This blog is written by Brian E. Barreira, an estate planning, probate and elder law attorney with offices at 118 Long Pond Road, Suite 206, Plymouth, Massachusetts. Brian has been named a Massachusetts Super Lawyer® in Boston Magazine during 2009-2023, is listed in The Martindale-Hubbell Bar Register of Preeminent Lawyers in the fields of Elder Law and Trusts & Estates, Wills & Probate, and is the Editor of Massachusetts Continuing Legal Education's best-selling Elder and Disability Law in Massachusetts, where he is the co-author of the "Trusts in the MassHealth Context" and "Taxation of Trusts" chapters. Brian also has a webinar series on his youtube channel, https://www.youtube.com/@elderlawwebinar6980.Brian's biographical website, including a webinar registration link and information for new clients, can be found at SouthShoreElderLaw.com
Nothing on this blog should be considered to be legal advice or tax advice.
Life Estate Can Be “Retained” for Estate Tax Purposes under Internal Revenue Code Section 2036 without Being Reserved in Deed
NOTE: This article reflects the current 2011 law, and also reflects pre-2010 law. It also is the default provision for decedents who died during 2010 unless the executor chooses to have 2011 law apply.
For many elderly persons in the middle class, a key tax goal is to keep the home includible in the person’s gross estate for federal estate tax purposes. Doing so results in a step-up in the basis of the home under Internal Revenue Code Section 1014, and the persons inheriting the home essentially receive, free of any capital gains tax, the appreciation in value from the time of the initial purchase of the home.
For example, suppose a person who paid $10,000.00 for a home dies when it is worth $200,000.00. The appreciation of $190,000.00 escapes capital gains tax if the home is includible in the person’s gross estate for federal estate tax purposes.
For a person who wishes to give away the home, the most common method of doing so may be to give away the remainder interest while reserving a life estate. Internal Revenue Code Section 2036 states that “the gross estate shall include the value of all property… of which the decedent has at any time made a transfer… under which he has retained for his life… the possession or enjoyment, or the right to the income from, the property.” Thus, if the person deeds the home to others, yet explicitly reserves a life estate, the full fair market value of the home is includible in the client’s gross estate for federal estate tax purposes and the transferees thereby receive the desired step-up in basis.
Unfortunately, some persons deed away their homes without reserving a life estate. Arguably, the federal estate tax inclusion ends up being lost by such a maneuver, but the literal language of Section 2036 quoted above can salvage the step-up in basis: note that the word “retained” is used. The Internal Revenue Service has successfully argued in the past that a right can be retained without having been reserved, and that the continued occupancy of the home after the transfer of title, without paying fair market rent, is evidence of an implicit agreement, understanding or assumption of the parties of the transaction. (See Estate of Linderme v. Commissioner, 52 T.C. 305 (1969).)
For example, if a person deeds the same home described above but reserves a life estate, upon the person’s death the home is includible on the Federal Estate Tax Return and the transferees receive a stepped-up basis of $200,000.00. If the person making the transfer had not reserved the life estate, but continued to live there rent-free or for less than fair market rent, the home should be included on the Federal Estate Tax Return as a “retained life estate” if a step-up in basis is desired.
One final note: under Internal Revenue Code Section 2035, a release of a life estate is ineffective for federal estate tax purposes for three (3) years. This means that a life estate that is released within three (3) years of death is included in the gross estate and results in the desired step-up in basis. Thus, if a person insists on making an outright transfer (perhaps due to Medicaid estate recovery concerns), it may be better to structure the transaction as a deed with a reserved life estate, then have the person release the life estate at a later time.
Internal Revenue Service Releases 12/16/2010 Advance Proof Copy of Form 8939 Required for Step-up in Basis for 2010 Deaths
Attached is the 12/16/2010 advance proof copy from the Internal Revenue Service of Form 8939, entitled “Allocation of Increase in Basis for Property Received from a Decedent.” This form is necessary for the estates of many 2010 decedents to achieve a step-up in basis. It reputedly is required to be filed with the decedent’s final income tax return, and is believed to be necessary only for estates in excess of $1,300,000. Until we see specific instructions from the Internal Revenue Service, however, it is my belief that all estates should consider filing this form.
