Quarterly Newsletters

December 2012: Will Barack Obama Increase the Federal Estate Tax?

"We need to change our estate planning documents before the end of the year when the Bush tax cuts expire." For the past month or two, some couple has come to my office making this statement. People believe now that President Obama has been re-elected, the federal estate tax exemption equivalent (the "credit") will be allowed to roll back to $1,000,000.

The fact of the matter is, no one can tell you with absolute certainty what is going to happen with the credit, but here are my thoughts.

The federal estate tax is a tax on the gross value of an estate. If the gross value of the estate exceeds the credit amount, the estate is subject to federal estate tax. The gross value of the estate includes all assets that the decedent died owning (his bank accounts, 401(k)s, stocks, bonds, annuities, IRAs, house) and the death benefit of his life insurance policies.

The federal exemption equivalent is a fixed dollar amount. Currently, the credit is $5,000,000. If the gross estate exceeds $5,000,000, the estate is subject to federal estate tax. If the gross value of the estate does not exceed $5,000,000, then the estate is not subject to federal estate tax.

In 2001, the exemption equivalent was only $675,000. Between 2001 and 2009, the credit gradually rose and ended at $3,500,000. In 2010, President Obama and Congress extended the Bush-era tax cuts, but they actually increased the exemption equivalent against federal estate tax from $3,500,000 to $5,000,000.

The extension of the Bush-era tax cuts that occurred in 2010 was temporary, designed to only last two years. The extension expires at the end of 2012, at which time the so-called "fiscal cliff" will occur. Part of the fiscal cliff involves the federal estate tax.

The history of the federal estate tax has been one in which the government increases the amount that is exempt from federal estate tax.

By the way, there is a New Jersey estate tax. The exemption equivalent against the New Jersey estate tax is $675,000. That has been the New Jersey exemption equivalent since 2001, and there are no plans to increase the exemption equivalent for purposes of the New Jersey estate tax.

So, what do I think will happen with the federal estate tax at the end of this year? If President Obama and Congress fail to act and the fiscal cliff does occur, the exemption equivalent will plummet to $1,000,000. For this reason, people are coming to my office asking me what they need to do to avoid the problem a significantly lower exemption equivalent will cause their estate.

Back in 2009, I thought that President Obama and Congress would leave the credit at $3,500,000 and index it for inflation. Instead, they increased the credit to $5,000,000 and indexed it for inflation. So, that tells you two things: 1. I cannot predict the future, and 2. The federal government typically increases the credit, it doesn't lower it.

Now, I think the federal government will leave the credit at $5,000,000 indexed for inflation. I would put the chances of the credit going down to $1,000,000 at less than 10%. I also think the government will incorporate a provision called "portability" into the federal estate tax law.

Portability is complex subject worthy of its own article, but essentially, portability permits the estate of the second-to-die spouse to use the unused portion of the first-to-die spouse. In short, portability permits a married couple to exempt $10,000,000 from federal estate tax with greater ease than currently exists.

Contrary to many people's way of thinking, I do not think the world is coming to an end in 2012, either literally or figuratively. I do not think that the taxes on people or on estates are going to shoot through the roof. While I do believe income taxes are going up (and they probably should), federal estate tax will, effectively, decrease.

BIG WIN FOR MEDICARE RECIPIENTS

This week the government settled a federal class action lawsuit involving the Medicare program. The settlement will affect millions of Medicare recipients and involves those Medicare recipients who require rehabilitative services.

Every day, I meet with individuals who have a family member receiving rehabilitation services. Rehabilitative services are commonly received in a sub-acute care facility or a skilled nursing facility. In common parlance, a skilled nursing facility is a nursing home.

Rehabilitative services typically come into play in a situation such as the following: Mr. Smith is eighty years of age and is a Medicare recipient. Mr. Smith, who lives at home alone, falls and breaks his hip. Mr. Smith is taken to the hospital and has surgery performed to mend his broken hip. After spending several days in the hospital, Mr. Smith is discharged to a nursing home for skilled rehabilitative services.

The rehabilitative services that Mr. Smith receives in the nursing home are covered by the Medicare program. The Medicare program will pay for up to 100 days of rehabilitative services for Mr. Smith. The Medicare program pays the first twenty days of rehabilitative services in full. Days twenty-one through one hundred have a co-payment. Currently, the co-payment is $144.50 per day. Many private health insurance programs cover this co-payment, so even if Mr. Smith receives the full 100 days of service, his rehabilitation may be fully covered by either the Medicare program or his private health insurance.

The 100 days of coverage is not a guarantee, meaning that no patient is guaranteed that he will actually receive 100 days of coverage. Most Medicare recipients do not receive the full 100 days of coverage.

What the recent class action settlement involves is the standard that the Medicare program uses in order to permit a Medicare recipient to receive coverage under the Medicare program. The law (federal regulations) has always stated that the rehabilitative services must be necessary in order to maintain the Medicare recipient's health status.

In other words, if Mr. Smith needs rehabilitative services in order to maintain his current health status, he is entitled to up to 100 days of coverage under the Medicare program. So, if Mr. Smith's current health status would slide backwards if he did not receive rehabilitative services, then under the Medicare law as it has been written would permit Mr. Smith to receive Medicare coverage.

