Quarterly Newsletters

March 2010: Making a Federal Case of It: Update

Several months ago, I wrote a series of articles about various federal lawsuits that I had filed against the state of New Jersey. Like many states, New Jersey has issues with its budget.

Spending on the Medicaid program represents a large portion of New Jersey's budget. Frequently, spending on the Medicaid program consumes 20% or more of a state's budget. So, it is only natural that when things are tough, states seek to close their budgetary shortfalls by cutting back or reigning in Medicaid spending.

One of the ways that New Jersey has sought to reign in its Medicaid spending is by trying to kill "Medicaid planning," the process through which individuals seek to protect a portion of their estate and qualify for Medicaid benefits quicker than they would if they simply spent all their money on nursing home costs.

Lawyers who assist clients with Medicaid planning are probably a thorn in the Medicaid department's side. I would imagine that my fellow elder law attorneys and I are viewed as schemers who are depleting the state's budget at the expense of honest, hardworking taxpayers.

The reality is, Medicaid planning has little effect on the state's Medicaid budget. Studies by the Congressional Budget Office have told us so. Empirical evidence tells me this because there just aren't many elder law attorneys in a given state and within the group of attorney who call themselves elder law attorneys, there are even fewer attorneys who engage with any earnest in Medicaid planning.

Furthermore, the thought that the typical elder law client was not an honest, hardworking taxpayer is comical to me. My typical client is in his eighties. He never qualified for Medicaid or took a handout in his life. He likely fought in World War II and lived through the Great Depression. Far from taking from this country, he helped make this country great.

Only because he is faced with a nursing home bill that exceeds $10,000 a month does he hope to qualify for Medicaid. Is it his fault that long-term care costs so much that his entire life savings will be squandered? Say what you want about the process of Medicaid planning, you cannot slight the average Medicaid planning client.

Nonetheless, Medicaid planning is a focus of New Jersey's Medicaid department, something that the state wishes to eradicate. So, last spring, New Jersey went on the war path against Medicaid planning and promulgated a series of unwritten policies that sought to eliminate many common Medicaid planning techniques.

I have filed about seven lawsuits in federal court against the state, challenging these unwritten policies. So, how are my suits going? Very well. Thanks for asking.

Unlike the typical state court appeals process that is so slanted in favor of the state that the conclusion is preordained, I have found federal court to be a forum for a just, legal result. In state court, I must prove that the director of Medicaid made an arbitrary and capricious decision. In federal court, I must only prove that he failed to implement the law correctly.

And because of this change in standard, the decisions in my federal cases, win or lose, have always been based upon the law. The decisions have been well-reasoned and coherent. Even if I don't like the decision, I can ultimately see the judge's point and learn from it.

How is my record so far? On the four separate issues on which I have filed suit, I've "won" two-and-a-half of the three cases on which I have received a decision and am awaiting a decision on the other fourth issue. I can tell you that compared to my ultimate record in state court, that's a heck of an improvement, and since I don't get smarter simply by filing a lawsuit in federal court, I think that speaks more to the process than me.

I will keep you posted. It's a very interesting time in New Jersey with regard to Medicaid planning, and I enjoy being at the center of it.

I ONLY SIGN THINGS I UNDERSTAND

A phrase that I have heard in my legal career several times-and which I am sure most of you have heard-is, "I never sign anything that I don't understand." This is one of the layperson's maxims of the law, much like "Book'em, Danno!" But is it truly wise advice?

I think that if, for instance, you were buying a used car, you might want to understand the import of the paperwork that you were signing. You might want to consult with an attorney and find out what your recourse is if the car does not live up to what was promised.

Ironically, few people do this. Instead, the person reads the contract until he starts to get bored with the legalese, which is probably after two paragraphs. He then signs the contract and drives the car off the lot.

When I draft documents for clients, I often draft very comprehensive documents. For instance, a power of attorney that I draft may be fourteen pages long. This can be compared with a power of attorney that you might buy at an office supply store that is two pages long.

