Federal Government Agrees That Non-Assignable Annuities Should Be Treated As Income

The Deficit Reduction Act ("DRA"), which was enacted in 2006, specifically provides that a non-cancellable, non-assignable immediate annuity is to be treated as a stream of income rather than as an available resource for Medicaid eligibility purposes.  Some states, however, have taken an aggressive posture in attempting to claim that despite the stated prohibitions, these types of annuities may have value in the secondary market, and thus should be treated as a resource.

Connecticut has been among the most aggressive states in challenging the validity of a number of commonly used Medicaid planning strategies.  In the pending case of Lopes v. Starkowski, Connecticut has denied a Medicaid application on the grounds that an immediate annuity purchased by the community spouse -- Mrs. Lopes -- is in fact a resource rather than an income stream, and thus the state claims that Mrs. Lopes has "excess resources" that renders her husband ineligible for Medicaid.

The facts here are straightforward.   After Mr. Lopes' long-term care insurance benefits ran out, Mrs. Lopes purchased an immediate pay annuity from The Hartford for about $167,000.  This sum represented the approximate amount by which Mrs. Lopes' assets exceeded Connecticut's Community Spouse Resource Allowance ("CSRA").  The annuity is paying Mrs. Lopes monthly income of $2,340.83 per month for a term of six years.

While such an annuity would ordinarily be assignable -- and thus deemed an available resource under the DRA -- at the time she purchased the annuity Mrs. Lopes signed a specific assignment restriction that specifically prohibits Mrs. Lopes from assigning any of her rights under the contract to any third party.  Such an assignment prohibition would seemingly make Mrs. Lopes' annuity fully DRA compliant.

Connecticut, however, saw it differently, and claimed that they had found a third party -- Peachtree Funding -- that might be willing to purchase Mrs. Lopes' annuity income stream for a lump sum.  On that basis, Mr. Lopes' Medicaid application was denied.

Mrs. Lopes subsequently filed suit in Federal court challenging Connecticut's denial of her husband's Medicaid application.  The District Court granted summary judgment in Mrs. Lopes' favor, holding that because the annuity is non-assignable, it is to be considered an income stream rather than a resource.  The state appealed the District Court's decision, and the case is now before the Second Circuit Court of Appeals.

What's especially interesting about this case is that the Second Circuit asked the U.S. Department of Health and Human Services ("HHS") to submit an amicus curiae ('friend of the court") brief summarizing the federal government's position as to the treatment of a non-assignable, immediate pay annuity.  In its brief, HHS stated unequivocally that such an annuity should be treated as a stream of income rather than a resource, and that so long as the appellate court were to hold that Mrs. Lopes' annuity was in fact non-assignable, then "the district court's decision should be affirmed."

One would hope that the Second Circuit pays heed to HHS' position and confirms that a properly structured non-cancellable, non-assignable immediate annuity is to be treated as an income stream rather than a resource for Medicaid eligibility purposes.

Click here to see the HHS brief in its entirety.

Democrats Fire First Volley in 2012 Estate Tax Debate

In late November Democratic Rep. Jim McDermott introduced the Sensible Estate Tax Act of 2011.  Under the bill, the federal estate tax exemption would revert to $1 million per person, an exemption amount that last was in effect in 2001. The exemption amount would be indexed for inflation, and McDermott's bill would continue "portability" under the current law that permits spouse's to use their deceased spouse's unused federal estate tax exemption -- thereby effectively allowing married couples to exempt up to $2 million from the imposition of federal estate tax. Under the proposal, the estate tax rate would jump from the current 35% to 55%, which is the same percentage that existed prior to the 2011 EGTRRA law. 

The proposed legislation would also revive the state death tax credit, a devise that allowed the states that have a separate estate tax -- including New York -- to derive significant revenue by collecting a "pick-up" tax.

Even were the Democrats to control all three branches of government after the 2012 elections -- with a filibuster-proof majority in the Senate -- it is hard to envision a return to a $1 million federal estate tax exemption from the current $5 million exemption.  Of course if Congress does not act by December 31, 2012, then we will see an automatic reversion to the pre-EGTRRA exemption of $1 million, with a 55% rate. 

