Summary:  Proposed regulations signal death of a popular estate tax savings technique. 

For approximately 25 years, wealthy individuals and families have retained estate planners to create corporations, limited partnerships, and LLCs to own and hold assets including family-controlled businesses, real property, mineral interests and securities with the objective of reducing estate tax liability.  However, proposed IRS regulations[1] effectively eliminate the use of valuation discounts in this context.  Until now, a valuation discount was available when an ownership interest in one of these entities was valued less for estate and gift tax purposes than the actual value of the underlying assets.  A qualified appraisal was needed to substantiate the discount, which was usually for lack of control[2] and/or lack of marketability.  The size of the discount depended on many factors, but ranged as high as 50%.  Now that valuation discounts will no longer be available, the golden age of family limited partnerships and family LLCs may have ended.  However, family-owned business entities are still useful for other reasons including centralization of management and asset protection planning.  This is the time for individuals and families who have established these types of business entities to take a fresh look at whether to keep, reconfigure, or eliminate them. 

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[1] The new regulations clarify the application of Section 2704 of the Internal Revenue Code.

[2] Also known as the minority interest discount.

Summary:  Recent Arizona case exposes weakness in many inheritance protection trusts.

If your estate plan includes inheritance protection trusts for your children or other beneficiaries, you may want to consider an amendment in response to a 2016 Arizona legal case.[1]  The case involved an inheritance trust established for a child by his Mother’s will upon her death.  The IRS filed a tax lien against the trust because the beneficiary owed substantial personal income taxes from prior years.  The beneficiary argued that the inheritance was a “purely discretionary trust” and therefore not a personal asset subject to the lien[2].  The judge ruled against the beneficiary based upon a careful review of the specific trust provision regarding distribution of income and principal.  
 
The relevant provision stated, “The Trustee shall pay to [the beneficiary] so much or all of the net income and principal of the trust as in the sole discretion of the Trustee may be required for support in the beneficiary’s accustomed manner of living, for medical, dental, hospital, and nursing expenses, or for reasonable expenses of education, including study at college and graduate levels.”

The judge interpreted the phrase “shall pay” as a mandatory fiduciary duty owed to the beneficiary by the Trustee, although he also noted that specific calculations were left to the discretion of the Trustee.  This approach is sometimes referred to as a “discretionary support” or “hybrid” trust.  The combination of the Trustee’s duty to make distributions (“Trustee shall pay to the beneficiary…”) and the inclusion of guidelines regarding how to define support (“in the beneficiary’s accustomed manner of living…”) gives the beneficiary an underlying right to distributions from the trust – at least to the extent of the support guidelines.  The judge applied this logic to permit the IRS to attach a lien to the beneficiary’s interest in the trust.[3] 

For maximum protection of inheritance you leave to others, it may be appropriate to amend your will or living trust to clarify your intent that a Trustee’s power to make distributions is purely discretionary and not mandatory.  Otherwise, a creditor could use the above-described case to establish a legal argument that diminishes, or worse, eliminates the protections you intended to create. 

If your trust was drafted by a Wealth Counsel attorney using its industry-leading WealthDocx software[4], it probably does not include the type of extraneous wording (“in the beneficiary’s accustomed standard of living”) that contributed to the adverse ruling in this case.  However, WealthDocx, by default, uses the phrase “shall pay” and that may be enough to give creditors a slight opening to argue that you actually intended to create a discretionary support trust.  Thus, in response to this recent Arizona case, I recommend an amendment that does the following:

• Uses the phrase “may pay” instead of “shall pay.”
• Includes the sentence, “The discretion to make distributions includes the discretion to distribute nothing.”
• Includes conservative guidelines of this nature, “Accordingly, I request that my Trustee always consider the other known resources available to the beneficiary before making discretionary distributions.  I desire that preservation of principal be a priority for purposes of this trust and that the beneficiary show genuine need before my Trustee makes any discretionary distribution.” 

I believe that these changes will eliminate any ambiguity about your intent and strengthen the protection an inheritance trust is capable of providing. 
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[1] Duckett v. Enomoto, U.S. District Court, D. Arizona; April 18, 2016.

[2] A purely discretionary trust does not grant a property interest to the beneficiary because the Trustee is not legally obligated to make any distributions to the beneficiary.  See A.R.S. §14-10504(E).

[3] Whether the IRS could immediately seize assets from the trust to pay the lien is a different matter and was not ruled upon in the case. 

[4] Bouman Law Firm has used WealthDocx software exclusively since October 2006.  