Schedule A pertains only to surviving spouses. For assets inherited by persons other than surviving spouses, Schedule B would be required. Note that on both of these schedules, the date that the decedent acquired the property is required, along with the decedent’s adjusted basis in the asset. While that information may be easy to determine for real estate, it may not be easy to determine for securities and mutual funds held in book entry for many years. Further, taxpayers and their accountants may find that attempting to list the separate purchases made in dividend reinvestment plans to achieve a step-up in basis on each investment may not be worth the time and effort.
A positive note for taxpayers is that this latest draft of the form still does not require an explanation of why the Executor of the estate believes the asset would be entitled to a step-up in basis under Internal Revenue Code Section 1022. Thus, technical issues as to whether life estates, reserved powers of appointment or irrevocable trusts are “owned by the decedent” and “received from the decedent” under Internal Revenue Code Section 1022 are not flagged on the form except, perhaps, where an “[a]ccurate description of the property” is required. For my previous posts on Internal Revenue Code Section 1022, see http://elderlawblog.info/category/internal-revenue-code-section-1022-2
Traps for the Unwary Regarding the Modified Carryover Basis Rules for 2010 Deaths
Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue
Code Section 1022?
More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010
Are All Revocable Trusts Eligible for a Step-up in Basis under the Modified
Carryover Basis Rules?
When Is an Asset Considered “Acquired from the Decedent” under Internal Revenue Code
Section 1022?
It still looks like we’re stuck with Internal Revenue Code Section 1022 being the tax law for estates of decedents who die during 2010. Here are a few traps for the unwary regarding this law:
(1) The law allows $1,300,000 of basis increase, plus an additional $3,000,000 for a surviving spouse. Increasing the decedent’s basis means somebody has to figure out the decedent’s exact basis in his/her assets. Old deeds and purchase-and-sale agreements may need to be tracked down, and a lot of tedious, time-consuming work will have to be put in on mutual funds and dividend reinvestment plans.
(2) In addition to the $1,300,000 or $4,300,000 basis increase, additional increases are allowed if the decedent had capital loss carryovers or net operating loss carryovers. That means in some cases the decedent’s final income tax return will need to be prepared first.
(3) Assets with unrecognized capital losses as of the time of the decedent’s death cause the decedent’s estate to have additional basis increases equal to the amount of the unrecognized capital losses. There is no requirement in Section 1022 that this additional basis adjustment be utilized on the asset with the unrecognized capital loss.
(4) Internal Revenue Code Section 121(d)(11) allows the decedent’s estate, the decedent’s qualified revocable trust or the decedent’s beneficiary (as defined under Section 1022) to utilize the decedent’s $250,000 capital gains exclusion on a sale of the decedent’s principal residence. There does not appear to be any time limitation on the usage of this exclusion, so in some many cases it could be wasteful (and legally actionable) to use the Section 1022 basis increase on the decedent’s principal residence without taking Section 121 into account. This means that the basis adjustment for many estates without surviving spouses under 2010 law can effectively be $1,550,000.
(5) Under Internal Revenue Code Section 6716, there is a $10,000 penalty for failure to file Form 8939 on a timely basis.
(6) Form 8939 is due at the time of the decedent’s final income tax return, so in many cases placing Form 1040 on extension may be advisable to give the Executor more time to gather all the necessary information for Form 8939.
(7) Beneficiaries are required to be sent information about the basis increase within 30 days after Form 8939 is filed. Failure to do so can result in a $50 penalty per beneficiary.
(8) Only an “executor” can allocate the basis increase, and that term is not defined within Section 1022, but under Treasury Regulation 20.2203-1, the term “executor” includes an executor or administrator, but if there is no executor or administrator, the term means “any person in actual or constructive possession of any property of the decedent, ” and the term can actually include “the decedent’s agents and representatives; safe-deposit companies, warehouse companies, and other custodians of property in this country; brokers holding, as collateral, securities belonging to the decedent; and debtors of the decedent in this country.” Thus, the lack of an executor or administrator being appointed for a decedent’s estate can mean the possibility exists for different persons or entities to file competing Forms 8939 with different basis adjustments (and perhaps the first one filed wins).