My guess is that the Democrats, after years of allowing the Republicans to set the agenda on this issue, are feeling emboldened to take a tougher stand given polling that seems to indicate that many people would like to see the deficit reduced by both spending cuts and higher taxes on the "wealthy."  But I believe that a $1 million exemption -- although it would likely only apply to approximately 3% of all estates -- is a non-starter.  Instead, a more likely outcome would be a $3.5 million exemption per person, with a continuation of portability.

That being said, a permanent repeal of the federal estate tax -- which seemed to be a real possibility just a few years ago -- appears to be highly unlikely as we head into 2012.

Click here to read more about Congressman McDermott's proposal.

Life Insurance -- Is it Really Tax Free?

Life insurance can be a critical part of an estate plan. The death benefit from a life insurance policy can provide both vital income replacement upon the death of a main “breadwinner,” and can cover the cost of estate taxes for larger estates. 

Many people are unaware that under existing law, life insurance that is not properly owned and administered may provide far less to the family than anticipated, with a significant portion of the death benefit potentially lost to estate taxes.  Why is this so?  Because life insurance is typically purchased in the following manner: the insured is also the owner of the policy, with the spouse as the primary beneficiary and the children as contingent beneficiaries.  Under this arrangement, upon the insured’s death, the entire amount of the death proceeds are included as part of the insured’s taxable estate.

  

Consider the following example:  Frank, a forty-five year old single father, lives in Goshen.  Frank owns a $2 million term life insurance policy insuring his life, and has other assets totaling $1.5 million. His two children are the beneficiaries of the insurance policy.  Frank dies in 2011.  Because he is the owner of the life insurance policy, upon his death his taxable estate will be $3.5 million.  With the current $5 million federal estate tax exemption, there will be no federal estate tax. However, because New York’s estate tax exemption is only $1 million per person, the New York estate tax bill will be $229,200.  Had the life insurance been excluded from Frank’s estate, the New York estate tax bill would have been $64,400.

If you cringe at the thought of your heirs paying an estate tax bill of $229,200 on a $3.5 million estate, consider the result if Frank were to die in 2013, when the federal estate tax exemption is scheduled to be reduced to $1 million per person.  Given the same $3.5 million total estate, of which $2 million consists of life insurance, upon Frank’s death the total federal and New York state estate tax due would be $1,220,000.  If the life insurance death benefit were not taxable in Frank’s estate, the total New York and federal estate tax obligation would be reduced by over $1 million, to $210,000.

Fortunately, removing life insurance for your taxable estate is fairly straightforward.  If in our example Frank’s life insurance policy had been owned in a properly structured and administered Irrevocable Life Insurance Trust (commonly referred to as an “ILIT”) for at least three years prior to his death, none of the death benefit would have been included as part of his taxable estate.  Instead, the entire $2 million would pass to his children free of federal or New York state estate taxes.

The ILIT would provide other benefits. The death benefit can be held in one or more creditor-protected trusts for the benefit of a spouse, children and other generations.  ILIT’s can also be used effectively to create “Dynasty Trusts” which can hold assets in trust for multiple generations free of both estate and generation-skipping taxes. 

ILIT’s can be set up for individuals or couples.  With married couples, we often fund a joint ILIT with one or more “second-to-die” joint and survivor policies, which pay out the benefits only upon the death of both the husband and wife.  These policies are typically used to provide liquidity to cover any estate taxes the couple may incur upon the death of the second spouse.  Because the insurance covers two lives, it is often substantially cheaper than a single-life policy.

One Caveat: if existing policies are transferred to an ILIT, the insured must live at least three years from the date of transfer to have the death proceeds excluded from his or her taxable estate. If possible, it is best to replace existing policies with new policies that are owned from the outset by the ILIT trustee; under this arrangement, the death proceeds will be fully excluded from the insured's estate from day one.

When There's Lots of Money Involved, the Knives Come Out

Forbes has posted a two-part article describing some recent (and mostly ongoing) battles over the lucrative estates involving various celebrities, including Michael Jackson and Whitney Houston (no, she's not dead -- it involves Whitney's father's estate and Whitney's vicious fight with her step-mother).  Part 1 is found here, and Part 2 is here.

