With the key goal of transferring a house to the kids to risk losing its value to long term care costs, a typical method is to transfer the home, but reserve a life estate.
For example, a house built or bought in 1952 for $10,000 and now worth, say $250,000, the appreciation of $240,000 will avoid being treated as a capital gain on sale if the home was includable in the person’s gross estate for federal estate purposes. There is no gain because IRC Section 1014 permits a “step-up” in basis at date of death.
The common method to transfer the home is to reserve a life estate: give the home to the kid but reserve the right for the parents to live there for life. IRC Section 2036 allows that “the gross estate shall include the value of all property…of which the decedent has at any time made a transfer…under which he has retained for his life…the possession or enjoyment, or the right to the income from, the property.” That is, if the parents (in the above example) deed the home to the kids and reserve the life estate, the full FMV is includable in the parents’ gross federal taxable estate and the kids receive the desired step-up in basis.
But what happens if the parents transfer the house but do not reserve the life estate. The black-and-white text of IRC Section 2036 appears to save the day. Here’s why:
Estate of Linderme V. Comm’r, 52 TC 305, a 1969 tax court case found that a right can be retained even though it was not specifically reserved. In the case of a house, if the parents continued occupancy, perhaps continued to pay the real estate tax and expenses, all without paying fair rent to the new owners (the kids), then the parents appear to have retained the life estate even though they did not specifically reserve that particular legal right.
The information contained in this electronic message is intended only for information and discussion and is not intended as legal advice. Note further, I am not your lawyer unless you have paid me money.
This article focuses on financial abuses, dealing with the most common situations we have seen in our office in recent years.
As background, the General Laws of Massachusetts require certain professionals to report suspected “Elder Abuse” to the appropriate protective service agency. Those agencies in turn conduct an investigation which may refer the case to the local District Attorney. An “Elder” or “Senior” is anyone over the age of 60. “Abuse” broadly refers to physical abuse, emotional abuse, sexual abuse, financial exploitation, neglect, abandonment and in situations where a person lives alone and is not properly taking care of his or herself, self-neglect.
This well-known from bank robber Willie Sutton. When asked why he robbed banks, he replied, “I rob banks because that’s where the money is.” The quote explains why Elders are targets. Elders have money, they are home; they open their mail, and, they answer their phone. Further, they have access to money that’s close at hand via an electronic key stroke or a plastic credit or debit card.
Not only are Elders easily available via telephone and mail but circumstances often mean that a spouse is deceased leaving the survivor more vulnerable and lonely. Also consider that cognitive decline may have affected judgment.
These are the scams and techniques we have seen that have separated you from your money. Perhaps surprisingly, elder abuse is most often perpetrated by someone the senior knows and trusts and is dependent upon for care, often friends and family members. Following are two scams, both by telephone and both common to New England this year.
“Granddad, do you know who this is?”
That’s the voice my client heard when he picked up the telephone and the grandfather, age 89, answered with “Christopher?” Hearing the reply, the scammer then had a name—Christopher. “Christopher” recounted his sad story that he had been arrested and “please don’t tell my mother, but I need money now to get out of jail.” Our client followed “Christopher’s” instruction and sent money via a wire transfer—money never to be seen again. Law enforcement could do nothing.
What to do: If you receive a call from a relative in distress and you’re unsure of the voice on the other end, tell him or her that you’ll call back. Call other friends or relatives to verify the story. “Christopher” may tell you he needs the money now, but, there is no such thing as an immediate money emergency. If someone—anyone—is pressuring you for immediate money, something’s suspicious.
This is the IRS.
We have seen an enormous increase in the numbers of the IRS scam recently. This scam starts with a telephone call from a representative from IRS calling to tell you that there are taxes owed and there is a lien or levy about to be served against you. The caller will ask that you immediately send money via prepaid cash cards or wire transfer.
The IRS will never:
• Call all to demand immediate payment using a specific payment method such as a prepaid debit card, gift card or wire transfer. Again, there is no such thing as an immediate money emergency.
• Threaten to bring in police to have you arrested for not paying.
• Demand that you pay taxes without giving you the opportunity to question or appeal the amount they say you owe.
• Ask for credit or debit card numbers over the phone.