Contrary to popular belief, it is rarely a good idea to name parent and child as joint owners of a bank or investment account.  Here is why:  
     

1. Exposes the parent’s assets to the child’s creditors.  If the child is sued, the child must disclose the joint account to the court and plaintiff’s attorney.  The burden falls on the child to convince a court that the child contributed nothing and that the account really belongs to the parent.  Similarly, the account would be a reportable asset if the child filed for bankruptcy.
2. Eliminates the fiduciary duty a child would otherwise have.  A child as joint owner has no fiduciary duty to manage the account in the best interest of the parent.  By naming the child as agent, the fiduciary duty is maintained so that misuse of funds by the child remains a crime punishable by law.
3. Parent loses full control of the account.  Although intended to facilitate a child helping the parent, a controlling child or the jealousy of other siblings could spoil the arrangement.  Similarly, if the child needs money, there is nothing to prevent the child from taking it without permission. 
4. Assumes the child will behave like a Saint.  The parent can only hope the child “does the right thing” and uses the joint account to pay estate bills and then shares it with other beneficiaries as directed in the parent’s estate planning documents.  The child’s attorney would be correct under the law to counsel the child otherwise.
5. Creates potential eligibility penalties upon application for ALTCS.  The parent must report gifts made within the prior 5 years when applying for nursing home benefits through the ALTCS program (Arizona Long Term Care System- a component of Medicaid).  Naming a child as joint owner may be interpreted as a gift that triggers a penalty and delays the start of benefits.
   

If there is a legitimate reason to have a child assist a parent with management of a bank or investment account, the better alternatives to joint ownership are (1) Title account in parent's individual name and add child as agent under financial power of attorney, and (2) Title account in trust name and add child as co-Trustee.   The only time when I would recommend joint ownership between parent and child is when they are operating a business together. 

Common scenario:

Child of elderly parent wants to take control of Parent's bank accounts because Parent is making questionable financial decisions, but Parent refuses to cooperate.  Child contacts me for help. 

My response:

Child may not take control of the Parent's bank accounts until Parent has been deemed to be incapacitated and unable to make sound financial decisions. 

A determination of incapacity in this context is made by medical physicians, not by me.  The parent's financial power of attorney and/or revocable living trust will likely include a provision that clarifies how an agent or successor trustee (as the case may be) should obtain evidence of incapacity in order to take over control of a bank account.  For example, the living trust document may require the parent's personal or attending physician to sign a written certification of incapacity.  This document may be shown to the financial institution as evidence of incapacity.  The certification is usually accompanied by a written diagnosis from a neurologist. 

If the parent is not been determined to be incapacitated by medical physicians, and the parent still does not want to relinquish control of finances to the child, then use of persuasive powers is the only other legal strategy.  My point is that a parent is entitled to make questionable financial choices, even if the child has a different perspective. 

Many people mistakenly assume that the Revocable Living Trust is only for the very wealthy.  However, in Arizona, a probate action is required whenever someone dies with more than $100,000 of equity in real estate or more than $75,000 in personal property.  Anyone with assets titled in personal name valued higher than these amounts should consider the potential benefits of a Revocable Living Trust versus the costs of establishing one.
 
The best candidates for a Revocable Living Trust are:

• Persons owning real property in more than one state.
• Persons wishing to disinherit a potential beneficiary, or when privacy is important.
• Small business owners, especially if operations would continue after the owner’s death.
• Married persons with children from a prior relationship.
  

There are several arguments against the use of Beneficiary Deeds:

• Fails to account for potential incapacity of owner.  A Beneficiary Deed fails to address the possibility of the owner becoming incapacitated.  For this reason, the owner should certainly have an up-to-date financial power of attorney, and consider titling the property in a revocable living trust instead.   
• Fails to deal with unusual situations.  A Beneficiary Deed does not permit the level of customization sometimes needed for unusual or unexpected situations.  For example, a Beneficiary Deed is not able to deal adequately with the possibility of minor, disabled, or irresponsible beneficiaries.     
• Eliminates many planning options.  For example, the property owner may wish to transfer the property into an asset-protected trust for benefit of the beneficiary, rather than grant outright ownership.  Beneficiary-controlled inheritance trusts can provide substantial creditor and divorce protection, which a Beneficiary Deed cannot.

No.  In Arizona, a Pre-hospital Medical Care Directive (aka “Do-Not-Resuscitate Order” or “DNR”) deals exclusively with response by medical personnel to cardiac or respiratory arrest.  The directive must be printed on orange paper and signed by the patient’s doctor and an independent witness.  It is recommended that the patient wear a bracelet to alert paramedics to the existence of a DNR Order. 

A DNR Order is a medical document.  A Living Will declaration is a legal document.  In effect, a Living Will declaration authorizes the implementation of a DNR Order by the patient's health care agent, or if none, by the patient's health care surrogate as determined by Arizona law. 

A new draft version of Form 4 for transfer of a NFA firearm was released by the ATF.  The new form includes reference to the definition of responsible person.  I interpret the definition to include current trustees, not successor trustees or beneficiaries.  If your NFA gun trust was prepared prior to release of the new Rule 41F in January 2016, I suggest you have your document reviewed to see whether it unintentionally expands the definition of responsible person to more than just current trustees.  Although not urgent, this issue should be reviewed prior to purchasing a new NFA firearm. 

Rule 41F goes into effect July 13 regarding purchase of NFA firearms.  After July 13 both individuals and responsible persons for trusts (current trustees) will have to undergo background check, photograph, fingerprints, and send form to CLEO.