IRS Formally Recognizes Same-Sex Marriage

Today, in a historic joint ruling, the U.S. Treasury and Internal Revenue Service (IRS) recognized legally-married, same-sex couples for all federal tax purposes.  Revenue Ruling 2013-17 was issued, and the ruling provides the following language:

"For Federal tax purposes, the terms “spouse,” “husband and wife,” “husband,” and “wife” include an individual married to a person of the same sex if the individuals are lawfully married under state law, and the term “marriage” includes such a marriage between individuals of the same sex."

Further, the ruling held as follows:

"For Federal tax purposes, the Service adopts a general rule recognizing a marriage of same-sex individuals that was validly entered into in a state whose laws authorize the marriage of two individuals of the same sex even if the married couple is domiciled in a state that does not recognize the validity of same-sex marriages."

For Wisconsin, the ruling does not apply to couples registered as domestic partners, unless the couple was legally married in a jurisdiction that recognized same-sex marriage.

This ruling follows in the footsteps of the recent U.S. Supreme Court decisions related to the Defense of Marriage Act (DOMA).  The decisions related to DOMA mandate that the IRS recognize same-sex marriage for federal tax purposes.  Revenue Ruling 2013-17 formally implements this drastic change.

The change will affect countless tax provisions. To begin, the ruling means that same-sex couples must file annual income tax returns as “married filing jointly” or “married filing separately.”

Wisconsin's New Estate Recovery Law

Recently, Governor Scott Walker signed the 2013-2015 budget bill into law.  The new law is referred to as 2013 Wis. Act 20.  The full text of the budget bill is available at this link:  https://docs.legis.wisconsin.gov/2013/related/acts/20.pdf

This budget bill contains significant changes to Wisconsin’s ability to recover funds from the assets of deceased persons whom received medical assistance, a/k/a Medicaid.  The changes made to portions of Chapter 49 of the Wisconsin Statutes are very impactful and will affect countless Wisconsin families.  Unless modifications are made, the new law is effective on October 1, 2013.

For many years, Wisconsin has maintained a Medical Assistance Lien and Estate Recovery law.  The law is codified in Chapter 49 of the Wisconsin Statutes.  This law permitted the State of Wisconsin to recover assets from a person’s estate, if the person received medical assistance during lifetime.  Most commonly, the recovery relates to the decedent’s receipt of Medicaid benefits, but other programs are also involved.  Federal law requires that Wisconsin have this type of law on its books.  Historically, Wisconsin used two methods to recover Medical Assistance cost:  (1) placing liens against a home owned by the recipient of the Medical Assistance, and (2) filing claims against a deceased recipient’s estate.  The claim against a deceased recipient’s estate was generally handled through a probate court proceeding.  A tremendous summary of the old recovery law can be found at this link:  http://cwagwisconsin.org/wp-content/uploads/2011/03/Lien-Law-Estate-Recovery-Program-Brochure.pdf

The new law greatly enhances the ability of Wisconsin to recover funds from a recipient or from the surviving spouse of a recipient of Medical Assistance.  In addition, the new law gives Wisconsin more power to file liens against real estate, in which the recipient of Medical Assistance had an ownership interest of any kind, including a life estate interest.  See Wis. Stat. § 49.849.  Wisconsin’s Estate Recovery rights were primarily contained in section 49.496 of the Wisconsin Statutes.  Among many others, 2013 Wis. Act 20 added sections 49.4962, 49.848, and 49.849 to the Wisconsin Statutes.  Each of these new sections provides broader powers to the Department of Health and Family Services to recover monies from recipients of Medical Assistance or spouses of recipients of Medical Assistance.  The broadness of this change can only be understood by looking at an example.

Example:  Many Wisconsin parents have deeded a remainder interest in their real estate to their children or perhaps to an irrevocable trust for the benefit of their children.  When this deed is made, the parent retains a life estate interest in the real estate.  When the Quit Claim Deed is signed by the parent, the five-year look-back period under Medicaid law is triggered.  This means that if the parent does not have to apply for Medicaid to pay for nursing home costs during the subsequent five years, the real estate becomes a non-countable asset under Medicaid rules, i.e., the real estate does not have to be used to pay for the parent’s nursing home costs, and the parent will otherwise qualify for Medicaid.  Also, upon the parent’s death, the state could not make a claim against the real estate to recovery sums expended on the parent’s behalf during the parent’s lifetime.  This type of planning has literally been done by thousands of families in Wisconsin.  Unless modified by the legislature, the new law turns this planning on its head.