The average person would probably prefer the two page power of attorney over the fourteen page power of attorney. To them, the two page power of attorney is "simple." He feels that he can understand what is in the two page document but is simply lost in the legalese of the fourteen page power of attorney. He falls back on the legal maxim and doesn't want to sign anything he doesn't understand.

In my opinion, if we only did or used things that we understood, most of us would be living in rickety hovels, shivering in the cold. Let's face it, most of the things we do every day we don't understand and many of those things could kill us.

For instance, I am typing this article on a computer. While I understand how to use some computer programs, I have no idea how a computer works. It is a complete mystery to me. If my computer stopped working, even if it were for a simple reason, I would probably have to call a technician in to fix it, and even if he explained what he did to fix it, I would have little idea as to what he was talking about.

Today, I will drive a car to work. I have no idea how a car works. If my car broke down, I would have no idea how to fix it. Yet, every day, I hop into my car and drive down the road in excess of 60 m.p.h. along with thousands of other cars without knowing how my car or their cars work and without knowing whether my fellow drivers know how to drive, got a sufficient amount of sleep, or are impaired by drugs or alcohol.

When I go on vacation, I get into a plane, essentially a heavy metal tube with large jet engines strapped to the wings, and go five miles into the sky, travelling at hundreds of miles an hour. I have absolutely no idea how a plane can fly through the air, yet I actually voluntarily get on the plane in order to transport my family and me to a pleasurable vacation.

I make these points because every day each of us does things that we don't understand and many of those things are much more dangerous than signing a Will or a power of attorney. Do I think you should ask your lawyer questions about your documents? Absolutely. But I don't think you should limit what you are willing to do legally to what you are capable of understanding.

For instance, I am a Certified Elder Law Attorney. Every day, I deal with people who have life and death issues. I have had a number of experiences with the issues that people face, but I have not experienced every issue that a person may face with regard to these issues. For that reason, I believe that estate planning documents (Will, powers of attorney, living wills) should be comprehensive. Well-drafted documents are designed to address both the expected and the unexpected, those things you understand and those things you do not.

If the document doesn't address an issue, then the person you named to make decisions for you in the documents may not be able to handle the issue for you. It is far better to error on the side of caution than to make the document "simple" (insert "brief") just so that a person feels that he understands everything in the document.

PLANNING IN UNCERTAIN TIMES

To the surprise of many estate planning attorneys, the federal government permitted the federal estate tax to lapse … at least for this year. If the law were to stay as it is written, next year, the federal estate tax will come back and the credit equivalent will be approximately $1,000,000. (The credit equivalent was scheduled to be $1,000,000 in 2006 then indexed for inflation thereafter, so if the law stays as is, the credit equivalent would be slightly higher than $1,000,000 due to inflation.)

Now, I still don't think that is going to happen and most estate planning attorneys do not believe that is going to happen. In fact, if you look at the history of the federal estate tax, Congress has a history of lessening the tax, not increasing it. And if the credit equivalent were only $1,000,000, that would mean that assets in an estate above $1,000,000 would be taxed at a 40% rate or higher.

In this area of the country, while $1,000,000 is a lot of money, it does not make someone rich, so to think that amounts over that figure would be taxed at a 40% rate seems a bit harsh.

Personally, I think the credit will be $3,500,000, which is what the credit was in 2009. The credit will then be indexed for inflation. Most of the proposals that have been floating around Congress in the past several months have included a $3,500,000 exemption.

But what do you do if you have a taxable estate and you want to plan today? Do you plan for a $1,000,000 credit, a $2,000,000 credit, a $3,500,000 credit, or something else? As someone who does this planning every day, I can tell you that it is a bit frustrating, and I believe that many estate planning attorneys feel the same way.

A common tax planning technique for a married couple involves the use of a trust in each spouse's Will called a credit shelter trust. Assume the following facts: Mr. and Mrs. Smith have a combined estate of $2,000,000. Assume further that the federal estate tax credit is $1,000,000. The credit equivalent against New Jersey estate tax, by the way, is $675,000. (Yes, New Jersey has its own estate tax, which is in addition to the federal estate tax.) Assume that Mr. Smith dies.

