Estate Planning Bits

One child, two separated or divorced parents. Who gets the tax exemption?

In many cases situations involving divorce, or those where a child is born of two parents who are not married, there is a question about who is allowed to take the child as an exemption on their income tax return. With the exemption at $3,650, and a potential tax credit of up to $1,000 per child, this is an important consideration, as the net amount could mean a significant refund to the taxpayer. The issue of who takes the dependent is hopefully determined at the time that the divorce is granted, or by a separation agreement, or by a judgment of the court.

For tax years beginning after July 2, 2008, the IRS has finalized rules that determine the dependency requirements and clarify who is permitted to take the dependent. In most cases, the dependency will be awarded to the custodial parent unless the non-custodial parent obtains a signed waiver for that tax year and attaches it to their income tax return when filed. This rule applies regardless of what the divorce decree says, so it is important within the divorce decree to not only attend to the exemption allowance, but also to the requirement of the non-custodial spouse to sign the waiver.

In some situations, there is a joint custody agreement designating that each parent basically has the right to the child for an equal period of time. If it is not agreed upon, then detailed records should be maintained so that the person claiming the dependency exemption will be in a position to defend the taking of the exemption of dependency if audited. It is often suggested that a calendar be marked with the days and nights the child is living each the parent. It will probably be nearly impossible to reconstruct the calendar years later, when the IRS challenges the dependency.

When both parents claim the dependency, it is likely that the IRS will question both parents and review both tax returns. In normal cases, the parent with the most number of nights will win, but it is important to maintain accurate records, including vacations and times that the child may be with a grandparent so you’re in a position to count the specific number of nights. However, if a parent has a night shift and therefore is not available to watch the child at night, there is a different test that will be applied by the IRS as to the dependency.

For purposes of medical deductions, both parents may be able to take the deductions on their respective returns to the extent that they paid for medical expenses for the child, even if they are not the custodial parent and may not be the parent who is permitted to take the dependency exemptions. In the event that there is a divorce already granted but is in need of a modification for any terms, it is always important to review tax related issues when considering the net result relative to the tax effect.

By: Hyman G. Darling, Esq.

Retirement changes in 2009

The Worker, Retiree, and Employer Recovery Act of 2008 provides for several alternatives for individuals in 2009. Due to the fact that the financial markets have dramatically reduced their values in the last quarter of 2008, the government felt it would be unfair to require individuals to take the minimum distribution in 2009 based on the value as of 12/31/08. Therefore, they have suspended the requirement that a distribution has to be made if a person is 70-½, as previously required.

In this manner, a person may allow the normal withdrawal to remain in the IRA, so it will hopefully come back in value and continue to build the account. In prior years, if you did not take a distribution that was at least the minimum required, the amount that you did not withdraw was taxed at an exorbitant rate of 50%.

The law that suspends the required minimum distribution in 2009 applies to all defined benefit plans: 401k plans, 403b plans, 457b plans, and IRA plans.

In addition, a person may continue to withdraw funds from their IRA (but not 401k or other qualified plans) and make charitable deductions directly from the IRA to the charity. The owner of the fund must be over 70-½, but the distribution that is being made may count towards the minimum required distribution. Therefore, if a person had an interest in making charitable contributions or had pledged certain amounts to various charities, it would make considerable sense to use these IRA funds rather than other liquid assets.

However, the funds must be paid directly from the holder of the funds to the charity and they may not pass through the hands of the account owner. This contribution may be made at any time during the year, so it is wise to consider when the contribution should be made based on a belief that the account will increase or decrease in value.

Naturally, with any tax related matter, it is important to obtain professional advice prior to making a decision, as these options are irreversible.

By: Hyman G. Darling, Esq.

EXPATS and taxes

The Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART) was recently passed. The major intent of this was to provide $1.2 billion dollars in tax relief for members of the military, provide for premature retirement plan withdrawals, deal with eligibility for the earned income tax credit, and other provisions.

Part of this Act was also needed to offset the cost by re-writing of the tax consequences of abandoning U.S. citizenship. It was estimated that just shy of 500 Americans renounced their citizenship in 2007. Evidently, many of these individuals felt that the tax advantages of getting beyond the reach of the IRS motivated them to renounce their citizenship and become a citizen of another country.