More than anything else, these cases point out how vitally important it is to regularly update your estate plan.  Our practice offers an annual estate plan maintenance program, which ensures our clients that their documents will remain current with changes in their lives, their finances, the law, and our own knowledge and experience.

Misconceptions About the Estate Settlement Process

People typically have only a vague idea of the steps necessary to settle an estate upon a person’s death.  Often they have heard “horror stories” regarding the expense and time needed to complete an estate administration. While there are certainly instances where estate settlements have dragged on for years and have cost the estate hundreds of thousands of dollars in legal fees and other administration expenses, it does not have to be that way.

Estate settlement is largely dictated by the form of ownership of the assets possessed by a deceased person (the “Decedent”).  Assets owned in the Decedent’s individual name are typically subject to the probate process, whether or not the Decedent has executed a will.  But for many people, a significant portion of their assets are not owned in their individual name.  Rather, assets may be owned jointly with another person, or the assets may pass to one or more persons who are the named beneficiaries designated to receive the assets at the Decedent’s death (for example, a bank account that includes an “in trust for” designation).  All such assets will not pass as dictated in the Decedent’s will, but instead will pass to the surviving joint owner or the designated beneficiary outside of probate.

Assets held in a revocable or irrevocable living trust will be distributed as provided in the trust document, and will not be subject to the probate process.  This result can be especially helpful when a person owns real estate in more than one state, or desires to disinherit children or other close relatives. If the trust is fully funded by the client during his or her lifetime, the probate process can be avoided and there will be no legal requirement to notify potentially litigious children or other relatives about the nature of the Decedent’s assets and dispositive wishes.

Whether a will or a trust has been used as the foundational estate planning tool, all estate administrations must follow certain procedural steps.  These steps include income tax return filings, and possibly the need to file federal and state estate tax returns.  Since a probate estate is a taxpaying entity, the executor of a probate estate will obtain a federal taxpayer identification number for the estate.  Trustees of any trusts created by the Decedent will also need to obtain taxpayer identification numbers for those trusts.  Whether the estate and/or trust(s) will owe federal or state income taxes depends upon the types of assets owned by the various entities, and the income produced.

Estates for New York Decedent’s owning assets of $1,000,000 or more – which amount includes the death benefits for any life insurance policies owned by the Decedent insuring his or her own life -- will need to file a New York State Estate Tax return, while estates for Decedents owning assets of $5,000,000 or more will need to file a Federal Estate Tax return as well.  Whether any estate taxes are ultimately due depends upon many complex factors, especially whether the Decedent is survived by a spouse, and how the assets are to be distributed upon the Decedent’s death.  Even in cases where no estate taxes are owed, the returns must be filed if the minimum asset threshold is reached.

One caveat:  people have often been led to believe that if you have a living trust, the estate settlement requirements will not apply to your estate.  While a fully-funded living trust will "avoid probate," all other estate administration requirements described above will apply.  While living trusts can be exceptional planning tools, establishing one with the objective of avoiding post-death administration (and all associated expenses) is unrealistic.  Ignoring the formalities of the estate administration process based on such misinformation can lead to trouble down the road, which may include the IRS or New York State assessing interests and penalties for the failure to timely file the requisite tax returns and pay the required amount of taxes.

Since We're Going to Spend Money on Health Care, Spend it Wisely!

As noted in my last post, the CLASS Act -- a provision of the Obama health care law that included modest long-term care benefits (not exceeding $75 per day) for those willing to pay the premiums -- has been scrapped as financially unsustainable.  The fact that has gone largely unspoken, however, is that their is money available to cover a substantial portion of long-term care expenses.  As former New York Times reporter Jane Gross points out recently in this excellent column, it's not that we lack the funds to cover a substantial portion of long-term care costs; rather, Medicare spends too much on the wrong type of care. 

As but one example supporting her argument, Gross points out that Medicare will cover the costs for a hip replacement for a frail senior citizen who will likely require long-term care with our without the procedure.  If the senior ends up in a long-term care facility, however, Medicare will at most cover a portion of the cost for 100 days' of rehabilitation.  Once Medicare stops paying the tab, if the senior is already of limited means -- or becomes impoverished as a result of an asset spend down -- then taxpayers, through the Medicaid program, will be on the hook for the senior's long-term care costs for the rest of her life. 

