Proper Beneficiary Designations

We have been discussing the importance of proper beneficiary designations in wills and living trusts. Generally, the most frequent type of designation seen is, assuming no surviving spouse, "to my children, in equal shares, per stirpes." This means that a distribution will be made to the surviving family members when a beneficiary dies before the testator or settlor of a trust. But what about beneficiary designations for non-probate assets such as life insurance, annuities, 401K's and IRA's? The answer is that equal attention must be paid to the beneficiary selection for these types of assets as with wills and trusts. The per stirpes designation on a financial institution's or insurance company's beneficiary designation form is acceptable. Some issues to be aware of include: per stirpes (for example, "to my son, A, per stirpes") may not avoid the appointment of a guardian by a court if a minor does inherit as a contingent or designated beneficiary of a non-probate asset. A simple solution: "To my son, A, per stirpes, but in the event such issue who inherit shall be minor (s) then said minor's beneficiary share shall be paid to a custodian under the Uniform Transfers to Minors Act until the maximum age permitted by law and thereafter directly to the beneficiary. The custodian, if none, shall be designated by the executor or administrator of my estate." If there is no per stirpes or per capita designation on a beneficiary designation form, the proceeds of the policy or retirement account will be payable to the testator's estate, and be distributed according to the terms of his or her will, or by intestacy, if no will exists. This may create unintended results and unintended beneficiaries. If a trust is named the beneficiary of a IRA, and the testator later revokes the trust, care must be taken to change the beneficiary designation form, as well. It is also recommended that a beneficiary designation form be completed in duplicate, with one copy returned to the owner of the account or policy. This avoids the potential problem of a misplaced or lost designation form by a financial institution.

Reviewing the Tax Relief Act of 2001

On May 26th Congress approved The Economic Growth and Tax Relief Reconciliation Act of 2001, the biggest tax cut in a generation. The bill, which provides for a tax cut of $1.35 trillion in the next decade, passed the House by a vote of 240 to 154, and passed the Senate by a vote of 58 to 33.

The new legislation makes 441 tax-law changes, according to the Wall Street Journaland will require CCH Inc. (a leading publisher of tax information) "to update more than 14,368 pages in its 23 core federal tax...looseleaf materials." This issue of THE ADVANTAGE and succeeding issues will focus on and highlight some of the changes in the Estate and Gift Tax Laws and the Generation Skipping Transfer (GST) Tax Law.

Beginning in 2002 and through 2009, the Estate and Gift Tax rates will be reduced. At the same time, the Unified Credit Exemption amount for Estate Tax purposes and the GST Tax Exemption amount will be significantly increased. In 2002, the Unified Credit Exemption amount for lifetime gifts will be increased to $1 million and will remain at that level. The Estate Tax and GST Tax are repealed in 2010, but only for one year. In that same year, assets would begin to be inherited at their purchase price rather than market value (carryover basis), so heirs could inherit old capital gains-tax liabilities - making bookkeeping potentially burdensome.

Commentators have noted some curiosities in this legislation. For instance, according to an Op-Ed piece humorously entitled Bad Heir Day in The New York Times (May 30th), the postponing of the repeal of the Estate Tax until 2010 left the "books insufficiently cooked," so Congress- added a 'sunset' clause, officially causing the whole bill to expire, and tax rates to bounce back to 2000 levels, at the beginning of 2011. So in the law as now written, heirs to great wealth face the following situation: If your ailing mother passes away on Dec. 30, 2010, you inherit her estate tax-free. But if she makes it to Jan. 1, 2011, half the estate will be taxed away. That creates some interesting incentives. Maybe they should have called it the Throw Momma From the Train Act of 2001.

Contrary to the somewhat cynical views espoused by some of these critics, it will not be necessary for our clients or their heirs to resort to criminal activity in order to benefit greatly from the new tax laws. With proper estate planning, the reduction in Estate and Gift Tax rates and the dramatic increases in the Unified Credit Exemption will allow much greater wealth to pass from one generation to the next, with far less tax erosion than was the case under prior law. More detials of the tax legislation, and some resulting planning opportunities, will be the subjects of ensuing articles.

Reviewing the Tax Relief Act of 2001 - Part 2

As we have noted in the previous newsletter, under the 2001 Tax Act (that President Bush has now signed into law), the amount exempt from estate taxes and the rate of tax on larger sums are slowly reduced beginning next year until 2010. At that time the estate tax (but not the gift tax) is repealed for one year. The new law then "sunsets", meaning the law existing prior to the 2001 Act will be reinstated effective January 1, 2011. Thus, (a) in 2009 only estates in excess of $3.5 million will be subject to estate tax, at a top federal rate of 45%; (b) in 2010 there will be no estate tax: and (c) in 2011 we revert to estate tax on estates exceeding $1 million, at a top rate of 55%.