Under the new law, the State of Wisconsin has the right to file a claim or lien against any real estate owned by the recipient of Medical Assistance.  This is a huge change.  Previously, after the five-year look-back period expired, the real estate was off the table.  Now, the State of Wisconsin may still file a lien against the recipient’s life estate interest, any partial interest, real estate owned by a living trust created by the recipient, or any other “current ownership interest in real property.”  Wis. Stat. § 49.848(3)(a)(1)(a).  The phrase “living trust” is not defined in the new statutory sections.  Basically, the prior life estate planning, which was used by countless lawyers in Wisconsin, is no longer completely effective under 2013 Wis. Act 20.  I write “completely effective,” because there still are some advantages, but clients are interested in securing complete protection for these real estate parcels.  Under the new law, a life estate/remainder interest split will only secure a partial protection after the five-year look-back period has expired.  If five years has expired, then the value of the remainder interest would be protected and not subject to the lien, but the value of the life estate interest remains subject to the Wisconsin’s recovery rights.  The value of the life estate interest at death is determined under an actuarial table published as part of Wisconsin’s Medicaid Eligibility Handbook.  See Wis. Stat. §§ 49.848((5)(bm) and 49.849(5c)(c).  The new law gives the state power to recover from any “Property of a decedent.”  “ ‘Property of a Decedent’ means all real and personal property to which the recipient [of medical assistance] held any legal title or in which the recipient had any legal interest immediately before death, to the extent of that title or interest, including assets transferred to a survivor, heir, or assignee through joint tenancy, tenancy in common, survivorship, life estate, living trust, or any other arrangement.”  Wis. Stat. § 49.849(1)(d)(1).

Further, section 49.4962 of the Wisconsin Statutes gives Wisconsin the power to void a real estate conveyance that was “made by a grantor who was receiving or who received medical assistance . . . during the time that the grantor was eligible for medical assistance.”

It cannot be emphasized too lightly how significant this law change is to elder law planning; Medicaid planning; post-death issues that families must address, if a deceased person received Medical Assistance; and many other issues.  To my knowledge, no articles have been written interpreting this new statutory language.  Furthermore, the Department of Health and Family Services must digest the statutory language and modify the Medicaid Eligibility Handbook accordingly.  Although this law is effective as of October 1, 2013, it will be several months before we have completely clear guidance on how this law will be applied to the public.

Watch Your Beneficiary Designations

Last month, the U.S. Supreme Court ruled in Hillman v. Maretta that federal law trumps state law related to beneficiary designations under a federal life insurance policy.  Often, federal employees receive a life insurance benefit associated with their employment.  The Hillman case presented these facts to the Supreme Court.

The Hillman case concerned a federal employee from Virginia.  He had an employer-sponsored life insurance policy that named his wife as his primary beneficiary.  That was perfectly fine until they divorced.  After the divorce, he never changed the beneficiary designation.  Subsequently, he died.  Virginia law, like Wisconsin law, has a statutory provision that legally removes a divorced spouse from being treated as a beneficiary of a life insurance policy or retirement account.  Oddly, Virginia state law conflicted with federal law.

Federal law regularly preempts or trumps state law.  Federal law is more powerful, and if there is a conflict between federal law and state law; typically, federal law wins.  In the Hillman case, the Supreme Court held that the beneficiary designation remained effective.  The federal law reads that the policy proceeds are paid to the designated beneficiary.  It makes no difference that the employee was divorced from the primary beneficiary.

As a result of the court's decision, the ex-spouse inherited a death benefit of $124,558.03.  The Hillman decision reminds planners that continual vigilance related to beneficiary designations is critical.  Facts change; clients divorce; and clients have more children.  When these life events occur, the beneficiary designations need to be reviewed.

This Supreme Court decision should only apply to life insurance policies and retirement accounts established under federal law; however, some commentators believe that the federal Employee Retirement Income Security Act (ERISA) could cause the court's decision to have a broader impact. If this is true, then an argument could be made that the Supreme Court's decision applies to any retirement plan governed by ERISA, which would encompass countless retirement plans across the nation.

The bottom line is to remember to change beneficiary designations.  This same principal also applies to Payable on Death Designations and Transfer on Death Designations.  Be vigilant, or you may have a deceased client's family pointing a finger at you, because you didn't remind the deceased client to change his or her beneficiary designation after that nasty divorce.