But that is not how the Medicare program has interpreted the law for many, many years. The Medicare manual, a policy manual the federal agency that administers the Medicaid program drafted, has always said that rehabilitative services must be necessary to improve the condition of the patient. In other words, unless the patient's health status is improving as a result of the rehabilitation, then Medicare won't cover the care.

The contrast is stark. The law has always said that the rehab must be necessary to maintain the patient's health status. The government has always said that the rehab must be improving the patient's health status.

I can tell you that a great number of patients who receive rehabilitative services do not improve but do require rehab to maintain their current health status. For that reason, this settlement, which affects all Medicare beneficiaries, will have a very large impact, and a positive impact, for Medicare recipients.

A DILIGENT INQUIRY

Why do I need a last will and testament?

Most people believe that if they die without a Will, their estate passes to the state of New Jersey. This is untrue. The reality is, if you die without a Will, there is a series of statutes that determines who receives your estate. Those statutes dictate that your closest relatives receive your estate.

For instance, if you die with a spouse, your spouse will receive your estate in most instances. If you die without a spouse but with children, your children receive your estate.

Now, first of all, some people don't want to leave their estate (or their entire estate) to their spouse, and some don't want to leave their estate equally to their children. Some people want to disinherit a child for one reason or another. Others might want to create a trust for a child because the child is disabled or has problems with drugs or alcohol.

Secondly, what if a person dies without any close relatives? Assume that Mr. Smith dies without a wife, children, or even siblings, who is going to receive his estate?

I have seen estates where individuals die without a Will and the closest relative the individual has are cousins. The cousins might live in any part of the world, and there could be hundreds of cousins to the decedent.

Finding these relatives falls upon the administrator of the decedent's estate. An administrator is similar to an executor; however, a person can only have an executor if he has a Will because an executor is someone who the decedent nominated in his Will to serve in that role. Without a Will, the decedent couldn't have nominated an executor, so someone must be appointed as administrator of the decedent's estate.

One big difference between an executor and an administrator (aside from the fact that one is nominated to serve by the decedent and one is not) is that an administrator must ensure he is distributing the decedent's estate to all of the decedent's heirs who are entitled to share in his estate. (An executor need only follow the Will with regard to distributions.) At first making distributions to an individual's heirs may sound simple, but as discussed above, if the decedent had no close relatives, this may be more difficult than it appears.

I have had several estates for which I either served as administrator or was appointed as administrator in which I had to hire a genealogist to search for the decedent's heirs, and as stated, those heirs may be anywhere in the world. I have had searches conducted in Ireland, England, and France, as well as the United States.

The cost of the genealogist is borne by the estate, and the time it takes to conduct a diligent search can be considerable. Many of these searches have delayed the distribution of the estate for years. The law states that an administrator must conduct a diligent search for known heirs and the search must be commensurate with the value of the estate.

An administrator who fails to conduct a diligent search can be liable to an heir who fails to receive his share of the estate. Imagine a decedent who has 100 heirs all of the same degree of relation and the administrator fails to conduct a diligent search, finding only eighty of the 100 heirs. The administrator could be held liable to the twenty heirs he failed to find and to whom he failed to make distributions. In other words, the administrator could be pulling money out of his own pocket to pay these heirs, which is not a good thing.

All of this can be avoid by hiring an attorney and expressing your wishes in a written last will and testament. If you clearly express your intentions and nominate an executor to handle your estate, your executor won't have to face any of these problems and the people you wished to benefit from your estate actually will benefit, not some unknown relative in another country.

TAX PLANNING FOR THE MARRIED AND UNMARRIED

"What can I do to save my family from taxes when I die?" This is a question that I often hear from clients, and the answer is different based upon the marital status of the client.

If a married couple is asking the question, there is a way in which their last wills and testaments can be drafted that will save the couple a significant amount of estate tax. If a single person is asking the question, gifting may be the only viable answer.

Currently, a New Jersey resident faces two distinct estate taxes-federal estate tax and New Jersey estate tax. While the New Jersey estate tax is based upon the federal estate law as the law existed in 2001, the two taxes have nothing to do with one another, and an estate may have to pay both taxes, if the estate is valuable enough.

New Jersey estate tax is imposed if the gross value of the estate exceeds $675,000. The gross estate includes all assets that the individual dies owning including the death benefit of life insurance. The federal estate tax is imposed if the gross value of the estate exceeds $5,000,000, though that may change in 2013.

Because the federal estate tax credit equivalent (that is, the $5,000,000) is so high, most of the clients I meet have New Jersey estate tax issues, not federal estate tax issues. Though, as mentioned, an estate could pay both federal and New Jersey estate tax. For instance, if a person died with $6,000,000 in assets, his estate would have to pay federal and New Jersey estate tax.

Let's assume that Mr. and Mrs. Smith come to see me, and they have an estate worth $1,000,000, which includes the value of their home, their brokerage accounts, IRAs, and life insurance policies. The Smiths have a New Jersey estate tax issue.