In the unlikely event that an IRS representative visits you, he or she will always provide two forms of official credentials called a pocket commission and a HSPD-12 card. HSPD-12 is a government-wide standard for secure and reliable forms of identification for Federal employees and contractors. You have the right to demand to see these credentials.
What to do: If the IRS calls, ask the caller for his ID number and the tax year that is the subject of the liability. Then, simply tell them that you will follow up with the local IRS office. If you think you do not owe tax, you’re probably right. Simply hang up. Why be polite to someone who is trying to steal from you? If you think you owe tax, also simply hang up, and then call your tax preparer or the IRS at 800-829-1040.
The next two scenarios are recent situations between friends and family. It’s the hardest abuse to identify and harder still to prevent:
The “Sugar baby,” or “When the bank balance is zero, the girlfriend’s gone”.
Recently a gentleman in his early 90s was befriended by a woman in her early 50s. She shopped for him, visited him at his home, eventually spending the night. He wrote more than one check to her in excess of $10,000 for a significant car repair. She was attentive to him. In turn, he made her feel appreciated, and was generous to her. After all, it was his money. Eventually, he named her as the holder of his health care proxy and power of attorney.
Consider this situation: An elderly man lived alone and was in declining health. His children helped him when they found the time, but he insisted on staying in his home and the children did not live close. He met a local lady who helped him out at home. She was clever and pretended that she has fallen in love with him. She was actually taking advantage of his failing health and persuaded him to name her as the beneficiary to his wealth and as his financial power of attorney.
If you haven’t guessed, the two examples are the same situation viewed first from the perspective of the elderly man, and second, from the perspective his adult children.
If you are aware of a similar situation and you, a friend or family member, think you should intervene, then proceed, and do so at your peril. The affairs with which you are about to concern yourself is meddling at the very least—justifiable perhaps but nonetheless meddling. Loneliness is typically an enormous factor in matters such as these, and even if the person is aware of the significant financial sacrifice he or she is making, the elder doesn’t wish to give up the relationship.
As a friend or child of the elderly person, the calculus of the situation is this: does the cost of meddling into the affairs of your elder parent or friend equal or exceed the cost of damages to be wrought by this person who is potentially a predator.
What to do:
• (Advice for adult children or friend) Encourage the person to consult an attorney regarding a prenuptial agreement. A contract such as a prenup can protect assets from a gold digger, and a third party such as an attorney may be able to evaluate the situation more dispassionately than family or friend.
• Do your homework. Seek information on the person and his or her background to see if there are clues in the person’s past regarding similar situations. (In the situation we described, a telephone call to a prior employer revealed that the Sugar Baby had worked in a nursing home and was terminated because of inappropriate relations with a resident at the facility).
• If marriage is being discussed and the elder is not willing to get a prenup or ask their future spouse to sign one, their lawyer may be able to persuade them to execute a new will. A new will might include a bequest to the new girlfriend, but could appropriately limit any inheritance. Another option is to arrange significant assets, such as the family home, to a trust, so that they will remain in the family.
The First National Bank of Grandpa.
Family members are lenders of last resort. That is, family turns to family when the banks have said no.
Consider the story of Ms. S and her adult child, Jane and Kim. There is no obvious elder financial abuse in this story but great distress nonetheless. Ms. S was a widow in her early 80s, living in a very nice lake front home in Central Massachusetts. Ms. S. managed to save a nest egg and her house, worth nearly $600,000, was paid for.
Daughter Jane has no money of her own and sought to open a business—a health club. Ms. S considered loaning her money but instead, added her daughter to the deed of her lakefront home and entered into a mortgage turning over the proceeds from the mortgage to Jane with the understanding that Jane would pay the monthly mortgage payments. It was Ms. S’s intention to leave the home to Jane at death and to leave her savings to the other daughter, Kim.
The financial crisis of 2008 hit; Jane’s business failed and Jane sought Chapter 7 Bankruptcy protection. Jane’s situation was a source of great anxiety for Ms. S who was afraid to closely question Jane about the matter. She was afraid that discussing the matter would cause problems in their relationship and perhaps in Ms. S’s relationship with her grandchildren.
