Choosing the Right Fiduciary

The importance of choosing the right people to fill fiduciary roles cannot be overstated.  The word “fiduciary” derives from the Latin verb fidere – to trust – and it is true that individuals named to these roles should have the highest level of trustworthiness.  Ideally, however, the people serving as fiduciaries should also possess the necessary skillset to successfully perform the tasks required.  Because the responsibilities in each role are somewhat different from the others, taking the time to think through whether a potential fiduciary’s skillset and personality are compatible with the role is well worth the effort.  Here is an overview of each role, which will be followed in subsequent posts with more detail about each particular one.

• An agent under a power of attorney may manage your finances on your behalf during your lifetime.  Agents are often granted nearly unlimited powers to carry out any action you might undertake for yourself.  Unfortunately, this broad power is sometimes abused, so trustworthiness is the absolute guiding star when choosing an agent.  Another important factor is attention to detail.  Investment, banking, bill payment, and other records of actions should be maintained.  This person may also be tasked with voting on (or otherwise controlling) your business affairs.  Thus, it may be easier for an agent who lives locally and has intimate knowledge of your affairs to act on your behalf.
• By contrast, an agent under a health care power of attorney is empowered to make decisions about your body.   If you are unable to make or communicate a decision about your own medical care, your agent is named to make those decisions.  Thus, this person becomes your advocate.  The person named should be familiar with your values and your wishes, and if necessary, be assertive enough to ask the right questions of medical professionals.  Finally, it is helpful (but not essential) to name someone with medical experience and who is local.  If you are in an assisted living or a nursing care facility, your agent is the facility’s main point of contact.
• An executor is appointed to wrap up your affairs after your death.  This begins by qualifying before the circuit court clerk and may include preparing an inventory of your assets at your death and an accounting showing payment of your debts, receipts by your estate, and distributions to your beneficiaries.  Your executor is also obligated to file your final income tax return.  Strong organizational skills are critical to this position because record-keeping, meeting probate deadlines, and making tax elections and filings are key aspects of the job.  Weeding through and selling, distributing, or donating household contents is also a major function of the job, and it’s no small task.  If the executor is not a resident of the state, this task is more cumbersome.  In addition, the court may require that the executor be bonded. 
• A trustee is put in place to manage money for the long-term benefit of the trust’s beneficiaries.  The person in this position must be prepared for a commitment and possess either a talent for asset management or the ability to assess information provided by a competent professional who is hired.   Consider naming someone who has a sense of your values and the beneficiaries’ needs, so that if the trustee is called upon to make discretionary distributions, he or she has a solid foundation from which to consider the issues.  Often the interests of beneficiaries conflict, so your trustee may be tasked with making difficult choices.

Naming the wrong people to these fiduciary roles can cause even a well-constructed estate plan to fall apart.  Your attorney can help you identify individuals in your life who would be a good fit for each role, but your knowledge of both the character and judgment of the people you choose is paramount.  If you lack confidence that people in your life have the talent or character required of the job, choosing a professional trustee may be the better course.

Jennifer Schooley  |  Contact  |  Estate Planning

Power Of Attorney Pitfalls

In one sense, being named to act as someone’s agent under a power of attorney should be considered an honor – clients are encouraged by their lawyers to choose agents who are highly trustworthy and competent.  Even well-meaning agents, however, can make mistakes, either from simple human error or from a misunderstanding of an agent’s obligations and responsibilities under Virginia law.  Here are just a few of the issues we see giving agents trouble.

Record-Keeping

Agents are obligated by statute to keep records of every transaction they undertake in their principal’s name.  Depending on the individual situation, this could mean keeping many years of records of deposits, withdrawals, expenses paid, reimbursements made to the agent, purchases, and sales.  This can be a lot to undertake while also trying to run your own, busy life, and many agents therefore let their records slip.  The pitfall?  If these records are requested by certain individuals listed in the statute, the agent is obligated to hand them over within thirty days.  Recreating these records (up to five years’ worth) may be impossible at the point the request is received, so it is critically important to maintain the records from the start.

Unauthorized Actions

Although powers of attorney often grant agents broad powers to undertake any action the principal could take with regard to his or her finances, certain powers are considered special and require an express grant of authority to be stated in the document.  If those powers are not specifically listed, the agent is not authorized to exercise them.  These “special powers” include:

• Creating, revoking, or amending the principal’s revocable trust;

• Making gifts of the principal’s property;

• Creating or changing rights of survivorship or beneficiary designations;

• Delegating the agent’s authority to someone else;

• Waiving the principal’s right as a beneficiary of a joint and survivor annuity (including a survivor benefit under a retirement plan); and

• Exercising fiduciary powers that the principal has authority to delegate.