If Mr. Smith's Will leaves his entire estate to Mrs. Smith, there will be no estate tax. There is no estate tax when one spouse leaves his estate directly to the other spouse. The problem is, by leaving the estate directly to Mrs. Smith, we failed to use any of Mr. Smith's credit against estate tax. Now, when Mrs. Smith dies, she will die with $2,000,000 and she only has a $1,000,000 credit against estate tax. Since the Smiths failed to use Mr. and Mrs. Smith's $1,000,000 credit, Mrs. Smith's estate will now pay $400,000 in federal estate tax, based upon my hypothetical facts.

The Smiths could have eliminated the tax by having credit shelter trusts, or "CST," in their Wills. The CST is a trust in the Will of each spouse. The CST is for the benefit of the surviving spouse, she can use the money in the trust to pay most of her bills.

When Mr. Smith dies, his $1,000,000 estate passes to the CST in his Will for his wife's benefit. By doing this, the Smiths have used Mr. Smith's $1,000,000 credit against estate tax and eliminated federal estate tax. (Mr. Smith's estate would owe about $32,000 in New Jersey estate tax since more than $675,000, the New Jersey credit, went into the trust, but $32,000 is a lot less than $400,000.)

Now, because times are uncertain, Mr. and Mrs. Smith may wish to have disclaimer credit shelter trusts in their Wills, or they may wish to have qualified terminal interest property trusts (or "Q-TIP trusts) in their wills. Next week, I will discuss the benefits of these types of trusts for planning in uncertain times. Stay tuned.

PLANNING IN UNCERTAIN TIMES: PART II

Last week, I wrote a column about tax planning in uncertain times. This year, the federal government permitted the federal estate tax to lapse, at least for this year. As I wrote, whether or not this lapse of the estate tax will last, even for this year, is the subject of great debate.

This week, I want to write about some planning techniques that can be utilized in these uncertain times. Let's assume that Mr. and Mrs. Smith have an estate worth $2.5M and all of their assets are jointly held or name one another as beneficiary.

If Mr. Smith were to die this year, all of his asset would pass to Mrs. Smith. There would be no estate tax (federal or state) on Mr. Smith's passing and there never would have been an estate tax because even when a federal estate tax existed, spouses could pass unlimited amounts of money to one another without incurring estate tax. For instance, Bill Gates could die, leave his entire estate to Melinda Gates, his wife, and no federal estate tax would be owed because of the unlimited marital deduction.

Now, assume that Mrs. Smith dies in 2011. If the federal law stays the same, there will be a $1M credit (approximately) against federal estate tax in 2011. Let's assume that Mrs. Smith leaves her entire estate to the Smiths' four children.

Mrs. Smith's estate will exceed the $1M credit by $1.5M. The federal estate tax rate is approximately 40%. So, on the $1.5M excess, Mrs. Smith's estate will pay approximately $600,000 in federal estate tax. This is not good.

How could this be helped? There are several ways and each way involves the use of a trust. The Smiths want to leave their estate to one another when either dies and only after both are deceased to the children The problem is, as outlined above, if the first-to-die spouse leaves his estate directly to the surviving spouse, the first-to-die spouse fails to utilize any of his credit against federal or state estate tax.

So, how do we prevent this? Or, more appropriately, how do we use the first-to-die's credit against estate tax? The answer frequently involves a testamentary trust. A testamentary trust is a trust contained in the last will and testament of the decedent.

When Mr. Smith dies, instead of leaving his assets directly to Mrs. Smith, he leaves his assets to a trust in his will for his wife's benefit. The wife could even be the trustee of the trust.

By leaving his assets to a trust for his wife's benefit, the inheritance is not subject to the unlimited marital deduction, so the inheritance utilizes Mr. Smith's credit against estate tax (currently no credit for federal purposes since there is no tax and $675,000 for New Jersey estate tax purposes). More importantly, the assets left to the trust are not included in Mrs. Smith's estate at the time of her death.