(9) It is possible that the Executor’s basis allocation decisions on a timely-filed Form 8939 may be final, binding and unamendable even if self-serving, biased or irrational.
(10) Where the date that the decedent acquired the property is required, Executors and their accountants may find that attempting to list the separate purchases made in dividend reinvestment plans to achieve a step-up in basis on each investment may not be worth the time and effort.
(11) The first version of Form 8939 withdrawn by the IRS did not require an explanation of why the Executor of the estate believes the asset would be entitled to a step-up in basis under Internal Revenue Code Section 1022. Thus, technical issues as to whether life estates, reserved powers of appointment or irrevocable trusts are “owned by the decedent” and “received from the decedent” under Internal Revenue Code Section 1022 may not be flagged except, perhaps, where an “[a]ccurate description of the property” is required. Even though the basis of an asset is a question of fact that the IRS can later bring up, a decision will have to be made as to how much information to include on Form 8939.
(12) Filing Form 8939 may make sense even for smaller estates, to help the beneficiary prove to the IRS (when selling the asset received from the decedent) that the estate did not exceed $1,300,000.
(13) It is possible, but not certain, that filing Form 8939 will begin the 3-year clock against the IRS on valuation issues.
(14) Internal Revenue Code Section 1022 has specific safe harbor provision for qualified revocable trusts but not for revocable trusts. (A qualified revocable trust is simply a revocable trust that is elected to be treated as part of the decedent’s estate for income tax purposes under Section 645(b)(1).) To be conservative and assure the possibility of a step-up in basis for assets held in a revocable trust for someone who dies during 2010, it seems that the Executor of the decedent’s probate estate and the Trustee of the decedent’s revocable trust should make the election under Section 645(b)(1) to treat the trust as a qualified revocable trust for income tax purposes.
Internal Revenue Service Has Gone Back to the Drawing Board on Form 8939
The Internal Revenue Service has withdrawn its drafts of new Form 8939, entitled “Allocation of Increase in Basis for Property Acquired From a Decedent.” http://www.irs.gov/pub/irs-dft/f8939–dft.pdf
Hopefully, The Internal Revenue Service will complete its work soon, since the form will be due with the decedent’s final federal income tax return on April 15, 2011. Once a new version of Form 8939 is made available, I’ll post it here.
12/16/2010 UPDATE: SEE Internal Revenue Service Releases 12/16/2010 Advance Proof Copy of Form 8939 Required for Step-up in Basis for 2010 Deaths
New Form 8939 Required to Be Filed with the Internal Revenue Service for Step-up in Basis for Estates of Persons Who Die During 2010
Attached is an early draft by the Internal Revenue Service of Form 8939, entitled “Allocation of Increase in Basis for Property Received from a Decedent.” This form is necessary for the estates of 2010 decedents to achieve a step-up in basis. It reputedly is required to be filed with the decedent’s final income tax return, and is believed to be necessary only for estates in excess of $1,300,000. Until we see specific instructions from the Internal Revenue Service, however, it is my belief that all estates should consider filing this form.
Schedule A pertains only to surviving spouses. For assets inherited by persons other than surviving spouses, Schedule B would be required. Note that on both of these schedules, the date that the decedent acquired the property is required. While that information may be easy to determine for real estate, it may not be easy to determine for securities and mutual funds held in book entry for many years. Further, taxpayers and their accountants may find that attempting to list the separate purchases made in dividend reinvestment plans to achieve a step-up in basis on each investment may not be worth the time and effort.
A positive note for taxpayers is that this draft of the form does not require an explanation of why the Executor of the estate believes the asset would be entitled to a step-up in basis under Internal Revenue Code Section 1022. Thus, technical issues as to whether life estates, reserved powers of appointment or irrevocable trusts are “owned by the decedent” and “received from the decedent” under Internal Revenue Code Section 1022 are not flagged on the form except, perhaps, where an “[a]ccurate description of the property” is required. For my previous posts on what types of assets may be entitled to a step-up in basis, see http://elderlawblog.info/category/internal-revenue-code-section-1022-2
12/16/2010 EDIT: Internal Revenue Service Releases 12/16/2010 Advance Proof Copy of Form 8939 Required for Step-up in Basis for 2010 Deaths
Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue Code Section 1022?