Agents should read the power of attorney granting them authority carefully to determine exactly which powers are granted to them and which are withheld.  In addition, certain powers, even if expressly granted, are further limited by statute depending on the agent’s familial relationship to the principal.

Conflicts of Interest and Good Faith

An agent is obligated to act on the principal’s behalf in accordance with the principal’s best interest, in good faith, and free from conflicts of interest.  Although these may seem like straightforward conditions, in practice they can be more complicated.  An agent can run afoul of these fiduciary responsibilities even when he or she has no intention to act against the principal’s best interest or otherwise cause harm to the principal. 

The bottom line? For violating these duties, agents can be held personally liable for any actual loss to the principal, as well as the attorneys’ fees and costs of a party who raises the issue.  Thus, the best practice is always to get legal advice before taking any action that raises the slightest question mark or causes you to hesitate for any reason.  If you are already acting as agent under a power of attorney and have questions about transactions you have already entered into, it may not be too late to “right the ship” and get back into compliance with your legal responsibilities.

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Estate Law  |  Jennifer Schooley

2016 Inflation-Adjusted Amounts for Trust and Estate Tax Brackets

Each year the trusts and estates tax lawyers eagerly await the new exemption amounts and tax brackets to see if there is any change due to upticks in the Consumer Price Index.  Ok...maybe we don't hold our breath, but we do pay attention.  It's vital information for a client meeting and fodder for conversation at the next cocktail party, where inevitably, the question "what do you do" comes up and one prepares to either enlighten or bore the other person with a font of tax knowledge.  Cue the sports conversation, "Hey, how about those Bears???"

Here are the highlights:

• The new estate tax exemption equivalent is $5,450,000, up from $5,430,000.
• The new generation-skipping transfer tax exemption is $5,450,000, up from $5,430,000.
• The gift tax annual exclusion remains at $14,000.
• The annual exclusion for gifts to noncitizen spouses increases to $148,000.
• The reporting threshold for foreign gifts received by a U.S. person from a nonresident alien individual or estate is $100,000 in the aggregate for the year and is $15,671 (increased from $15,601) if received from a foreign corporation or partnership.
• Irrevocable trusts and estates reach the top income tax rate of 39.6% on income over $12,400.

In other news, the Bears defense will face a tough test on Sunday when the Raiders come to play at Soldier Field.

"Give A Little Respect...Just A Little Bit?" (When a handwritten note is just not enough.)

People often hold the mistaken belief that their family and their financial institutions will respect their wishes, even if they do not dot all their "i's" and cross all of their "t's."  Admittedly, following rules and procedures and dealing with paperwork can be dull, but don't let your failure to do so take your intended beneficiaries by surprise.  In a recent 8th Circuit case, Hearing v. Minnesota Life Insurance Company, the Court determined a handwritten note apparently intended to effect a change of beneficiary did not satisfy a life insurance policy’s contractual requirement that the policy owner file a beneficiary change with the insurance company prior to death.  The policy owner, Jon Holloway, wrote a note to his daughter, Nikki, directing her to “sell everything you don’t want and bank it.”  The policy number for Holloway’s Minnesota Life Insurance policy was listed at the bottom, along with contact information for the insurance agent.

The beneficiary of Holloway’s life insurance policy, however, was Holloway’s sister, Joetta Hearing.  Holloway made Hearing his beneficiary when, following his divorce, he did not want his ex-wife to control the proceeds on behalf of Nikki in the event of his death.  In fact, on his insurance application he wrote “[n]aming sister as beneficiary so ex-wife can’t control the death proceeds.”  So, it could be inferred that Holloway really intended for his daughter (a minor) to be his beneficiary but named his sister instead in an attempt to safeguard his death proceeds from his ex-wife.  The Court, however, was not willing to make such an inference, even given the existence of a handwritten note, signed and dated by Holloway, designating Nikki the recipient of the proceeds.

Minors cannot legally own property, and Holloway may have been advised of this when he decided to make his sister the beneficiary. However, a better way for Holloway to have approached this situation would have been to create a trust with Nikki as beneficiary and name the trust to receive the life insuranace proceeds.  Trusts allow a greater degree of control and management over ones wealth, even after death. If Holloway had made a trust agreement naming a competent adult as trustee, he could have outlined precisely when, after reaching the age of majority, his various assets (including policy proceeds) would pass to Nikki.