Why, you may ask, does it matter whether Medicare or Medicaid covers the cost of care -- both of federal programs, right?  As Gross points out, however, Medicare is supported by payroll taxes and thus at least has a significant element of being a self-funded program.  Medicaid, in contrast, is essentially a pure "welfare" program that is completely taxpayer supported.

The solution, Gross argues, is to have a serious national conversation about the reallocation of our precious health care dollars away from pointless and wasteful procedures (hip replacements for Alzheimer's patients) and towards the costs of custodial long-term care that is increasingly bankrupting our seniors.  Of course such a conversation will inevitably lead to the "R" word -- that is a discussion of the rationing of health care services.  I am continually amazed that conservatives who  complain about runaway government spending will decry rationing of health care -- even raising the phony spectre of "death panels" -- and seem unwilling to have a serious conversation about the irrational nature of spending on health care in this country.

Long-Term Care Program Scrapped by Obama Administration

The Community Living Assistance Services and Supports Act (commonly referred to as the "CLASS" Act) was one of the many controversial components of the 2009 federal health care legislation.  As implemented, the CLASS Act would have allowed any American who paid premiums into a long-term care fund for five years to be then eligible for long-term care benefits of between $50 and $75 per day for various long-term care services, including home care.

Even at those modest numbers -- full-time home care runs about $250 per day in the Hudson Valley, while most local nursing homes average about $350 per day on a private pay basis -- the CLASS Act was deemed financial unsustainable by the Department of Health and Human Services.  The concern was that people most likely to require the services would pay the premiums, while healthier people would opt-out, thereby putting too big a strain on the system.  Apparently concerned that our nation could ill-afford another expensive federal government program, President Obama's administration has decided to halt implementation of the CLASS Act.

To learn more, check out this article at Elder Law Answers.

New Decanting Statute Facilitates Transferring Assets Out of a "Bad" Trust

In 1992, New York became the first state to enact a statute that expressly permitted a trustee to move assets from one trust to another trust.  These trust to trust transfers – known as “decanting” – provides flexibility that is often desired to address changing circumstances and in correcting errors that might otherwise defeat the trustmaker’s intent.

Since 1992, however, many states have enacted decanting statutes that provide trustees with far greater flexibility than has been possible under New York’s decanting statute.  In response to criticism from trustees and attorneys that New York’s law was too restrictive, New York recently amended the state’s decanting statute to provide a much-needed expansion of a trustee’s decanting authority.

The statute, which was signed into law by Governor Cuomo on August 17, 2011, applies to all existing trusts as well as trusts created after enactment of the legislation. The law includes the following significant changes from the prior decanting statute:

• Previously, a trustee could move assets to a new trust only if the original trust document provided the trustee with the “absolute discretion” to invade trust principal. Under the amended law, however, a trustee may transfer principal to a new trust so long as the principal invasion powers in the new trust are at least equivalent to the invasion powers in the original trust.  For example, many trusts permit principal invasions for the beneficiaries’ “health, education, maintenance and support” (commonly referred to as the “HEMS” standards).  Under the prior “absolute discretion” standard, a trustee had no authority to transfer assets from a trust utilizing the HEMS standards to another trust, even if the new trust provided for HEMS distributions.  Under the revised law, a trustee may transfer the trust principal from one HEMS trust to another trust also following a HEMS standard.   
• If in fact the existing trust provides the trustee with “absolute discretion” to make distributions to one or more trust beneficiaries to the exclusion of other trust beneficiaries, then the trustee may transfer the principal from the original trust to a new trust that may include any one or more of the beneficiaries of the original trust; the new trust need not include all the beneficiaries from the original trust.  If, however, the trustee in the original trust does not have unlimited discretion as to distributions of trust principal, then the beneficiaries of the new trust must be the same as the beneficiaries of the original trust.
• Trust assets may be decanted to a new trust that has a longer term than that of the original trust, which provides expanded opportunities for multi-generational estate planning.
• The new trust can be established by the trustmaker of the original trust or by the trustee of the original trust.
• For a “living trust,” there is no longer a requirement to file the decanting document with the Surrogate’s Court, unless proceedings involving the original trust have previously been commenced with the Court.