More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010
Are All Revocable Trusts Eligible for a Step-up in Basis under the Modified
Carryover Basis Rules?
When Is an Asset Considered “Acquired from the Decedent” under Internal Revenue Code
Section 1022?
Massachusetts Supreme Judicial Court Rules Favorably on Validity of Postnuptial Agreements
In the 2010 Massachusetts case of Ansin v. Craven-Ansin, the Supreme Judicial Court ruled that postnuptial agreements can be valid under certain conditions. This case was brought by a disgruntled wife who had signed an agreement during the marriage on how the couple’s assets would be distributed upon a divorce, but the case has far-reaching ramifications and can be useful in the estate planning context.
A postnuptial agreement is essentially a prenuptial agreement that is entered into after the marriage has taken place. Either of these agreements can completely ignore divorce and child support issues and be limited solely to estate planning issues. Where many married couples (especially those with children from prior marriages) are concerned about what might be done with their inheritance by the surviving spouse, this case makes it clear that under Massachusetts law they can enter into a limited postnuptial agreement, which I refer to as an Estate Planning Agreement, to prevent the surviving spouse from later disinheriting the family of the first spouse to die.
There are other ways to protect the children from the previous marriage, but those other ways have limitations. For example, under Massachusetts law, a will contract can be entered into by a married couple to prevent the surviving spouse from changing his/her will; unfortunately, a will contract would only cover assets passing through probate, yet many assets pass free of probate. Further, some spouses establish a so-called QTIP trust to provide income for life to the surviving spouse, with the eventual inheritance going to the previous family; unfortunately, the surviving spouse would have the right to make a statutory election against the decedent’s will and trust and could end up with a lot more assets than was planned.
A limited postnuptial agreement that covers estate planning issues is a document that more and more married couples may be entering into in future years, due to the great increase in blended families.
Can a “Retained” Life Estate Be Eligible for a Step-up in Basis under Internal Revenue Code Section 1022?
Some tax professionals are trying to find an argument that a retained (as opposed to reserved) life estate can obtain a step-up in basis under the modified carryover basis rules in effect for estates of decedents who die during 2010. I have already covered whether an explicitly reserved life estate is eligible for a step-up in basis during 2010 under Internal Revenue Code Section 1022, and concluded that the possibility exists. (See Why DOESN’T a Reserved Life Estate Get a Step-up in Basis under Internal Revenue Code Section 1022? and More about Whether Life Estates Are Eligible for a Step-up in Basis in 2010) The deeper question that is now being posed by some tax professionals is whether a life estate that was not reserved can nevertheless be considered “retained” by the conduct of the parties after the gift, and thereby be eligible for a step-up in basis under the modified carryover basis rules. Based on the language in Section 1022, I do not believe such a retained life estate has any chance whatsoever of being eligible for a step-up in basis.
Under pre-2010 law, an asset that was includible in the decedent’s gross estate for federal estate tax purposes always received a step-up in basis. A retained life estate, includible under Internal Revenue Code Section 2036, was one of those assets, and a line of tax cases developed that defined the word “retained” as including not only a life estate that was explicitly reserved, but also life estates that were retained by agreement, understanding, assumption or conduct of the parties. That meant that under Internal Revenue Code Section 2036, the real estate of someone who had completely given it away could be pulled back into the decedent’s gross estate. For pre-2010 deaths, Section 1014 allowed a step-up in basis for assets pulled back into the gross estate under section 2036, but, unfortunately, neither of those laws are in effect for decedents who die during 2010.
