Quarterly Newsletters

September 2010: Making Your Federal Case

Those of you who read my column regularly (and I have to tell you, there are many of you) know that I have been engaged in a series of lawsuits against the state of New Jersey on various issues affecting the Medicaid program. For the most part, I have been rather successful with these lawsuits.

But you cannot win all of your cases, at least not on the first try, so I do currently have some appeals pending in federal court.

The other week, I had the opportunity to argue before the United States Court of Appeals for the Third Circuit. The federal court system is comprised of district courts, which are trial courts, and appellate, or circuit, courts. There are fourteen circuit courts in the entire United States.

At the top of the federal court hierarchy is the Supreme Court of the United States.

At the district court level, there is one judge who hears your case. At the circuit court level, there are three judges who hear your case. The supreme court is comprised of nine justices.

Very few lawyers have an opportunity to argue before a circuit panel, fewer still ever have the opportunity to argue before the supreme court.

My oral argument before the third circuit was heard in Newark at the central post office building. Older federal courthouses are typically found in post office buildings.

When you go to a state court house, the court house is typically bustling with lawyers, jurors, litigants, and staff. You could rarely say that a state court house was quiet.

State court houses, at least the newer ones, are also typically rather austere. The court houses aren't very nice looking. Some older state court houses are beautiful. Union County, for instance, has a neat rotunda court house, and Essex County has an iconic, old court house.

Federal court houses are quite different. Federal court houses are frequently very opulent. And when you walk around the court house, you often feel as if you are there for the only case being heard that day.

I thought that when I presented my argument before the third circuit that the atmosphere would be the same. I was wrong.

When I entered the courtroom, the room was packed to capacity. Most of the attendees, however, were not present to argue a case but to watch the oral arguments that were going on that day. My case was one of three cases that was being.

The gallery consisted mostly of law clerks, interns, and law students who had come to witness oral arguments before a federal appellate court. I don't think they were particularly interested in the substance of my case or the other cases, just the process of presenting an argument before this very high-level federal court.

How do I think I did? I think I did very well. Thank you for asking. Time will tell. I'll let you know what the judges rule when I receive their written opinion, but I didn't blackout at any point in time and I actually made the points that I wanted to make. When you argue before an appellate court, federal or state, I can tell you that you typically walk away thinking that you should have said this, that, or the other thing, or that you shouldn't have said something you did say. I walked away feeling that I said just what I wanted to say, nothing more or less.

In the history of New Jersey elder law, there was only one other case that was argued before the third circuit. (Those attorneys lost by the way.) But I'm optimistic.

SOMETIMES THINGS ARE WHAT THEY SEEM

The other week, I wrote about my oral argument before the United States Court of Appeals for the Third Circuit. As I mentioned, in the history of New Jersey elder law, there was only one other elder law case that was argued before the third circuit, and that case did not go well for elder law attorneys.

Well, I'm happy to report that I received my decision from the third circuit, and the court ruled in my favor. While this isn't the end of the case, the appellate court remanded the case to the trial court for further proceedings, it is a very big step in the right direction.

The issue before the court was whether or not a promissory note can be treated as a trust-like device. This issue is important because promissory notes are utilized as a planning technique for Medicaid eligibility.

Essentially, the technique works as follows: Assume that Mr. Smith has $100,000 in assets. In order to qualify for Medicaid, Mr. Smith must have less than $2,000 in assets.

If Mr. Smith were to gift his assets to his son, he would be ineligible for Medicaid benefits, called a penalty period," for approximately fourteen months. In order to calculate a penalty period, the state takes the amount of assets gifted (in this case, $100,000) and divides the gift-figure by a divisor number, currently $7,282. In this hypothetical, the penalty period would be fourteen months.

Assume that Mr. Smith is in a nursing home that costs $10,000. Assume further that Mr. Smith has fixed monthly income (pension and Social Security income) of $2,500. So, Mr. Smith's net monthly deficit would be $7,500. Fourteen months in this nursing home will cost Mr. Smith $105,000 ($7,500 * 14 = $105,000).

Given these facts, gifting the $100,000 makes no sense at all, since Mr. Smith will have to pay $105,000 to the nursing during the period of ineligibility that results from the gift.