At the time, what was unknown to Ms. S and Jane was that non-residential real estate (Jane did not live in the mother’s home) is unprotected in Chapter 7. Had the Chapter 7 bankruptcy proceeded, the Trustee would have possibly sold the home with the proceeds to pay the Jane’s debts. Ms. S, in order to save her home, was compelled to pay off all the daughter’s creditors rather than risk losing her home.
When Ms. S died the home went to Jane because her name was on the deed. Kim received no inheritance because Ms. S had exhausted her savings using the money to pay off Jane’s creditors. Ms. S’s story illustrates how a parent’s desire to use accumulated wealth for the benefit of adult children can have terrible outcomes.
What to do when a family member asks for a loan:
• Remember that you are a lender of last resort. If a bank refuses to lend money to your family it’s because the bank fears it will not be paid back. You too should not assume you’ll be paid back if you are making a loan to a family member. Think of it as a gift. And, if making a gift in that amount causes you stress or puts you at financial risk, don’t do it.
• Remember that money doesn’t solve all problems. If you were witnessing your son or daughter drowning in a lake and the child yelled to you “Dad! Throw me some money,” would you do it? Of course not, you would attempt to save him, but not by listening to a bad solution (“Throw me money.”) but rather by understanding the problem to better come to a solution.
• Remember this recurring theme: there is no such thing as an immediate money emergency. If asked for money, take your time. It took you a lifetime to accumulate your savings; don’t give it away quickly or easily.
• If the reason for the loan is complicated, don’t do it. It’s your money and you have a right to understand how it’s going to be used.
Massachusetts Budget Proposal
In January, Governor Charlie Baker released his administration’s budget proposal for 2017. Pay close attention to “Outside Section 11”.
“Outside Section 11” proposes changes to significantly expand the scope of estate recovery claims that MassHealth could pursue after the death of residents aged 55 and older who received MassHealth benefits prior to their deaths. These proposed changes would affect all applicants who qualify for MassHealth after July 2016, regardless of any prior estate planning done by applicants or their spouses. Therefore, anyone who has done such planning should closely follow this proposal and plan accordingly.
MassHealth, the Massachusetts name for Medicaid and pays for long term care, to people who qualify. Those aged 55 and older apply for MassHealth either because they require nursing home care or because they need substantial in-home care in order to remain at home and are unable to pay for that care.
Under the current law, MassHealth has a claim against the probate assets of any deceased person who received long term care MassHealth benefits prior to his or her death. However under current law, the agency has no claim against the assets of a MassHealth recipient’s surviving spouse. “Outside Section 11” seeks to change that.
“Outside Section 11” is after those assets that did not pass outside of probate. Under “Outside Section 11”, MassHealth would have a claim against any interest that a deceased MassHealth recipient had at the moment of his or her death in assets that are not subject to the probate process. For example: life estates in real property and joint ownership interests in real estate or other kinds of property, such as bank accounts, stocks, and bonds, as well as annuities, life insurance policies and retirement accounts.
Further, “Outside Section 11” gives MassHealth a claim against the estate of the surviving spouse of the MassHealth recipient, regardless whether the surviving spouse ever received MassHealth benefits or has since remarried or moved outside of Massachusetts.
So much for the tried and true method of gifting the home to the children while retaining a life interest in that home! Under OS 11, the value of such a life estate interest at death would be subject to a MassHealth claim for recovery.
Or consider the technique when a married couple, concerned that one partner may need to qualify for MassHealth, transfers the assets to the healthy spouse. “Outside Section 11” would expose the assets of that healthy spouse, if he or she survives the spouse who received MassHealth, to a MassHealth claim upon the death of the healthy spouse to the extent that those assets were subject to the probate process.
It hasn’t passed yet, but stay tuned.
The interest charge domestic international sales corporation (IC-DISC) is available to manufacturers, producers, resellers, and exporters of goods that are produced in the United States with an ultimate destination outside the United States. The IC-DISCs defers the recognition of income related to foreign sales and may also reduce the income tax liability of a corporation’s shareholders by converting ordinary income into qualified dividend income.
An IC-DISC reduces its shareholders’ income tax liability by converting ordinary income from sales to foreign unrelated parties into qualified dividend income.
Step 1: Form a corporate entity (the new entity i.e. the IC-DISC is exempt from federal income tax under Sec. 991) separate from the related producer, manufacturer, reseller, or exporter. Also, set up the IC-DISC bank account.