According to an article in The New York Times (June 14, 2001), these: roller-coaster changes can turn an estate plan drafted under the old law to eliminate estate taxes into a financial disaster. ...Six prominent estate tax lawyers agreed in interviews [June 13th] that the repeal would probably not take place, but they all said individuals must have wills that take into account a range of possibilities, including all of the changes planned over the next 10 years, the possibility of permanent repeal and the prospect that repeal will never take place. ...Those who...have a will and estate plan drafted under the old laws need to ...have it reviewed and in many cases rewritten. ...Without revisions, these experts said yesterday, widows may be left with far less than they expected, children and grandchildren may be stuck with huge tax bills that could have been avoided and litigation over who receives tax-favored assets may erupt, even in families whose members have worked together to build and preserve their wealth.

The above-quoted article may be somewhat alarmist, particularly in light of some interesting statistics the same newspaper published in a different article on April 8th this year: while 17% of Americans in a recent Gallup survey think they will owe estate taxes, only a much smaller perentage in fact do. "And nearly half the estate tax is paid by the 3000 or so people who each year leave taxable estates of moer than $5 million." While The New York Times doesn't specifically say so, the negative implication of this latter statistic is that somewhat more than half the estate tax is paid by people who leave less than $5 million (though we don't have statistics to verify that inference).

We believe that clients are advised to continue to make "annual exclusion" gifts and take other steps to reduce estate tax where there is risk that they may die before repeal with an estate larger than $1 million. We also agree with the experts quoted by The Times above that it is sensible for clients to have their wills and other estate planning documents reviewed. Many clients may benefit from having their "optimum marital deduction" will updated to avoid the anomaly of having all or most of their estate diverted to the "Bypass" trust (a/k/a "Credit Shelter" trust). Further, since the gift tax exemption increases to $1 million per person in 2002, leveraged gifts via GRATs and Family Limited Partnerships will take on added importance in the "reform" period.

Reviewing the Tax Relief Act of 2001 - Conclusion

In the previous issues of this newsletter we have taken a detailed look at some of the changes to the estate and gift tax laws made by the Tax Act of 2001. We have also taken note of the Tax Act's "sunset" rule, under which the new laws expire and the pre-2001 Act laws return. And, we observed that estate planning has been made more difficult due to (a) the uncertainty of whether the sunset rule will ever come into play, and (b) the uncertainty of whether an individual will die during aperiod of increasing Exemption Equivalents. The focus in this issue is on a topic that has been only touched upon in prior articles, namely: the 2001 Tax Act's switch from the "stepped-up" basis rule to the "carryover" basis rule.


"Stepped-up" Basis vs. "Carryover" Basis. When a person makes a gift, the donee generally gets the donor's basis (usually cost). That is, the donor's basis "carries over" to the donee. As a result, if there is a gift of appreciated stock, for example, the donee will have a taxable gain if he sells at the gift value. By contrast, under pre-2001 Act law, property acquired from a decedent generally got a basis equal to its value at his death - the heir's basis of the property was "stepped-up" to the date of death value. This meant that, on a later sale by the heir, he or she wouldn't have to pay capital gains tax on the appreciation in the property that occurred while it was owned by the decedent.

Changes to the Basis Rules. When the estate tax is repealed in 2010, the basis rules applicable to property acquired from a decedent will be changed to be similar to the gift tax rules noted above, subject to some exceptions. In other words, the heir will no longer receive a setpped-up basis; instead, the decedent's basis will carry over to the heir.

Certain exceptions to Carryover Basis. One important exception to the new carryover basis rule is that each estate will receive $1.3 million of basis to be added to the carryover basis of any one or more of the assets held at death. For example, if an individual dies owning stock worth $5 million for which he paid $3.7 million, the basis of the stock can be increased to $5 million under the Act. Another exception is that estates will be allowed an additional $3 million of basis, to be allocated among the assets passing to a surviving spouse. Under the "sunset" rule, the step-up in basis rules return for 2011.

Record Retention. With the change to carryover basis in 2010, clients must retain all records of cost or other basis. For purchases, this means receipts and statements showing the amounts paid for the items. For items inherited before 2010, basis ordinarily is the date of death value of the item. For property acquired by gift, the donee's basis usually is the same as the donor's.