So, the question is, how can Mr. Smith gift a portion of his assets, causing a period of ineligibility, yet also retain a payment stream that will permit him to pay the nursing home during the period of ineligibility that results from the gift? For several years, the answer was a promissory note.

Mr. Smith would gift $50,000, causing a seven month period of ineligibility, and would loan $50,000 to his son, who would pay the money back over a seven month period of time, permitting Mr. Smith to pay the nursing home during the period of ineligibility that results from the gift. The promissory note is a prudent investment for Mr. Smith that accomplishes all of his needs.

About a year and half ago, the state changed its policy with regard to promissory notes and began a policy of treating all promissory notes as trust-like devices. This fantasy permits the state to say that the loaned assets (that is, $50,000) are still the property of Mr. Smith. If this were true (and it is not), then no penalty period for the gifted assets would begin until the promissory note funds were completely depleted, because Mr. Smith must have less than $2,000 before the state will begin a penalty period.

In the recent decision that I received, the third circuit held that if a promissory note is bona fide (and the law provides a test for whether or not a note is bona fide), then the note cannot, as a matter of law, be treated as a trust-like device. So, we are now back to the trial court to prove that the note is bona fide. This is a major step in the right direction.

THAT GIFT MIGHT COST YOU

Is it better to receive something as a gift or as an inheritance? Most people would think that the sooner you receive something, the better. So, most people would think that receiving something as a gift is better than receiving something as an inheritance. But that may not be the case.

Assume that Mr. Smith gives his son, Joe, his house. Mr. Smith's house has a fair market value of $400,000, and he purchased the house in 1965 for $50,000. Since he has owned the house, Mr. Smith has made $50,000 in capital improvements to his house.

Based upon these facts, Mr. Smith's basis in the house is $100,000, which represents the $50,000 purchase price plus the $50,000 in capital improvements. "Basis" is the value used to calculate gain or loss realized on the sale of an asset. When Mr. Smith gifts his house to Joe, his son acquires Mr. Smith's basis in the house, or $100,000.

This is called a "carry-over basis." Mr. Smith's basis of $100,000 carries-over to Joe, and Joe now has the same basis in the asset that Mr. Smith had.

If Joe sells the house someday for $400,000, the son will realize $300,000 in gain, the difference between the sales price of $400,000 and the basis of $100,000. Joe will have to pay tax on that $300,000 of gain. Currently, the capital gains tax on that $300,000 would be about 20%, or $60,000.

On the other hand, if Mr. Smith died and devised his house to his son through his last will and testament, Joe would receive a "step-up in basis" on the house. In other words, the basis of the house would increase from $100,000 to $400,000, the fair market value of the house on the date of Mr. Smith's death.

When Joe sells the house for $400,000, he will realize no gain, so no capital gains tax will be owed. By dying with the house, Mr. Smith saved his son $60,000 (or more) in capital gains tax.

Many people think about gifting in order to save their families estate tax. They believe that if they give their assets away before they die, their family members will have to pay less estate tax, and this may be true.

Proper gifting can save estate tax. For instance, a person can gift $13,000 a year to an unlimited number of people. So, if Mr. Smith had five children and ten grandchildren, Mr. Smith could reduce his estate by $195,000 (which represents $13,000 multiplied by fifteen) each and every year.

The questions Mr. Smith may want to ask himself are the following: Would his estate be subjected to estate tax? And would it be worse for his family to pay estate tax or capital gains tax?

In New Jersey, estates with a value greater than $675,000 may be subject to an estate tax. The estate tax rate is about 10% of the amounts over $675,000. So, for instance, a $1,000,000 estate passing to children would pay about $32,000 of New Jersey estate tax.

As mentioned above, the federal and state capital gains tax rates are about 20% of the gain above an individual's basis. When an individual receives a gift, the gift-recipient receives a carry-over basis. When an individual receives an inheritance, the beneficiary receives a stepped-up basis.

So, if Mr. Smith's estate, valued at $1,000,000, consisted of a home and stocks, all with a low cost basis, it would probably be better for his family to receive his assets as an inheritance and pay the estate tax in order to receive the stepped-up basis. On the other hand, if Mr. Smith's estate consisted of bank accounts, it would probably be better for him to gift the $195,000 for at least two years in order to reduce his estate below the $675,000 credit limit. The basis of a dollar is a dollar, so there will be no step up in basis on death anyway.