Step 2: Qualify the company with the IRS.
Step 3: When the IC-DISC structure is in place, the producer pays and deducts the IC-DISC a tax-deductible commission that is calculated based on the related supplier’s foreign sales or foreign taxable income for the year.
Step 4: The IC-DISC then distributes that commission to its shareholders in the form of qualified dividends under Sec. 995(b)(1). These calculations and payments are generally made once the tax year is complete and the related supplier’s taxable income can be accurately determined or estimated.
Entities that sell “export property” and are profitable. Export property as property:
- That is manufactured, produced, grown, or extracted in the United States;
- That is then held for sale, lease, or rental for direct use, consumption, or disposition outside the United States; and
- The fair market value of which is not more than 50% attributable to articles imported into the United States.
The definition focuses on the source and ultimate use of the products and not their producer.
What’s the Commission?
Assuming the producer has taxable income, there are two primary methods to calculate the commission under Section 994(s):
(1) 4% of the qualified export receipts, or
(2) 50% of the combined taxable income of the related supplier and IC-DISC from the sale of qualified export property (generally, this would be 50% of foreign taxable income).
The higher the commission, the greater the benefit and the related supplier may select the method of commission calculation that is most beneficial to it each year.
How to pay the Commision?
The Regs. Sec. 1.994-1(e)(3), allow that the commission, or a reasonable estimate of the commission, can be paid to the IC-DISC within 60 days after the close of the tax year. The cash does have to move in that time frame to take advantage of the benefits and generally would have to meet or exceed the final commission amount. If the related supplier does not make the payment within the 60-days, the IC-DISC may lose the tax benefits associated with being an IC-DISC.
Assuming that the commission is calculated as described above and the commissions and dividends are paid out every year, there is no statutory limit on how much income can be pushed through the IC-DISC annually, aside from the taxable income limitation and the limitations inherent in the commission calculations.
Structuring the IC-DISC?
IC-DISCs that are owned directly by the related supplier and structured as passthrough entities (partnerships and S corporations) are able to pass through the qualified dividend income directly to their individual partners or shareholders. Parent-subsidiary or brother-sister entity structures both work well when the related supplier is a passthrough entity. Related suppliers structured as passthrough entities, coupled with the parent-subsidiary ownership structure of the IC-DISC, work well when cash flow is a concern, because the passthrough entity pays the dividend to the IC-DISC and then receives the cash dividend back from the IC-DISC. The passthrough entity is then able to pass the character of the qualified dividend income it received from the IC-DISC up to the shareholders or partners without having to actually distribute the cash out of the company to realize the tax savings.
Let’s do this!
IC-DISCs are incorporated as C corporations and set up at the state level. An election is made to treat the entity as an IC-DISC, similar to how an S election is made. Under Regs. Sec. 1.992-2(a), the election to be treated as an IC-DISC is made on Form 4876-A, Election to Be Treated as an Interest Charge DISC, and must be filed within 90 days of the beginning of the tax year in which the election will take effect.
The marginal cost of setting up and maintaining the IC-DISC are 1) the cost of set-up and 2) ongoing cost of a) maintaining qualification with the IC-DISC state of incorporation (typically hundreds of dollars) and b) the professional fee cost of filing tax returns for the IC-DISC.
Requirements to Maintain IC-DISC Status
The IC-DISC must maintain the following requirements annually:
- 95% or more of the gross receipts the IC-DISC receives are qualified export receipts;
- The adjusted basis of the qualified export assets meets or exceeds 95% of the total adjusted basis of all assets held by the IC-DISC;
- The IC-DISC maintains only one class of stock;
- The par value of the stock is at least $2,500 for each day of the tax year;
- The corporation maintains separate books and records; and
- The election to be an IC-DISC described above is in effect for the tax year.
Qualified export assets under Sec. 993(b) include:
- Export property;
- Assets used primarily in connection with the sale, lease, or other specified activities relating to qualified export property, and in connection with performing certain services;
- Sufficient cash required to meet the working capital requirements; and
- Amounts on deposit in the United States used to acquire other qualified export assets, subject to the limitations of Regs. Sec. 1.993-2(j).