What to do now. While the 2001 Act may well save estate tax, it has also added new planning complications. Clients should continue to have wills and estate plans prepared to ensure that their assets will pass as they desire, taking into account the spec ial needs of particular heirs. This is so even if there is a good chance of survival until a yar when estate tax won't be owed due to the increasing exemption or repeal. Clients who may have an estate larger than the increasing exemption amount will want to take steps to reduce estate tax, including setting up life insurance trusts, grantor retained annuity trusts, qualified personal residence trusts, and family limited partnerships. Many existing estate plans should be re-examined to keep estate taxes and income taxes to a minimum.

New York State Disability Law Passed

Recently, a law (Executive Law, Article 25) was passed in New York State which requires that persons with disabilities reside in the most integrated setting possible regardless of their age.

New York State must now develop and put into place a plan which allows persons of all ages to be appropriately placed in the most integrated setting possible and avoid institutionalization.

The term "most integrated setting" means a setting that is appropriate to the needs of the individual with the disability and enables that individual to interact with persons without disabilities to the fullest extent possible.

The "Most Integrated Setting Coordinating Council" has been created to develop and oversee the implementation of a statewide plan to provide services to disabled individuals of all ages in the most integrated setting. The plan is slated to be completed in the Spring of 2003. It will include the creation of a toll free hotline with information on community-based services for persons with disabilities of all ages.

Updating the Health Care Proxy

Last year legislation was enacted to allow for organ donation provisions to be included on Health Care Proxies. The Department of Health has now revised the standard Health Care Proxy form in order to accommodate for organ donation provisions. Furthermore, the standard form itself has been altered to allow for the primary agent to be selected and the alternate agent to be selected immediately thereafter (which is more logical).

The organ and/or tissue donation provision specifically states: "I hereby make an anatomical gift, to be effective upon my death, of: (check any that apply) Any needed organs and/or tissues _______ Limitations _________.

If you do not state your wishes or instructions about organ and/or tissue donations on this form, it will not be taken to mean that you do not wish to make a donation or prevent a person, who is otherwise authorized by law, to consent to a donation on your behalf."

The Health Care Proxy must now be signed twice. The second signature is required immediately after the organ donation provision. The Health Care Proxy must still be signed in front of two disinterested witnesses over the age of eighteen (18) and cannot be one of the selected agents.

Even if a Health Care Proxy is completed and a person has selected to donate his or her organs and/or tissues, it is still recommended that a person complete the back of his or her New York State Driver's License to accommodate for the same permission of organ and/or tissue donation.

For more information or for a copy of the Department of Health form, please contact Davidow, Davidow, Siegel & Stern or you can access this directly on the Department of Health website.

Medicaid and Joint Accounts

Often seniors who may be potential Medicaid applicants are under the mistaken impression that if they add their children's names on the title to their financial accounts (banking or brokerage) that this is considered giving up control of some or all of their money and that at some point, it would be protected if they needed Medicaid. This is not necessarily so. If the money in the account actually belongs to the client, making that account joint with a child or even adding that child as the primary account holder joint with the client using the child's social security number will still not be considered a relinquishment of control by the client for Medicaid purposes. There are certain ways to effectively move these assets out of the senior's name: 1. If, by chance, some or all the money in the joint account actually does belong to the child instead of the seniors and proof of this is available for offer to the Dept. of Social Services, and the senior's name is removed from the account prior to the month the senior needs Medicaid, the portion belonging to the child will not be counted as a resource belonging to the senior. This involves careful record keeping over the years. 2. If all of the money belongs to the senior, to remove the account from the senior's name, the account should be retitled in the children's name only with their social security numbers. The senior's name should not appear on th title of the account, and the account should not be held in trust for the senior or be payable on death to the senior. This is considered an uncompensated transfer and will incur a period of Medicaid eligibility for the senior based on the size of the account starting the month following the date of the transfer. 3. Where the senior has ccreated a joint account with a child already, a transfer to that child occurs when the senior removes his or her name from the account. Again, a period of Medicaid ineligibility will start running in the month following the date the senior's name is fully removed from such account. 4. If the senior has a disabled child who is not on SSI, all of the senior's resources can be transferred to that child alone without incurring a period of Medicaid ineligibility for the senior and without jeopardizing the child's SSI. It is highly recommended that any of the above transfers be made under the supervision and upon the recommendation of an Elder Law attorney as part of an overall estate plan, especially if any of the financial accounts contain highly appreciated assets.