In general, those who do relinquish their citizenship will be treated as having sold all of their assets for the fair market value on the day before the expatriation date. In that situation, all of their net unrealized gains would be taxable, and the new provision of the Act covers those with a net worth of over $2 million or who had average annual net income tax liability during the proceeding five years of $124,000 ($139,000 in 2008 after adjustment for inflation.)

In addition, the first $600,000 of gain would be tax free (also adjusted for inflation after 2008.). Under prior tax law, after ten years, an expatriate was immune to any gift tax in the United States. There are new rules for the donees who may owe tax on the transfer of funds received from a former U.S. citizen who expatriated. A significant change was that the obligation has passed from the donor to the donee, much like the prior law of many years ago regarding inheritances taxes. In those cases, the estate was not liable for the tax, but rather the inheritor.

This is also similar to an IRA situation where the beneficiary pays income tax on the amount received, but the person who died did not have to pay tax on the funds while they were alive, even though they passed the assets to another person.

In any event, if anyone is considering expatriating or has received funds from an expatriate, it is important to be familiar with the new rules so that there will not be penalties or interest accruing from gifts or transfers.

By: Hyman G. Darling, Esq.

Demystifying terms used by estate planning attorneys

Agent: The person given legal authority to make financial decisions for a person through a durable power of attorney document or the legal authority to make health and medical decisions for a person through a health care proxy document.

Artificial Life Support: Medical equipment and other technology used to prolong the life of a person who is seriously ill by sustaining essential body functions, like breathing.

Assets: Personal possessions of value, including cash, bank accounts, real estate, vehicles and investments.

Beneficiaries: The people named in the will to receive the estate of the person upon his or her death.

Conservator: The person appointed by the courts to make financial decisions on behalf of a person.

Custody: Legal responsibility of a person.

DNR:  Stands for “Do not resuscitate” and refers to a person’s instructions that, if his or her heart or breathing stops, the doctor should not try to restart it.

Durable: When a power of attorney document is durable, it is valid even after the person with dementia can no longer make his or her own decisions.

Execute: To legally sign or “carry out” a legal document.

Executor: The person named in a will to manage the estate of the person upon his or her death.

Grantor: The person for whom a living trust is created.

Guardian: The person appointed by the courts to make health care decisions on behalf of a person (sometimes also includes financial decisions.)

Health care agent: The person given legal authority to make health care decisions for a person through a health care proxy document.

Legal capacity: The level of judgment and decision-making ability needed to sign official documents.

Probate:   The process used by the court to distribute the property of a person who has died.

Trustee: The individual or bank chosen to manage the property (assets) in the trust document of a person.



by: Todd C. Ratner, Esc.

Charitable Gift Annuities - a new twist to Savings Bonds

Most people who have savings bonds hold them for reasons such as having a rainy day savings or for a specific purpose in the future. Many of these bonds were purchased many years ago and have accrued a significant amount of interest over the years. And all that interest will be taxable by the IRS when they are redeemed.

Very often, bonds are found in a safe deposit box or in a drawer when a person dies. Since E bonds and EE bonds may no longer be converted into H bonds with the interest being deferred, a person normally cashes in these bonds, pays the tax, and either spends or reinvests the net proceeds.

However, you may want to have your cake and eat it too. While you may wish to make a donation of the savings bonds to charity, you cannot do so during your lifetime, as savings bonds may not be transferred to an organization this way. However, they can be used in a gifting arrangement, whereby the bonds are cashed in, and then the net proceeds are given away.

To the extent that you itemize your taxes, you will receive an income tax deduction for the value of the gift to the charity, which will be an offsetting deduction against the interest reported on your income tax return as taxable income. However; if you want to derive some income from the gift, you may convert the assets into a charitable gift annuity. The result will be receipt of income during your lifetime and a charitable deduction for a significant portion of the gift.

By counting the income received from the gift annuity as well as the tax deduction for the gift, you may have more money left over time than if you had merely cashed the bonds in and paid the tax. Most tax exempt organizations will accept gift annuities, but the usual minimum for a gift is $10,000 in cash or other assets.


by: Hyman G. Darling, Esq.

Tax deductibility of assisted living facilities

With the number of baby boomers growing, more people are electing to move to assisted living facilities as opposed to waiting until a long term care facility may be necessary. With the sale proceeds of the house being non-taxable in most cases due to the exemptions available, these funds may be placed into other investments, which will now produce income that was not generated by the house.