If an IC-DISC does not meet and maintain these requirements each year, it could lose IC-DISC status and the associated tax savings.
No major tax overall was proposed when President released the 2016 Budget Proposal, not yet deemed dead on arrival, but soon enough. A highlight or two affect IRAs:
Death of the backdoor Roth. The Roth IRA, generally speaking permitted lower wage earners the opportunity to contribute to the Roth, then upon reaching retirement will withdraw the money, paying no tax on the amount contributed or the earnings thereon. Using the backdoor Roth technique, higher earners contribute to a regular IRA and receive no deduction, but immediately convert to a Roth. The Budget Proposal eliminates this technique.
Mandatory distributions from Roth. Proposal says no contributions to a Roth after age 70 1/2 and mandatory distributions must be made after 70 1/2.
Eliminates the “stretch IRA”. Under current law, if you inherit an IRA, you can choose to withdraw the IRA over your life. The proposed budget allows the stretch but only if the spouse is the beneficiary. Others who inherit are limited to a 5 year payout.
Source: DOs and DONTs of Market Crashes
Washington Post, January 10, 2016
It’s that time!
Every few quarters, we find ourselves running through the same muster drill. Something happens somewhere in the world, the markets go a little nutso, and they sell off a dozen percent or so of their value. The usual suspects panic. Eventually things stabilize. And everyone wonders what the hell just happened. Post-mortem explanations come along that seem reasonable (after the fact, of course, never before).
That sort of gallows humor is typical on Wall Street. But if you follow the good advice above, you can sleep soundly, knowing your portfolio is working for you.
2016 Standard Mileage Rates for Business, Medical and Moving Announced
WASHINGTON — The Internal Revenue Service today issued the 2016 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.
Beginning on Jan. 1, 2016, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
- 54 cents per mile for business miles driven, down from 57.5 cents for 2015
- 19 cents per mile driven for medical or moving purposes, down from 23 cents for 2015
- 14 cents per mile driven in service of charitable organizations
The business mileage rate decreased 3.5 cents per mile and the medical, and moving expense rates decrease 4 cents per mile from the 2015 rates. The charitable rate is based on statute.
The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs.
Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.
A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.
These and other requirements for a taxpayer to use a standard mileage rate to calculate the amount of a deductible business, moving, medical or charitable expense are in Rev. Proc. 2010-51. Notice 2016-01 contains the standard mileage rates, the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate, and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan.
1) File and suspend 2) Restricted Application and 3) Retroactive lumpsum loopholes are closing.
The File and Suspend strategy is this: once one spouse reached full retirement age (currently 66), that person files for Social Security and then immediately suspend the benefits. Then, the husband or wife would claim the spousal benefit. Meanwhile the suspended benefits grow 8 percent per year until age 70.
The file-and-suspend strategy, as outlined above, will not work after May 1, 2016. After May 1, 2016 a person must file for Social Security and actually receive benefits in order for a husband or wife to receive a spousal benefit. Those taxpayers who are at least 66 or who will turn 66 by April 30, 2016, can still use the file-and-suspend strategy.
The second rule being eliminated relates to restricted applications. A restricted application works like this: if you are between their full retirement age and age 70 you can file a restricted application to claim spousal benefits, but defer your own benefits until age 70. When you reach 70, you can change from receiving spousal benefits to your own, (hopefully) greater benefits.
The effect of the change is that with the elimination of restricted applications and the introduction of deemed filing for all ages, a spouse can only receive the larger of either the spousal benefit or their own benefit. And, they can’t change their choice after having made the election.
Those who will turn 62 by the end of the year will be grandfathered in under the old rules for restricted applications.
Retroactive Lump Sum Payments
The final change applies to suspended benefits. Currently, those with suspended benefits can elect at any time to request payments retroactive back to their filing date.
If, for example, someone filed for Social Security at age 66 and then suspended payments, the benefits would grow at a rate of 8 percent per year. However, if the recipient decided to retroactively unsuspend benefits, he would lose the 16 percent increase he was earning by deferring benefits, but Social Security will send a lump sum payment for the past two years. Future monthly payments would be made at the same rate the man would have received had he started benefits at age 66.
Under the new rules, Social Security beneficiaries can no longer retroactively unsuspend benefits: no more lump sums.