Deciding who will be the beneficiary of your insurance policy is not always easy.  But it is always a good idea to keep abreast of your policy’s requirements for changing beneficiaries.  Check with your insurance agent to ensure your policy is up-to-date regarding the direction of your assets, and consult an estate planning attorney if your primary or contingent beneficiary would be one or more minors.  Furthermore, it may be a good idea to create a trust agreement.  After all, having your proceeds go to someone unintended really may be the last thing you want.

Same Sex Marriage in Virginia

In October, the U.S. Supreme Court declined to hear appeals from five states, including Virginia, that sought to prohibit same sex marriage. Critics of the rejection have argued that the Court should have engaged the issue in order to set a national standard. But regardless of whether the Court should have reached further by ruling on the appeals, the refusal to hear the cases effectively legalizes same sex marriage in the appellant states.

This means that weddings between same sex couples began immediately in the Commonwealth.  In addition, same sex couples currently residing in Virginia who were married in states where such marriages were already legal will now be subject to all Virginia state laws governing marriage, including divorce, estate, and tax law.  

The Court’s 2013 decision in U.S. v. Windsor extended federal protection and recognition to same sex marriage, with the result that same sex couples became subject to all federal tax law. (For more details, see the post of September 25, 2013.) Although this pair of decisions inarguably expands same sex rights, it also requires the same sex married couples to navigate and comply with all laws and regulations, both federal and state, that previously just applied to heterosexual married couples.

These changes should prompt all same sex married couples to consider contacting an attorney to review their estate plans and update them, if necessary.

Clark v. Rameker: Inherited IRAs Are Not Protected from Creditors

Clients who have named a child or spouse with financial problems as the direct beneficiary of an IRA should reconsider their beneficiary designation. In June, the Supreme Court unanimously held that IRAs inherited from the original owner are not exempt from the bankruptcy estate. This means that if a holder of an inherited IRA files for bankruptcy, funds from the IRA will be accessible by a bankruptcy trustee to satisfy unpaid debts.

Section 522 of the Bankruptcy Code states that “an individual debtor may exempt from property of the estate [. . .] retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code.” This includes both traditional IRAs (section 408) and Roth IRAs (section 408A). Thus, when Heidi Heffron-Clark filed for Chapter 7 bankruptcy, she listed an IRA inherited from her mother as exempt property. The bankruptcy trustee disagreed, as did the Seventh Circuit. This case, Clark v. Rameker, affirmed the Seventh Circuit’s holding and resolved a conflict with the Fifth Circuit’s decision in In re Chilton, which had held that inherited IRAs did constitute exempt retirement funds.

The Court distinguished inherited IRAs from traditional and Roth IRAs in three ways. First, the holder of an inherited IRA cannot invest additional money in the account. Second, holders of inherited IRAs MUST withdraw from the accounts, regardless of proximity to retirement. Last, a person who holds an inherited IRA may withdraw all the funds at any time, without penalty.

The Court explained that the purpose of exempting retirement funds from the bankruptcy estate is to allow the debtor to meet his or her essential needs during retirement. Because funds in a traditional or Roth IRA are only accessible without penalty when the account holder reaches approximate retirement age, exempting these accounts comports with that goal. On the other hand, the holder of an inherited IRA can (and in fact, must) withdraw the funds over a prescribed time period, even if the person is many years away from retirement. As Justice Sotomayor pointed out,

“nothing about the inherited IRA’s legal characteristics would prevent (or even discourage) the individual from using the entire balance of the account on a vacation home or sports car immediately after her bankruptcy proceedings are complete. Allowing that kind of exemption would convert the Bankruptcy Code’s purposes of preserving debtors’ ability to meet their basic needs and ensuring that they have a ‘fresh start,’ into a ‘free pass.’”

This ruling means that inherited IRA funds are accessible by creditors in the bankruptcy context. Therefore, estate planners should counsel their clients with substantial retirement accounts not to name individuals with a history of insolvency in their beneficiary designations. A better option is to create a trust, which can be impenetrable to most types of creditors. Trusts can hold a variety of assets and can be designated as IRA beneficiaries. In addition, distributions to beneficiaries can be limited to prevent trust assets from being consumed by the creditors of an insolvent trust beneficiary. 