No Bankruptcy Law Protection for Inherited IRAs

Last week, in Rameker v. Clark, the 7th Circuit Court of Appeals ruled that assets held in an inherited IRA are not exempt assets in a bankruptcy court proceeding. This is important for parents and beneficiaries of their IRAs to understand. This ruling clarifies the law on this point, at least for Wisconsin and Illinois, which are states subject to decisions from the 7th Circuit.

This ruling is unique and important. First, if money is in a participant's IRA, the money is an exempt asset in a bankruptcy proceeding pursuant to sections 522(b)(3)(C) and (d)(12) of the bankruptcy code. This exemption is critically important. If a person files for bankruptcy protection and has an IRA, the balance of the IRA is exempt from creditor attack and does not need to be used to pay creditors. The recent court ruling specifically addresses whether the creditor protection extends to an inherited IRA.

For example, parent names child 1 and child 2 as equal primary beneficiaries of his $500,000 IRA. Parent dies. Child 1 and child 2 each inherit an IRA worth $250,000. Child 1 subsequently files a bankruptcy petition. The precise issue before the court was whether the bankruptcy trustee could force child 1 to use the IRA to pay creditors. The 7th Circuit ruled that the bankruptcy trustee could take the assets of the IRA to pay creditors.

The case in question originated in the Western District of Wisconsin. Heidi Heffron-Clark inherited a $300,000 IRA from her mother, Ruth Heffron. The court reasoned that once the IRA was inherited by Heidi, the funds in the IRA were no longer retirement funds. While Heidi's mother was alive, the IRA represented retirement funds, "but when she died they became no one's retirement funds." To the court, the funds in the IRA "represented an opportunity for current consumption, not a fund of retirement savings."

The Clark decision will have a ripple effect. There are likely many pending bankruptcy cases in the 7th Circuit that will be impacted. In addition, the opinion of the 7th Circuit conflicts with opinions from the 8th and 5th Circuits. Consequently, the U.S. Supreme Court will likely eventually grant certiorari to a case to decide this issue on a national basis.

From an estate planning perspective, if a child has creditor issues, and that child is the likely beneficiary of a retirement account, it may be logical for the parent to designate a trust as the beneficiary of the retirement account.  With a properly drafted trust as the beneficiary, the IRA would be exempt from creditor attack.  Heidi Heffron-Clark may be wishing her mother would have considered this type of planning before her death.  Instead, she is now faced with using the $300,000 in the inherited IRA to pay her and her husband's creditors or appealing her case to the U.S. Supreme Court.

President Obama's 2014 Proposed Budget

As the financial community knows, the current federal estate tax exclusion amount is $5.25 million per deceased person for tax year 2013.  This amount is also indexed for inflation and will likely increase each year, pending legislative change.

Last week, President Obama issued his proposed budget for 2014 ("Green Book").  The President's budget contains four significant tax law changes.  One of those changes is a proposal to return the federal estate tax law to the law on the books in 2009.  This would mean a reduction in the federal estate tax exclusion to $3.5 million.

While the passage of the budget plan is likely slim, considering the republican-controlled House of Representatives, the proposal still amazes me.  Just when I thought the estate and gift tax environment was relatively stable and permanently fixed, politicians continue to propose measures to defeat the "permanency."  The concept of wealth redistribution will never die.  People will keep seeking a false utopia through the concept of wealth redistribution.

The Green Book also reminds me that no tax law is permanently established.

Preserving Family Wealth

Earlier this month, the Wall Street Journal published its first edition of a new magazine called: WSJ.Money. The magazine is a helpful resource that addresses wealth planning for families. I read some of the articles with much interest, because my practice is heavily involved in advising families regarding the transfer of wealth and the retention of wealth from one generation to the next. The new magazine included a short article regarding perpetual trusts or dynasty trusts, which I have drafted for numerous families to help preserve and control wealth after death. While the idea of a trust lasting into perpetuity is a bit difficult to grasp, the same format can be used for long-term trusts, and if the trust is drafted appropriately, it can provide each generation with flexible options regarding possible termination of the trust.

What was most interesting to me was the magazine’s focus on the inability of many wealthy families to preserve wealth from one generation to the next. Recently, I have seen two figures regarding the total wealth of American families. One figure estimates the total wealth at $64.8 trillion. Another source represented the total wealth at just over $63 trillion. Unfortunately, when this wealth transfers down from one generation to the next, the younger generation has a very difficult time preserving the wealth. Often, the wealth is wasted on lavish living and child-like pursuits or hobbies. It is my goal as a planner to help families preserve the wealth and not have it slip through the fingers of their descendants.