The bottom line is, gifting isn't always the best way to go and can cost you more tax than the estate tax you are trying to avoid.

WHAT'S MY CUT?

Recently, a person came to me for assistance with estate administration. A relative of his had passed away, and he correctly believed that he would need assistance with administering the relative's estate. During the course of the interview, he asked me how much I charge for my services. He had heard that attorneys charge a percentage of the estate. I've heard that too.

From what I have heard, I've never actually seen it, there are attorneys who charge clients a percentage of the estate. So, for instance, if the estate were worth $800,000 and the attorney billed at the rate of 4% of the value of the estate, the attorney's bill would be $32,000.

An attorney's fees must be reasonable. In my opinion, billing a percentage of the estate will frequently bear no relation to the amount of work required for the estate. For instance, I am confident that attorneys who charge a percentage of the value of the estate as their fee would switch to an hourly billing schedule if the estate were modest, for instance, $200,000 or less.

Moreover, even with an estate of moderate to high value, the amount of work required of the attorney probably would not equate with the fee. While an $800,000 estate is a nice chunk of change-I certainly wouldn't mind if someone wanted to leave me their $800,000 estate-the work required of the attorney probably would not justify a $32,000 fee.

Now, an executor of estate is entitled to a commission and that commission is a percentage of the estate. For instance, an executor is entitled to 5% of the first $200,000 of the estate, 3.5% of the value over $200,000 up to $1,000,000, and 2% of the value above $1,000,000. The executor is also entitled to a commission on the income that the estate generates of 6%.

But the executor's role and the attorney's role are different. Not only does the executor frequently do most of the legwork-cleaning up the house, going to bank to close out accounts, paying the bills of the estate-but the executor also holds a fiduciary obligation to the beneficiaries. The commission that the executor receives compensated the executor not only for the time expended performing services for the estate but the liability that the executor incurs in his role as executor.

If a beneficiary of an estate claims that something was done improperly with the estate-for instance, the house was sold for too little money-the beneficiary has a right to sue the executor for the "damages" that the beneficiary claims he incurred as a result of the executor's actions or, perhaps, inactions. Being an executor is a tremendous amount of work and exposes a person to a tremendous amount of liability.

In most cases, the lawyer simply is not doing as much work as the executor and is not exposing himself to as much liability as the executor. Certainly an executor who hires an attorney could always say, "Well, the lawyer told me I could sell the house for that much," but it is the executor who is primarily responsible for the damages. Furthermore, the attorney can always cover himself by informing the client of his obligations and duties to the beneficiaries.

I think many executors can benefit from legal advice. I don't think people should be afraid that the attorney is going to charge an outrageous sum of money for that advice. A reasonable hourly rate for services rendered is what clients should expect.

HOW DO WE PAY FOR MOM?

How do we pay for mom's care? It is a question that I hear at least once a week, yet there is no standard answer.

Many people come to see me because an elderly parent or loved one is in need of care. Frequently, the family wants the elderly individual to remain at home, but they don't know whether the family member can pay for that care.

The fees for a home health aide are between $19 and $25 per hour and $155 to $185 per day for a live-in aide. Many elderly individuals have fixed incomes between $700 and $2,500 per month, so paying $5,000 per month for a live-in home health aide can be scary.

So, assume that Mrs. Smith lives at home. Her home is worth $300,000 and she owns approximately $50,000 of liquid assets (for example, CDs and money market accounts). She is eight-five years old.

Mrs. Smith has four children. Her desire is to remain at home for the rest of her life, but her children are concerned about her care needs.

Her children have noticed that her short-term memory has deteriorated significantly. She frequently asks the children the same question again-and-again. She leaves items on the stove and she gets lost when she goes for drives in her car.

Mrs. Smith's children want her to hire a home health aide, but they are concerned about the high cost of the aide. None of the children have the financial wherewithal to pay for an aide for mom.

With $50,000, mom would have enough assets to pay for the aide for about one year. After that time, she will have depleted her liquid assets and only her home will remain.

So, what options are available to mom to assist her with paying for the home health aide?

One program is a veteran's benefit known as Aid and Attendance. In short, if Mrs. Smith spouse (or Mrs. Smith) were a veteran for ninety days or more with one day of service during wartime and if Mrs. Smith's income and assets are insufficient to pay for her care, she could qualify for approximately $1,000 in cash per month from the Veteran's Administration to pay for her long-term care needs. Aid and Attendance can help Mrs. Smith stretch her $50,000 for a month or so more.