New IRS Regs: Thanks a "Bundle"

At long last, the IRS finalized regulations that were initially proposed in 2007. Treas. Reg. §1.67-4 clarifies which estate and non-grantor trust costs are fully deductible for income tax purposes and which are only allowed to the extent that they exceed 2% of the estate’s or trust’s adjusted gross income as set out in §67(a). Section 67(a) “miscellaneous itemized deductions” are generally subject to this 2% floor for individuals, but §67(e)(1) provides an exception for costs paid or incurred by an estate or trust if an individual who held the property outright would not have paid them. In essence, costs incurred by an estate or non-grantor trust as a direct result of the form of ownership are fully deductible.

The standard under the regulations tracks the Supreme Court’s decision in Knight v. Commissioner, 552 U.S. 181 (2008). If an individual who held the same property outside of a trust would “customarily” or “commonly” incur the expense at issue, it is subject to the 2% floor. Using this inquiry, the Court determined that investment advisory fees would generally be subject to the 2% floor, and the finalized regulations reflect that holding. But if an investment advisory fee incurred by an estate or trust is higher than what would normally be charged to an individual investor, then the portion of the fee that exceeds a ‘normal’ charge is considered a special cost, particular to the estate or trust context and therefore not subject to the 2% floor. This also means that normal “ownership costs,” defined in §1.67-4(b)(2), such as condominium fees or insurance premiums, are subject to the 2% floor, but only if they are costs properly analyzed under §67. (Business costs, for example, would be fully deductible under §162.) On the other hand, some tax preparation fees and appraisal fees are not subject to the 2% floor because they arise out of the form of ownership. This includes estate and generation-skipping transfer tax returns and the appraisals required for preparation of those returns. Likewise, certain fiduciary expenses are fully deductible, a non-exhaustive list of which is provided in the regulations. This all seems fairly consistent with Knight and the Code.

The real head-scratcher appears in subsection (c). If an estate or non-grantor trust pays a single fee (for example, to an attorney or accountant or as a fiduciary commission) attributable to both kinds of costs, this so-called “bundled fee” must be allocated between the portion that is subject to the 2% floor and the portion that is not. Practitioners objected to this allocation requirement during notice and comment, arguing that it would drastically increase administration costs. The IRS disagreed, pointing out that the new regulations allow “any reasonable method” to be used in allocating bundled fees. However, a vague standard is no one’s friend, and this one is unlikely to comfort planners. In addition, unscrupulous professionals could choose to collude with their estate and trust clients by itemizing their “bundled fees” but allocating a minimal portion to costs subject to the 2% floor.

The Service’s position on bundled fees in the finalized regulations is a departure from the temporary guidance it issued in 2008, which had stated that the portion of a bundled fee subject to 2% floor costs did not have to be determined. Hence the bottom line is that estates and non-grantor trusts incurring these types of fees will no longer enjoy a complete deduction, and will have to develop a “reasonable” method of determining how they break them down. This means increased costs, both in taxes paid and in administration.

Lessons Learned, From Someone Else's Mistake

Tax Court Memorandum 2014-15, issued on January 27, 2014, is another example of a taxpayers falling far short of the requirements to substantiate a charitable income tax deduction resulting in the deduction for their contribution of a 34 unit apartment building to charity being denied.  The taxpayers, a doctor and his wife, provided false information and submitted appraisals that did not meet the substantive requirements of Code section 170 for submitting a “qualified appraisal,” hiring a qualified appraiser, and the appraisal summary requirements.  The result….well,  the judge absolutely denied their claim for a deduction, and that, readers, is the loss of real money.

When making large donations, failing to meet these requirements (which often occurs by failing to invest the time and money in hiring appropriate appraisers and advisors) can result in the loss of major dollars!  Unless a donation can be readily valued, such as donations of cash and marketable securities, it’s important to know the type of documentation you need.

Under Treasury Regulation 1.170A-13(c)(2), a taxpayer who claims a charitable deduction in excess of $5,000 must (1) obtain a qualified appraisal for the property contributed; (2) attach a fully completed appraisal summary to his tax return; and (3) maintain records containing certain information (as required by paragraph (b)(2)(ii) 13 of this section).

