicable to the transfer of
assets under Medicaid?
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
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.
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
What type of trusts can protect family assets?
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.
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.
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
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
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.
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).
What options exist for long-term care insurance (LTCI)?
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.
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.
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).
What are the relevant considerations when reviewing a LTCI
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
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
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.
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).
What elder-planning issues exist with respect to IRAs?
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.
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.
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).
must be verification that the withdrawal of an individual’s
Required Minimum Distribution has occurred, particularly
when the individual has a terminal illness.
What are the tax traps in the gifting of assets to third
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.
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
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).
What problems are associated with having all of a family’s
assets titled jointly by a husband and wife?
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.
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.
How often should the beneficiary designations of nonprobate
assets be reviewed?
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
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.
Why should disclaimers be factored into elder-planning recommendations?
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
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.
What elder-planning considerations are applicable to 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
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.
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.
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.
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.
Why is a family limited partnership beneficial?
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
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.
flow emanating from the underlying assets (and the accompanying
income tax burden) can be shifted to the younger generation.
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
What strategies can be considered nearly universal in elder
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.
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
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.
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.
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
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.
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.
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.
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.
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 (www.oag.state.ny.us)
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 www.guidestar.org.
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
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
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 www.1031exchangetax.com.