The payment to the assisted living facility (ALF) is mainly non-deductible, but in many cases, a portion of these expenses may in fact be deductible. This amount, which may be construed to be qualified long-term care costs, is deductible if it is for necessary rehabilitative services, maintenance or personal care services that are:

• Required by the individual who is deemed to be chronically ill and
• Paid pursuant to a plan of care by the licensed health care practitioner

While the rules are fairly specific, the IRS regulations that attempt to clarify the Internal Revenue Code for deductibility of these expenses are not as clear as one may wish. Maintenance or personal care services that provide assistance for an individual who is deemed to be chronically ill or disabled are normally deductible (subject to IRS limitations) if the individual needs require help with two activities of daily living (ADLs.) These ADLs include:

• Feeding
• Toileting
• Transferring
• Dressing
• Bathing
• Continence

Therefore, if a person is able to perform all of these duties and is merely obtaining custodial care at the assisted living facility, the payment or any part of it to the ALF will not be deductible. Similarly, if the facility is operated by a non-profit agency, the amount paid will also not be deductible as a charitable expense, since services are being provided for the payment, which is not considered a contribution.

If deductions are going to be taken, a test must be met, and it is also suggested that a qualified certified licensed care professional or practitioner provide a written plan that can be used as evidence in the event that the IRS questions the deductibility of certain payments. Although there is no definition set forth in the Internal Revenue Code for a plan of care, it is one of the best sources of establishing the credibility of the need for services.

Most ALFs also provide each resident, each year with a calculation of the costs of care that is deductible if all tests are met. Naturally, if there are any reimbursements made to the individual, these amounts must reduce the deductible expenses by the amount of payment received via governmental, private or otherwise. The facility normally provides these calculations on a year-to-year basis, which may change as various administrative and professional services change from year-to-year.

Naturally, if a person is disabled and living in a facility, with or without additional assistance, the full amount of care may be deductible if it is determined that this person must be institutionalized and is not any longer able to remain at home alone. It may also be a prudent decision to review the assets a person is utilizing for long-term care. If that person has a significantly large retirement plan, it may be beneficial to withdraw further funds from the plan, which may deductible as medical expenses, as opposed to merely withdrawing funds from a savings account. In this manner, retirement plan assets, although they will not continue to grow, will not be taxed by the beneficiaries at a significantly higher income tax rate, but rather, will allow other assets to pass income tax free to beneficiaries.

By: Hyman G. Darling, Esq.

How to handle affairs upon the death of a loved one

When a person close to you dies, there are several issues that need to be attended to. Sometimes there might not be any tax or probate requirements, but nevertheless, it is important to review the situation to ensure that all matters are being handled properly. The following is a relatively short checklist that is not inclusive of all matters to take care of, but certainly, should be on the top of your list:

• Obtain a certified copy of the death certificate and request an extra one. Although these documents are not difficult to obtain from town hall or the city clerk’s office, it is easier to get an extra one now that may be used in the future, which will save time.
• Check benefits with Social Security. If a person who dies has a spouse, minor children, or was already receiving benefits or possibly had filed for benefits but not yet received them, it is important to notify Social Security to determine what the new benefit will be for the spouse or children or possibly a disabled child.
• Life insurance must be claimed, which in most cases is not income taxable to the recipient. Be sure to check with the decedent’s employer to determine whether there may have been any term life insurance death benefit. All prior employers should also be contacted even if there is no obvious benefit, to verify that a death benefit is not missed.
• Review the income tax return of the decedent to determine where all assets listed on the return may have been owned, such as income, gains or potential losses. Be sure to check 1099’s for other income which may not be listed specifically on a tax return such as dividends from reinvestment shares, life insurance dividends and municipal bonds.
• Take charge of the Real Estate to secure it and be sure that no one has access to the property. Inventory the contents of this property and if necessary, change the locks and alarm code of the residence.
• Take charge of the vehicle and determine whether it is insured for others to drive if other family members continue to use it. If not, inform the drivers of the situation, secure the car and possibly take away all keys.
• Verify ownership of bank accounts, stock, bonds, etc. If they are held jointly, determine if that is for convenience of if they are to be held truly for joint ownership and that the surviving joint owner or beneficiary of the account is entitled to retain ownership of the asset.
• Determine if any assets are in the decedent’s name alone which require a probate proceeding. This may also include a cause of action against a company or individual for causing the death or potentially to pursue a continuing action that may have been filed by the decedent prior to his/her death. If the will needs to be probated, be sure to obtain good legal advice as well as tax advice when proceeding.
• When distributing any tangible property to any individuals or charities, be sure to obtain a receipt in case there is any opportunity to obtain a charitable deduction. Possibly, the person receiving the property or their family may not be aware of the terms of the distribution, and in the absence of a memorandum signed by the decedent, some family members may be in disharmony about the ultimate distribution.