So, what is a qualified appraisal?  Under the regulations, a qualified appraisal must be made not more than 60 days before the gift and no later than the due date of the income tax return, it must be signed by a “qualified appraiser” (more on that later), must not involved a prohibited appraisal fee, and must include the following information:

1. A description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed;

2.  In the case of tangible property, the physical condition of the property;

3. The date (or expected date) of contribution to the charity;

4. The terms of any agreement or understanding entered into that relates to the use, sale, or other disposition of the property contributed;

5. The name, address, and the identifying number of the qualified appraiser;

6. The qualifications of the qualified appraiser who signs the appraisal, including the appraiser's background, experience, education, and membership, if any, in professional appraisal associations;

7.  A statement that the appraisal was prepared for income tax purposes;

8. The date (or dates) on which the property was appraised;

9. The appraised fair market value of the property on the date (or expected date) of contribution;

10. The method of valuation used to determine the fair market value; and

11. The specific basis for the valuation. (See Regulation §1.170A-13(c)(3)(ii))

A “qualified appraiser” is an individual who (1) “has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations….; (2) “regularly performs appraisals for which the individual receives compensation”; and (3) “meets such other requirements as may be prescribed by the [Treasury] Secretary in regulations or other guidance.”  Additionally, the individual must demonstrate verifiable education and experience in valuing the type of property subject to the appraisal and not be prohibited from practicing before the IRS.  (See IRC § 170(f)(11)(E)(ii) & (iii)).

Under the regulations, a qualified appraiser is an individual who includes on the appraisal summary a declaration that: (1) the individual either holds himself out to the public as an appraiser or performs appraisals regularly; (2) the appraiser is qualified to make appraisals of the type of property being valued; (3) the appraiser is not excluded from qualifying as a qualified appraiser under section 1.170A-13(c)(5)(iv), Income Tax Regs.; 21 and (4) the appraiser understands that an intentionally false or fraudulent overstatement of the value of the property described in the qualified appraisal or appraisal summary may subject the appraiser to a civil penalty under section 6701 for aiding and abetting an understatement of tax liability.  (See Regulation  § 1.170A-13(c)(5)(i)).

The rules surrounding charitable contributions and the required receipts and verifications needed for different types of property are complex.  It is important to discuss these issues with your CPA (because I assure you, they are not all covered here!) and ensure you take the steps necessary to protect the deduction you wish to take in April!

IRS Recognizes Same-Sex Marriages for Federal Tax Purposes

In response to the Supreme Court’s decision in United States v. Windsor, the Internal Revenue Service has issued Revenue Ruling 2013-17, stating married same-sex couples will receive the same tax benefits as other married couples.

To be applicable, the same-sex couple must have been legally married in a jurisdiction permitting such marriages, but they can reside in any of the 50 states, U.S. territories, or any foreign country, regardless of that jurisdiction’s recognition of such marriages. The ruling does not apply to domestic partnerships, civil unions or other similar formal relationships, regardless whether the individuals are of the opposite sex or the same sex.

For individuals affected by this recent tax change, it is important to contact your income tax advisor and financial advisor to discuss planning.  Couples should be aware that the 2013 filing status should now be either married filing jointly or married filing separately and amended income tax returns may be filed for any tax years still open under the statute of limitations, which for many will be three years (2010, 2011, and 2012).  

Beyond income tax issues, Windsor and Revenue Ruling 2013-17, allow same-sex couples to be eligible for estate, gift, and generation-skipping transfer tax benefits such as the election to split gifts for federal gift tax returns, the unlimited marital deduction for gifts and bequests, and the portability election on any unused portion of a deceased spouse’s applicable exclusion amount.

The Internal Revenue Service has stated it will continue providing further guidance in areas such as retroactive application of employee benefits and employee benefit plans and arrangements.

To File a Claim for a Refund

Form 1040X, Amended U.S. Individual Income Tax Return should be used by taxpayers wishing to file a refund for income taxes.

Form 843, Claim for Refund and Request for Abatement is used for taxpayers wishing to file a refund for gift or estate taxes.

More information on filing an amended return can be found at  Tax Topic 308, Amended Returns at http://www.irs.gov/taxtopics/tc308.html

Annual Gifting

Nothing is certain but death and taxes, right?  And though we can't skirt the certainty of death, we can at least reduce the certainty of our taxes.  For those fortunate enough to have an "estate tax problem," there is much that can be done to reduce the severity of that problem.  

Annual gifting is one of the easiest methods.  We regularly discuss with our clients the mechanics of making annual exclusion gifts, which are those gift that do not reduce the amount of the unified gift and estate tax exclusion amount ($5.25M in 2014) and in some cases do not necessitate the filing of a gift tax return (Form 706).  

Here is a recent article  on annual gifting in the Wall Street Journal that is a helpful synopsis for more routine annual cash gifting.  (Click on "Source" above to view if you have a WSJ subscription.)  

The suggestions are particularly helpful for maximizing cash gifts to adult children and funding the education of grandchildren.  Making gifts to a trust for the benefit of a minor is more complicated and requires proper planning.  For advice on how to set up such a trust and have the gifts qualify for the annual exclusion, please contact us for a consultation.