If the Smiths have simple Wills-Wills that simply leave everything to each other then their children -a New Jersey estate tax will be imposed upon the death of the second-to-die spouse. The New Jersey estate tax is about 10% on average, so on a $1,000,000 estate, the tax will be approximately $32,000, after the $675,000 credit is applied to the estate. The Smiths could avoid this tax by employing a rather common tax planning technique in their Wills.

In order to eliminate this tax, the Smith would have trusts drafted into their Wills. The problem with a married couple having simple Wills is that there is no tax between spouses, so Mr. Smith could die and leave $20,000,000 to Mrs. Smith and there would be no tax.

But, because there is no tax, the Smiths don't use Mr. Smith's $675,000 credit when he dies, and after he dies, his credit is lost forever. The Smiths then have a doubling up of their estate in Mrs. Smith's name and are left with only one $675,000 credit, Mrs. Smith's credit.

If the Smiths have their Wills drafted so that up to $675,000 in assets passes to a trust for the second-to-die spouse, then they will use both $675,000 credits. For instance, when Mr. Smith dies, up to $675,000 in assets passes to a trust for Mrs. Smith's benefit. Because those assets passed to a trust, and not directly to Mrs. Smith, the assets passing to the trust use up Mr. Smith's $675,000 credit. This is true even though the trust is for Mrs. Smith's benefit and even if Mrs. Smith were the trustee of the trust assuming the trust is drafted correctly.

Now, when Mrs. Smith dies, she doesn't die owning $1,000,000 in assets, she dies owning only $325,000 in assets, the difference between $1,000,000 and the $675,000 in assets that passed to the trust. Since neither Mr. Smith nor Mrs. Smith die with more than $675,000 in assets, there is no tax imposed on either of their estates. Their children now avoid the $32,000 in tax, and Mrs. Smith had the benefit of the couple's money her entire life.

This kind of planning cannot be done with a single person. So, if Mrs. Smith comes to me after Mr. Smith dies and assuming Mr. Smith had a simple Will that left Mrs. Smith her entire estate, my advice might be that Mrs. Smith's only method of reducing the estate tax for her children is to make gifts. There are all types of gifting methods, but a common, and simple, technique involves giving $13,000 a year to anyone person you wish to benefit and repeating this gift each and every year.

WHERE DO I STORE MY DOCUMENTS?

As I gazed out over the mounds of trash that were once my neighbors' furniture, personal belongings, and parts of their houses, I thought about all the documents my neighbors had lost in Superstorm Sandy. I live close to a river and the ocean, yet for some silly reason, my family and I decided to stay in our house during the storm.

By 9:30 on Monday night, I realized that my house simply wasn't high enough to prevent water from coming into the living areas of the house, and by 9:45 p.m., we were raising the furniture and our personal belongings off the floor to prevent damage. To say that I never thought the water would reach as high as it did is an understatement.

Prior to Superstorm Sandy, the highest the water ever reached in my neighborhood was during the nor'easter of 1992. Sandy's tidal waters were four feet higher than the 92 storm.

The water in my house reached a height of about five inches, so things certainly could have been worse. Many of my neighbors measured the water that came into their houses by the foot, not the inch, and most of my neighbors, like me, failed to prepare for water entering their houses; however, unlike me, they weren't home to prevent their belongings from being ruined by the tidal waters.

As an elder law attorney, I am frequently called upon to draft estate planning documents for clients. I have, quite literally, drafted thousands of last wills and testaments, powers of attorney, and living wills.

After my clients sign their estate planning documents, I provide them with a well-organized binder that contains the primary estate planning documents and many other helpful documents. But no matter how great the binder is that I provide to my clients, it isn't waterproof.

So, that's what got me thinking about one classic question that many clients have asked me. "John, where do we keep this binder?"

I always offer to store a client's last will and testament for them. I have large, fireproof safes in my offices, and I store the client's Will in one of those safes. I tell the client that if they retain their original Will and if they lose the Will, there is a law that presumes that they revoked their Will. For this reason, I think it is helpful if I retain a client's Will.

I do not, however, offer to store powers of attorney or living wills for clients. Quite simply, if I stored all of these documents for clients, I would need a much larger storage space. And some clients do retain their original Will notwithstanding my offer to store the Will for them.

When I drafted powers of attorney and living wills for clients, I provide the client with two originals of each document-two original living wills, two original powers of attorney. When the client asks me where they should store their documents, I tell them it might be wise if they retain one original of each document and provide their agent (the person whom they have named to make decisions for them in the event they are incapable of making those decisions for themselves) with the other original.

By doing this, the original documents will be located in two different houses, and it is unlikely that two homes will be damaged at the same time. At least it's a lot less likely that such an event will occur, though not unthinkable after Superstorm Sandy.

A client may also wish to store his documents in a safe deposit box at a bank, but if the client does this, I always advise that they add someone else's name to the box. If you put your power of attorney and living will in a safe deposit box and you become incapacitated, how will your power of attorney agent get in the box if their name is not on the box as a co-owner?

Finally, you may want to put the power of attorney on file with all of your financial institutions and your living will on file with your doctor. In this way, the places and people who need the documents already have the documents, so if the documents are destroyed, the hardship is substantially mitigated.