For 2010 deaths, Section 1022 requires that assets be owned by the decedent at the time of death and received from the decedent at that time, and those are much stricter standards than were required under Sections 2036 and 1014 in previous years. Tax positions formerly available utilizing Section 2036 are irrelevant in 2010, as there is no language in Internal Revenue Code Section 1022 that would allow an argument that the conduct of the parties after the gift would be equivalent to the retention of ownership. The retained life estate argument is an extreme stretch on the “owned by the decedent” test, but even if that argument were to pass muster, the argument in favor of the step-up would still fail on the “received from the decedent” requirement of the statute. If full legal title to the real estate was already given away, at the time of death the donees of the lifetime gift cannot possibly receive from the decedent what they have already completely owned.
Claiming that assets that were given away during lifetime were nevertheless owned by the decedent and received from the decedent at the time of death, and receive a step-up in basis under Internal Reveue Code Section 1022, seems to me to be a frivolous tax argument. We’ll know better how much leeway tax professionals will have to take such a position when we finally see the new tax return that is in the process of being created by the Internal Revenue Service for allocation of increased basis for 2010 deaths.
New HUD Counseling Rules Take Effect on Reverse Mortgages
On September 11, 2010, the U.S. Department of Housing and Urban Development (“HUD”) put into effect new procedures for counseling elders for reverse mortgages. These new procedures require that more detailed information be provided to the prospective borrower in advance of the counseling session, and specify what must be covered, who must attend and the issues the counselor should and shouldn’t discuss with the prospective borrower. These new HECM Counseling Protocols can be found here.
Before the counseling meeting, the elder must be sent an information packet that includes detailed loan information with comparisons, a document entitled Preparing for Your Counseling Session, and a 28-page booklet entitled Use Your Home to Stay at Home – A Guide for Older Homeowners Who Need Help Now.
During the processing counselors must now gather information from the prospective reverse mortgage borrower to examine the elder’s ability to maintain the reverse mortgage, including taxes and insurance premiums. The point there is to attempt to prevent foreseeable foreclosures due to cash flow problems.
As part of the process, counselors must ask 10 questions to ensure that the elder understands the reverse mortgage’s key elements. If the elder fails to give the correct answer at least 5 of the questions, or appears to be coerced or a possible victim of fraud, the counselor may withhold the counseling certificate. Thereafter, if the elder is insistent on proceeding, HUD states that “the counselor will issue a certificate and will flag the certificate in FHA Connection so the lender is aware that the client’s level of understanding of reverse mortgages is minimal.” Once that occurs, presumably it will be up to the lender and the lender’s counsel to decide whether to give the loan to the elder, especially where mental incapacity would then appear to be a possible problem.
More about the Mechanics of Obtaining a Step-up in Basis in 2010 under Internal Revenue Code Section 1022
The Internal Revenue Service has not yet published the form necessary to obtain a step-up in basis for 2010 deaths, but it has published FAQs about the New Tax Rules for Executors for 2010 .
It appears from the tax law that a tax return (which as of now doesn’t even have a number assigned to it) would be due at the same time as the decedent’s final income tax return (April 15, 2010, unless extended) and would only be required if the estate exceeded $1,300,000 in value or if the decedent received property via gift in the 3 years before death. The recipients of property to which the step-up in basis is allocated would receive written proof of the step-up within 30 days after the return is filed (which may be too late for some early filers, and cause the need for amended returns.)
It appears that an automatic basis increase would occur for smaller estates, but the question remains whether estates of less than $1,300,000 should also file the return. My opinion is that the return should be filed, for how else would the IRS, many years down the road, be able to determine whether a legitimate step-up in basis is being claimed? If the burden is someday placed back on the taxpayer to prove that the estate was less than $1,300,000, how would the taxpayer be able to prove that point? In addition, it may make sense to file the return for smaller estates if attempting to achieve a step-up in basis on questionable items under Internal Revenue Code Section 1022, such as reserved life estates (see http://wp.me/pRFoy-8k), reserved powers of appointment (see http://wp.me/pRFoy-90) and irrevocable grantor trusts (see http://wp.me/pRFoy-fW).
Rumors abound that a political compromise may allow taxpayers have the option of using 2009 tax law for 2010 estates. If such a law change doesn’t occur soon, the executors, personal representatives and trustees of larger estates should soon begin the process of determining the adjusted basis in the 2010 decedent’s assets. Busy accountants often have an available window of time from October 16 on through the end of the year, and larger estates should use that availability to begin dealing with this 2010 tax mess dumped on us all by the 2001 Republican Congress.