Before proceeding hastily, always obtain good advice to determine whether or not the estate must be probated, whether a tax return must be filed for the decedent’s final year of receiving income and whether an estate tax return needs to be completed and filed. Without obtaining advice, a person serving in the capacity of the named executor and person in possession may find himself answering to other beneficiaries in a court later if the settlement was not attended to properly.

By: Hyman G. Darling, Esq.

The advantages of owning a second or retirement home

Many people wish to own a second home at the beach, in the mountains or possibly a condominium or house where they plan to retire. In these situations, a vacation home can prove to be very tax efficient.

In your lifetime you can own the property and hopefully rent it if it is favorably geographically located. It need not be rented twelve months a year, but hopefully with interest rates low, and a significant down payment, the rental income will pay for most of the carrying charges including the mortgage, taxes, insurance, etc. In this manner, when you’re ready to retire, hopefully a significant portion, if not all of the mortgage, will be paid off.

Now may be an appropriate time to consider refinancing your property in order to take advantage of lower interest rates and possibly reduce the term so that when retirement is attained, you will be mortgage free. That will result in relatively inexpensive property ownership in retirement.

In the meantime, when you sell your principal residence, you will take advantage of the benefit available to you of the exclusion of up to $500,000 of capital gain on your principal residence if married. If you’re single, you will only be entitled to $250,000 of exclusion of gain. In any event, at that time, you will be able to take these proceeds after paying off any mortgage on the first property and bank the money or invest it. This will provide you with up to $500,000 (or $250,000 if single) of tax free money above and beyond the basis in the property. So long as you owned the property and used it as your principal residence for at least two of the last five years, you will be able to take these exclusions.

After retirement, you may then move into the rental property and convert it to your principal residence. After living in it for at least two years, you will again be able to sell that property and obtain the same tax benefits as you would have if you had lived in it all along. In the meantime, the rental income has helped pay the mortgage and you don’t have to dip into retirement funds as soon as otherwise anticipated, since you will have little or no mortgage on your new home as well as a significant amount of money that you will have received tax-free from the sale of your former primary residence. You may then wish to consider transferring the property to your children or taking other steps to protect the asset from being taxed or available for long term care expenses.

In the meantime, if you don’t mind being a landlord and can find relatively good tenants to live in the property, and if you don’t mind renting out what will be your future home, you will be in a good position for retirement. You will own a residence with relatively small debt.

By: Hyman G. Darling, Esq.

IRAs rollovers from a deceased loved one – how to achieve tax-free rollover status

The Pension Protection Act of 2006 enacted several provisions that affected Qualified Retirement Plans and also IRAs. Until that time, a beneficiary who was not the surviving spouse was not able to “rollover” retirement funds and had to pay taxes on these funds at their own income tax rate.

The new rule applies to distributions made on or after January 1, 2007 and now permits the beneficiary the ability to defer taxable distributions when received from a person who is deceased. They may have the funds rolled over to a Direct Rollover IRA and may allow the fund to grow while only taking out the annual required minimum distribution from this particular IRA. This has also been frequently called the “Stretch IRA.”

In these situations, if the person does not need the money, they may allow the funds to accumulate tax deferred (not tax-free) which will hopefully will be a greater amount earned on a yearly basis than the minimum distribution. In any event, the full amount of the principal of the IRA as of the date of death will not have to be withdrawn.

However, there are several specific requirements that must be met in order to obtain tax-free rollover status:

• The 20% withholding requirement will not be required.
• The required minimum distribution is not eligible for rollover, but the current year distribution must be taken by the beneficiary prior to the qualified plan being transferred.
• The IRA Rollover account may be established for the benefit of the individual. If there is more than one specific beneficiary named, then the oldest Trust beneficiary must utilize their age for determination of the minimum distributions.
• The funds must be transferred directly from the prior IRA or account to the new one. The beneficiary may not request the funds himself/herself, receive them and deposit them with the new IRA custodian as they could do with their own IRA account.