Mrs. Smith might want to qualify for Medicaid benefits. If eligible, Medicaid would pay for approximately four to five hours of home health aide services per day. With proper planning, Mrs. Smith may qualify for Medicaid benefits.

Mrs. Smith might also consider obtaining a reverse mortgage. I do not like these mortgages as a general proposition. Reverse mortgages have very high start up costs, so I do not believe reverse mortgages are appropriate for people who have other sources of money; however, if an elderly individual truly has no cash assets, the a reverse mortgage may be her only choice.

By obtaining a reverse mortgage, Mrs. Smith may be able to tap 80% of the equity in her house. This equity could permit Mrs. Smith to live in her home for several more years.

A reverse mortgage does not have to be repaid until Mrs. Smith dies or moves out of her house. So, Mrs. Smith can tap the equity with no obligation to repay the loan.

Another option may be a home equity loan. Typically, a home equity loan is less expensive to obtain than a reverse mortgage, but unlike a reverse mortgage, Mrs. Smith will have to begin repaying the loan immediately. She may not have the means to meet her monthly needs, including the home health aide, and make the monthly mortgage payment.

There are options available to many elder individuals, but there is no one, easy answer.

I'M LEAVING IT TO THE KIDS

Most couples have Wills that leave everything to the surviving spouse. But for an elderly married couple this may not always be the most appropriate manner of disposing of their assets. By leaving all of the assets to the surviving spouse, an elderly couple may be unnecessarily exposing their entire estate to long-term care costs.

Assume that Mr. and Mrs. Smith own a house worth $400,000 and $200,000 in cash. Assume that Mr. Smith enters a nursing home. Medicaid would begin to pay for Mr. Smith's nursing home expenses when the couple's cash assets reached $100,000. Medicaid would permit Mrs. Smith to retain the house. So, for a married couple, Medicaid is quite generous.

But if Mrs. Smith were to die and leave the entirety of her estate to Mr. Smith, Mr. Smith would own all of the couple's assets in his name alone. He would own the $400,000 house along with the $200,000 in cash. If Mr. Smith entered a nursing home, he would have to spend down his assets, which total $600,000, to $2,000 before he would qualify for Medicaid benefits. So, unlike with a couple, for a single person, Medicaid is not generous at all.

To avoid this outcome, what I sometimes suggest to my clients is that they draft their Wills in such a way as to leave the surviving spouse the smallest amount of the deceased spouse's estate as is possible under the law. A surviving spouse is the only person that a deceased spouse cannot disinherit without the surviving spouse having a claim against the deceased spouse's estate. This claim is called the "elective share."

For simplicity sake, it is often said that the surviving spouse is entitled to one-third of the deceased spouse's estate pursuant to the elective share. But, as with most simple statements and the law, this statement is grossly inaccurate.

It would be more accurate to say that the surviving spouse's right of election is a maximum of one-third of the deceased spouse's estate. That maximum, however, is frequently reduced and can be eliminated depending upon the assets that the surviving spouse owns.

For instance, if Mr. Smith dies disinheriting Mrs. Smith and his estate is worth $300,000, many people would say that Mrs. Smith is entitled to $100,000 of his estate if she files for the elective share. But if Mrs. Smith owns assets in her own right worth $200,000, she will not receive any portion of Mr. Smith's estate because the assets she owns in her name reduce the assets to which she would have been entitled from Mr. Smith's estate.

Given the above, here's the planning technique. Assume Mr. and Mrs. Smith own their home worth $500,000 and $400,000 in cash. I might suggest that they divide their estate so that Mr. Smith owns one-half the house and one-half the cash and Mrs. Smith owns the other half. I then draft each of their Wills so that Mr. Smith leaves the smallest fraction of his estate to Mrs. Smith and Mrs. Smith leaves the lowest fraction of her estate to Mr. Smith. The balance of their respective estates passes to their children.

If Mr. Smith dies, his estate, worth $450,000 will pass to the children, not Mrs. Smith. Mrs. Smith will now be left with only half the estate, the half she already owns. If she requires long-term care, only half of the couple's estate will be exposed to long-term care costs.