It is estimated that $7.6 trillion will be inherited by the Baby Boomers during their lifetimes. This is a significant amount of wealth, and many Baby Boomers will inherit wealth that is simply added to existing wealth which they generated during their lifetimes. It is critical that appropriate estate planning and financial planning be used to preserve this wealth so that it is not wasted through prodigality. The greatest means of preserving and controlling wealth is done through family instruction and the use of effectively drafted trusts. Families must have open dialogue between the older generations and the younger generations. If there are relationship problems or lack of communication, the added wealth will only increase the problems. Families need to prepare their descendants for the receipt of inheritance. Americans need to take the time now to adequately plan and inform their descendants of the transfer of this wealth. Time is of the essence, and your descendants’ livelihood may depend upon it. Leave a legacy—not a mess.

Long-Term Care Changes

The long-term care industry is becoming increasingly disrupted. Last weekend in the Wall Street Journal, an article appeared addressing the affordability of long-term care. As many have learned, the cost of long-term care insurance has skyrocketed, and many insurance companies that previously offered the product have exited from the market place.

Recently, Genworth Financial, which is the largest seller of long-term care insurance in the United States, declared that it would stop writing new individual long-term care policies in the State of California. The company’s withdrawal from the State of California may portend Genworth’s future action in other states. It is becoming increasingly difficult for families to address the cost of skilled-nursing care or other long-term care facilities. In Wisconsin, cost of a skilled-nursing home can exceed $300.00 per day. In fact, at one of the nursing homes in Janesville, Wisconsin, the cost does exceed $300.00 per day, depending upon the needs of the patient. In addition, the Medicaid system in the United States is becoming excessively drawn upon to cover the long-term care costs of millions of aging Americans. While the idea of government support is useful, the extent of the support is beginning to drain the federal budget. As the Baby Boomers increase in age, we will only see an even larger scope of Medicaid applicants.

It is never too early to consider how you will address the cost of long-term care. While my firm does not sell the insurance product, I can provide you information on long-term care insurance alternatives and options. The State of Wisconsin has also published a comprehensive report, which can be found at oci.wi.gov/pub_list/pi-047.pdf. The report provides detailed information on long-term care insurance policies and other aspects of the long-term care industry.

Permanent Tax Law. Are you serious?

Obviously, President Obama still needs to sign the fiscal cliff bill that passed the Senate and House, but assuming he does so, our country’s tax law just became much more predictable. Sometimes, even legislators surprise me. As everyone knows, congress passed legislation to permanently extend the majority of provisions originally enacted under the Bush Administration by virtue of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Amazingly, these are “permanent” extensions. In 2010, congress extended the tax provisions for two years by passing the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. Now, congress has nearly done the unthinkable. We now have fixed tax law. We can plan. We can forecast. We can sleep.

As the fiscal cliff drew closer, estate planning attorneys from around the country were scurrying with their clients to move money out of clients’ estates. The fear of being subject to a $1 million estate tax exemption was unthinkable to many, especially older clients with assets between $1 million and $5 million. I tend to believe that more money was transferred from one generation to the next in 2012 than in any other year in history. In fact, if we could see numbers, I suspect the month of December may have surpassed any other single month in history.

Fortunately, the new legislation provides us with permanent gift tax, estate tax, and generation-skipping transfer tax law. This is a tremendous relief from a planning perspective. The new law repeals the sunset provisions of Title IX of EGTRRA and section 304 of the Job Creation Act of 2010. The federal estate tax applicable exclusion amount and generation-skipping transfer tax exemption will remain $5.12 million per person in 2013. In addition, the current index for inflation will remain in place moving forward. Due to the inflationary index, the exemption will grow each year. It is possible that the 2013 amount of $5.12 may be increased slightly, but I have not seen any figures yet. The only change relates to the actual estate tax rate. In 2012, if a decedent’s estate exceeded $5.12 million, his or her estate was subject to tax at 35% on all amounts above $5.12 million. Beginning in 2013, the tax rate will be 40%. This is the result of a compromise between Republicans and Democrats. The Republicans retained the higher exemption amounts, but the Democrats gained a higher tax rate.

The lifetime gift tax exemption of $5.12 million will remain in place subject to the same inflationary index. This is also pleasant news, because the estate tax, gift tax, and generation-skipping transfer tax exemptions will remain unified. This unification creates simpler planning. For 2013, the federal gift tax annual exclusion has been increased to $14,000 per donee. Last year, the exclusion amount was $13,000, but the inflationary index made the amount increase to $14,000 for 2013.