For instance, Mr. Smith dies and leaves $675,000 (the amount of the New Jersey credit) to a trust in his will for Mrs. Smith's benefit. Mr. Smith has now fully utilized his credit against New Jersey estate tax and removed $675,000 from his wife's estate on her death.

Mrs. Smith can use the $675,000 in the trust for her benefit for the remainder of her life and upon her death, the money will pass to the Smiths' four children. By doing this, the Smiths have saved about $32,000 in New Jersey estate tax and $270,000 in federal estate tax.

Next week, I am going to write about Q-TIP trusts and disclaimer trusts. It's very exciting (well, it's about saving money, which may not be exciting but is interesting) so stay tuned.

PLANNING IN UNCERTAIN TIMES: PART III

In the last two columns, I have written about planning for the estate tax (federal and New Jersey) in uncertain times. This year, the federal estate tax does not exist. Next year, the federal estate tax comes back with only a $1,000,000 credit equivalent, compared to the $3,500,000 credit that existed in 2009.

Most estate planners did not expect the federal government to allow the estate tax to lapse this year, and many continue to believe that the federal government will retroactively re-enact the tax. But for now, what do you do with your estate plan? There are two common planning techniques that may help with this uncertainty-a disclaimer trust and a Q-TIP trust. This week, I will discuss disclaimer trusts.

Let's assume that Mr. and Mrs. Smith have an estate worth $2.2M. Let's further assume that the Smiths have four children. If Mr. Smith dies first, and let's assume that he dies in March of 2010, and his entire estate passes to his wife, there will be no tax, because of the "unlimited marital deduction" against estate tax; however, when Mrs. Smith dies, she will die with an estate worth $2.2M. If the credit against the federal estate tax were $1M at the time of her death, her estate would pay federal estate tax of approximately $480,000, based upon an effective tax rate of 40%.

This tax could have been greatly reduced if the Smiths had planned with disclaimer credit shelter trusts. The credit shelter trusts ("trust") are in both Mr. Smith's and Mrs. Smith's last wills. Since the trusts are in the Smiths' Wills, the trusts are testamentary trusts (as opposed to living trusts, which are trusts that are not contained in a Will).

The trusts are for the surviving spouse's benefit and, frequently, the surviving spouse is the trustee of the trust. So, the terms of the trust may say, "my spouse shall receive the income from this trust and shall have access to the principal of this trust for her health, maintenance, and support." And, since the surviving spouse is the trustee of the trust, she determines when she needs the money in the trust for her health, maintenance, and support.

The purpose of the trust is simple-By leaving his assets to the trust for his wife's benefit, he did not leave his estate to his wife, the inheritance does not qualify for the unlimited deduction, and he uses some or all of his credit against estate tax. So, for instance, assume that Mr. Smith has $1.1M in his name and Mrs. Smith has $1.1M in her name. If both of the Smiths have trusts in their wills and each trust is to be funded with the amount of the federal credit against estate tax and, assume, the credit is $1M, then when Mr. Smith dies, $1M will pass into his trust for Mrs. Smith's benefit.

Most trusts have a funding formula that says something such as, "I give my wife an amount equal to the credit against federal estate tax"; however, if the credit against federal estate tax is $0, then $0 is going to pass into the trust this year. So, if Mr. Smith dies this year, nothing will pass into his trust. When Mrs. Smith dies next year, she will have $2.2M and only her $1M credit against estate tax. The Smiths' children will then pay $480,000 in federal estate tax.

What the Smiths could have done was insert disclaimer credit shelter trusts into their Wills. With a disclaimer trust, each will says, "I give my spouse my entire estate; however, if my spouse disclaims some or all of my estate, then that portion shall pass into a credit shelter trust." When Mr. Smith dies, Mrs. Smith has nine months in which to disclaim (or say she doesn't want) some or all of the money Mr. Smith left her.

If Mrs. Smith does disclaim, that portion of the estate passes into a credit shelter trust for her benefit. So, either way, the money is there for her. And because she has nine months in which to make a disclaimer, she can wait to see what Congress does with the estate tax during that nine month period of time and make a decision a based upon the government's actions, or inactions.