While the new decanting rules may prove useful in an array of situations, here are two common scenarios where the new decanting rules might be especially helpful: first, with existing “Medicaid” trusts that may not conform to new regulations implemented in New York in September 2011; and second, with old irrevocable life insurance trusts that no longer meet the family’s planning objectives. If you have created an irrevocable trust that you believe no longer fulfills your intent, or if you are a beneficiary of such a trust, you may want to consult with an estate planning attorney to determine whether the new decanting rules might prove useful in your situation.

New York's Expanded Estate Recovery Rules Complicate Medicaid Planning

New York law has long provided that only a Medicaid recipient’s probate assets (i.e., those titled solely in the name of the Medicaid recipient) were subject to “estate recovery” after a Medicaid recipient’s death.  Other types of dispositions, including popular planning tools such as joint tenancy, “life estate” deeds, and assets held in revocable and irrevocable trusts were excluded from the reach of estate recovery.

Last March, however, the New York State Legislature’s 2011 budget included “expanded” estate recovery rules that will allow the county Departments of Social Services to recover more assets from the estates of deceased Medicaid recipients.  These new rules were made subject to regulations to be promulgated by the New York State Department of Health.  On September 8, 2011 the Department of Health finally promulgated the regulations required by the statute.

Traditionally, the use of a life estate deed for a primary residence has been one of the most popular planning tools used to protect assets from a Medicaid “spend down.”  So long as the deed in which the grantor retained a life interest was executed at least five years prior to a Medicaid application being filed, the entire interest in the residence would be deemed “exempt” from a Medicaid spend down.  This planning tool has long been popular largely because it is easy to quickly implement, and is considered inexpensive compared to other planning strategies such as irrevocable trusts.

 

The new regulations, however, specifically include as assets subject to estate recovery those owned by the decedent “through joint tenancy, tenancy in common, survivorship, life estate, living trust or other arrangement, to the extent of the decedent’s interest in the property immediately prior to death” (emphasis added).  The value of the life estate subject to recovery is deemed to be the “actuarial life expectancy of the life tenant” as of the date of death.  For an 80-year-old, for example, that value is deemed under the life estate tables used by Medicaid to be worth 43.6%.  Assume Mrs. Jones, an 80-year-old long-term nursing home resident on Medicaid, executed a life estate deed in 2003 leaving her residence to her children upon her death. Mrs. Jones dies in September 2011, with the fair market value in her home valued at $300,000.  Under the new regulations, 43.6% of the home value – or $130,800 – would have to be repaid to the Department of Social Services, with the children to receive the remainder.

Some may argue that it is good public policy to permit the government to recoup as many assets as possible from the estates of Medicaid recipients.  But what may trouble many people is that the regulations do not provide any “grandfathering” for pre-existing life estate deeds – even those drafted decades ago.   This provision of the new regulations is sure to spark legal challenges, so it is too soon to tell if this particular rule will “stick.”

Fortunately, the irrevocable “Medicaid Trusts” remains an important planning tool that can used to help protect assets if created and funded well before the time long-term care may be needed.  Under the regulations, estate recovery from any irrevocable trust is limited “to the extent that the person was entitled to the distribution of …principal and interest pursuant to the terms of the trust.”  Since a Medicaid Trust will always restrict the grantor from receiving any of the trust principal, the trust assets may pass at the grantor’s death to the trust beneficiaries without risk of estate recovery, even if the grantor received Medicaid benefits during his or her lifetime.  Also, while the issue is not fully resolved, it appears that these trusts will still permit the grantor retain the STAR, veteran’s and other property tax exemptions without exposing the value of the residence to any form of estate recovery.

While long-term care insurance remains the best way to protect your assets in the event you ever need long-term care, the policies can be expensive and not everyone can qualify medically for the insurance.  With the ever-shrinking state and federal budgets putting the squeeze on Medicaid benefits, it is more important than ever that people looking to help protect assets against the high cost of long-term care seek the advice of an experienced elder law attorney to investigate the alternatives.