Are You Personally Responsible for Your Spouse’s Nursing Home Bills in Massachusetts?
It may come as a surprise to some people, but you can be held personally responsible for your spouse’s bills if they are for payment of necessaries. In the case of East Longmeadow Management Systems v. Wilson, the nursing home resident’s wife, Judith Wilson, was successfully sued for $45,243.24 in unpaid nursing home bills of her husband, Robert Wilson. This case serves as a stern warning to older married persons that they need to obtain legal advice from an elder law attorney when their spouse enters a nursing home. If she had done so, all of her husband’s nursing home bills could have been covered. Even though Robert had no assets and even though Judith had not signed any contract or agreement accepting financial responsibility for his nursing home bills, she was successfully sued because she did not file for and obtain MassHealth (i.e. Medicaid) benefits for him on a timely basis. On a motion for summary judgment, the Court found that under Massachusetts General Laws, Chapter 209, Section 1, she was liable as his wife for the full cost of necessaries furnished to Robert during his life. This case highlights why anybody concerned about the costs of nursing home care should be sure to obtain legal advice about MassHealth. If Judith had obtained legal advice from a Certified Elder Law Attorney promptly after Robert entered a nursing home, she would have learned how to apply for MassHealth for him on a timely basis. MassHealth coverage could have been applied for as long as three months after his health insurance had stopped paying for his care. For some basic information about the at-home spouse’s ability to retain assets under MassHealth (i.e., Medicaid) law, see http://elderlawblog.info/2010/04/05/preserving-all-assets-and-maximum-income-for-the-community-spouse-when-the-other-spouse-enters-a-nursing-home/
Is Your Massachusetts Durable Power of Attorney Still Valid?
A Durable Power of Attorney can be a good way to avoid conservatorship proceedings in Probate Court if you need somebody to handle financial matters for you, but it is only as good as the respect it receives. In the past, many financial institutions would refuse to honor Durable Powers of Attorney if they were too old. Their argument — not found anywhere in the law — was that old Durable Powers of Attorney became stale, and no longer effective.
On July 1, 2009, the Uniform Probate Code became effective in Massachusetts, and it specifically states that a Durable Power of Attorney does not become ineffective due to a lapse of time. That means that Durable Powers of Attorney executed on or after July 1, 2009 can remain in effect for as long as you want, including your entire life.
The legislation implementing the Uniform Probate Code in Massachusetts involved changing many different laws, and some were replaced or amended, and others were repealed. The Uniform Probate Code does not specifically protect Durable Powers of Attorney under the law in effect before July 1, 2009. After a careful review of the law, it is my belief that all Durable Powers of Attorney executed under previous Massachusetts law may be invalid. Where the previous Massachusetts durable power of attorney laws were repealed, not replaced, and where the state legislature had made choices in that legislation as to whether laws should be replaced or repealed, the effect is that the previous Massachusetts law, Chapter 201B, was eliminated as of July 1, 2009 as if the law had never existed. That means Durable Powers of Attorney which make reference to Massachusetts General Laws, Chapter 201B became invalid on July 1, 2009, and any persons who have such documents should arrange to re-execute new Durable Powers of Attorney effective under the Massachusetts Uniform Probate Code.
Obtaining Free Banking Information for MassHealth Applications
When applying for MassHealth long-term care benefits to pay for nursing home care in Massachusetts, it can be expensive to obtain copies of up to 5 years of banking information. Under Massachusetts General Laws, Chapter 118E, Section 23A , banks are required to provide this information free of charge if the information has been requested by a representative of MassHealth. In order to comply with this law, the Executive Office of Health and Human Services of the Commonwealth of Massachusetts has prepared pre-signed letters that can be completed by or on behalf of the MassHealth applicant. There are four versions of the letter, and the one to be used would be based on which office that the application has been filed with: Revere, Springfield, Taunton or Tewksbury.