Please note that this account should not be commingled with any other IRA funds, since a person’s own funds will not have to meet the minimum distribution requirements until at least age 70- ½. This allows the beneficiary another option as opposed to taking the funds in a lump sum and paying taxes or taking the funds out over a five-year period. IRS Publications 575 and 590 are quite helpful in explaining the new requirements and options available under the Pension Protection Act.

By: Hyman G. Darling, Esq.

Beneficiary Designations – how your “gift” may have significant tax implications

It is often the case that there is not sufficient thought and time devoted to reviewing the tax issues as they apply to beneficiary designations. Most life insurance is non-taxable, and the receipt of it by the beneficiary is not income taxable, but the death benefit will be includable in the estate for estate tax purposes.

Following are some things to think about.

It is possible that although you don’t currently have a taxable estate (exemption of $2,000,000 in 2008 and $3,500,000 in 2009), your estate may cross that threshold when you accept the death benefit of employer owned insurance, group insurance or accidental death coverage.

In many cases, a term insurance policy should not be owned by the insured because this will merely bring the policy into the estate for estate tax purposes. Since you won’t be taking the money with you upon death, it’s often preferable to have the policy owned by and payable to another, be it family, friends, any revocable trusts, etc.

Relative to IRAs, annuities, and other qualified retirement plans, it is very important to consider the beneficiary of these policies to be sure that the appropriate person, people, or charities are named on the forms. A married individual may receive qualified retirement plan benefits tax free by rolling the funds over into their own IRA.

There is no estate tax or income tax due when one dies and leaves all assets to their living spouse. However, there will be a significant income tax and potential estate tax upon the death of the surviving spouse.

Until recently, one significant drawback was that non-spouse beneficiaries were not eligible for tax deferred transfers to their own IRA. A non-spouse may now have certain options available so that they do not have to pay taxes in a lump sum upon the death of the contributor of the funds. The non-spouse beneficiary may now take these funds over their lifetime, take them in a lump sum distribution, or have them rolled over into a special type of an IRA called a decedent IRA, where they receive the funds over their lifetime. However, these distributions have to be made to what is known as Trustee to Trustee for the benefit of the beneficiary. A person may not elect to merely take the funds on their own, deposit them in an IRA for themselves and claim no income tax status.

A beneficiary may also wish to take what is known as a Stretch IRA. In this case, the beneficiary does not necessarily have to pay all of the income taxes in a lump sum, as he or she spreads the distribution out over their lifetime. By doing so, they are not only deferring their taxes, but also protecting these assets in the event that they are sued, because the assets won’t be available as a lump sum.

In addition, a lump sum receipt of these funds may push the recipient into a significantly higher income tax bracket, since the receipt of the IRA would be at ordinary income tax rates. When added to the recipient’s own income, these funds may push the individual into a significantly higher income tax bracket. By taking the funds as an annuity over their lifetime, the recipient allows the funds to continue to build tax deferred.

Later in life, these funds may be construed as additional retirement benefits, which may permit the beneficiary to retire earlier, since they have a steady stream of income guaranteed for their lifetime.

Sometimes, even when a person is married, it makes sense to consider leaving retirement funds to their children instead of their spouse. If the kids are minors, the funds may be left in a conduit trust that allows receipt of the funds basically tax free, but requires the Trustee to make minimum distributions to the children. However, if the children are young, the distribution, based on their life expectancy, may be relatively small enough that the income taxes they will pay are inconsequential or nominal.

In these types of situations, it is necessary that the spouse sign off on the beneficiary form. This is simply a requirement of Federal Law. A person may not exclude their spouse from being their beneficiary unless the spouse signs a written, notarized waiver. If they are willing to accept this waiver, additional planning may be considered that utilizes a retirement plan for the benefit of the children. However, one must take into consideration income taxes, estate taxes and the need for one spouse to survive on only his or her income upon the death of other spouse.

It is always important to obtain qualified legal and tax advice prior to making any beneficiary designations.

By: Hyman G. Darling, Esq.