http://www.mass.gov/Eeohhs2/docs/masshealth/appforms/fir_1-revere.pdf
http://www.mass.gov/Eeohhs2/docs/masshealth/appforms/fir_1-springfield.pdf
http://www.mass.gov/Eeohhs2/docs/masshealth/appforms/fir_1-taunton.pdf
http://www.mass.gov/Eeohhs2/docs/masshealth/appforms/fir_1-tewksbury.pdf
Note that it appears to be a requirement of these letters that a MassHealth application be already filed. In that situation, time is usually very limited to comply with MassHealth’s written requests for verifications of banking transactions. Since you wouldn’t know whether the bank had complied with the request unless you received the bank records yourself, it is probably not a good move to request that the records be sent directly to the MassHealth Enrollment Center.
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Revocable Trust Containing Minor Child’s Assets or Lawsuit Settlement Causes Loss of SSI When Child Becomes Adult
In the case of Hunt v. Astrue, the U.S. District Court for the District of Massachusetts reviewed a case where a revocable special needs trust had been established by parents of their injured child. The funds in the trust had been received in the settlement of a personal injury case filed on behalf of the child when he was a minor, and the child could revoke the trust. Because of the way the trust was established, the child ended up being disqualified from SSI when he became an adult.
If the special needs trust had originally been made irrevocable (not revocable) with explicit provisions to supplement but not supplant governmental benefits, the trust would likely have been of greater long-term benefit to the disabled child. To allow the child to be eligible for SSI, the trust would also have required restrictions on payments directly to the child and restrictions involving expenses for the child’s food and shelter.
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When Is an Asset Considered “Acquired from the Decedent” under Internal Revenue Code Section 1022?
It seems that the more I look at Internal Revenue Code Section 1022, the more questions I have. Let’s look closely at the “acquired from the decedent” requirement in 1022(e), which I’ve posted below:
1022(e) Property acquired from the decedent
For purposes of this section, the following property shall be
considered to have been acquired from the decedent:
(1) Property acquired by bequest, devise, or inheritance, or by
the decedent’s estate from the decedent.
(2) Property transferred by the decedent during his lifetime–
(A) to a qualified revocable trust (as defined in section
645(b)(1)), or
(B) to any other trust with respect to which the decedent
reserved the right to make any change in the enjoyment thereof
through the exercise of a power to alter, amend, or terminate
the trust.
(3) Any other property passing from the decedent by reason of
death to the extent that such property passed without consideration.
At first blush, it may appear that Congress meant for (e)(1) to deal with all estate issues, for (e)(2) to deal with all trust issues, and for (e)(3) to deal with anything else, but why in (e)(1) did Congress specifically reference bequests, devises and inheritances when it would have sufficed to mention the decedent’s estate? The extra phrases must have been placed in the law for a reason, and the comma after the word inheritance is significant, in that it seems to separate (e)(1) into two sections: “bequest, devise, or inheritance” and “the decedent’s estate.” Further, the definition of “inheritance” found at law.com is “whatever one receives upon the death of a relative due to the laws of descent and distribution, when there is no will. However, inheritance has come to mean anything received from the estate of a person who has died, whether by the laws of descent or as a beneficiary of a will or trust.” Black’s Law Dictionary, Fifth Edition goes even further on the definition of inheritance and includes assets which pass “by operation of law.” Based on this way of reading (e)(1), I conclude that Congress probably intended that the phrase “acquired from the decedent” include inheritances from trusts.
On the other hand, (e)(2) seems to suggest limited step-up opportunities for assets in trusts. Under (e)(2)(B), the step-up would be limited to trusts established by the decedent with a reserved power to alter, amend or terminate, so many irrevocable trusts would not be eligible for a step-up in basis, but perhaps Congress, already having dealt with bequests, devises and inheritances in (e)(1), wanted to make sure that certain other grantor trusts not be eligible for a step-up in basis, and was expressing its intention to exclude powers that had been given to the decedent to attempt to obtain a step-up in basis.
If (e)(1) and (e)(2) were meant to cover estate and trust issues, then (e)(3) was meant to cover any other types of transfers, such as jointly-held assets and transfer-on-death, pay-on-death and beneficiary designations. It also seems that a so-called Ladybird deed, where the owner of real estate deeds it away but reserves the right to retrieve it, fits into the (e)(3) category, although it may be questioned whether the non-exercise of a reserved power could be considered passing “from” the decedent.
Two other common types of transfers, a reserved power of appointment and a reserved life estate, are more problematic, but may also fit under (e)(3). A reserved power of appointment in a deed is not a possessory interest but can also fit into the (e)(3) category because the real estate was a vested interest subject to divestment, and the real estate passes without consideration when the original owner dies and the divestment possibility is eliminated; until the power holder’s death, the person or entity to whom the real estate was deeded cannot sell or mortgage it, and is therefore not the owner in any significant economic sense.
A reserved life estate may fit under (e)(3) because the person or trust to which the real estate was deeded does not have possession during the life tenant’s lifetime, and, at the time of the life tenant’s death, the life tenant has an ownership interest to the exclusion of the holder of the remainder. Under this type of analysis, even though title passed when the deed was recorded and the remainder interest became vested at that time, the real estate could still be viewed as passing “from” the decedent.
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When Are Assets in an Irrevocable Trust Eligible for a Step-up in Basis in 2010 under the Modified Carryover Basis Rules?
As I have suggested in earlier blog posts about Internal Revenue Code Section 1022, it seems that the modified carryover basis rules were not well-written by the 2001 Republican Congress that passed them. It is possible that Congress may have wanted to allow a step-up in basis in very limited circumstances, but it appears to me that broad catch-all descriptions in Section 1022(e) such as “inheritance” and “[a]ny other property passing … by reason of death” were placed there to allow liberal interpretation of this tax law. From that standpoint, it appears that the assets in an irrevocable trust may often be eligible for a step-up in basis.
As I suggested in Which Powers of Appointment Are Eligible for a Step-up in Basis in 2010 under the Modified Carryover Basis Rules?, it appears that the assets in an irrevocable trust that contains a reserved special power of appointment can be eligible for a step-up in basis. A deeper reading of Section 1022, however, reveals other step-up opportunities as long as the assets are deemed owned by the decedent under Section 1022(d) and received from the decedent under Section 1022(e).
The grantor trust rules in Internal Revenue Code Sections 671-679 have long determined whether someone should be treated as the owner of an irrevocable trust for income tax and capital gains tax purposes. In particular, Internal Revenue Code Sections 673-678 all begin with the general rule that the “grantor shall be treated as the owner of any portion of a trust” described in that section. Since none of those sections are specifically negated in Section 1022, it appears that ownership under the grantor trust rules should suffice as the decedent’s ownership under Section 1022. While there are special rules about ownership under Section 1022(d), those rules do not appear to be an exhaustive list. Further, when Congress intended to negate certain planning maneuvers being treated as ownership in Section 1022, such as powers of appointment given to a decedent, it specifically did so.
Thus, it appears that grantor trusts meet the “owned by the decedent at the time of death” standard in Section 1022(d)(1). It is not much of a stretch to state that assets that were deemed “owned” by the decedent during lifetime were then at the time of death “received” from the decedent. Assets in a grantor trust established and funded by the decedent would then fit into the category in Section 1022(e)(3) of “other property passing from the decedent by reason of death to the extent that such property passed without consideration.”
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What Is the Adjusted Basis of Common Stock Received from Demutualized Life Insurance Companies?
Many people owned life insurance or other policies with life insurance companies and, when those companies became publicly-traded, received shares of common stock. In the 2008 case of Fisher v. U.S., the U.S. Court of Federal Claims held that the basis for capital gains tax purposes was the fair market value of the stock when it was received, not zero.
If you have already sold your stock from a demutualized life insurance company and your income tax returns showed the entire sale proceeds as taxable income, you should file amended returns and claim refunds as soon as possible.
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Caregiver Authorization Affidavit Allows Appointment of Temporary Decision Maker for Minor Child
Parents who are going away for an extended period of time (such as on vacation, on a business trip or for hospitalization) are often concerned about what would happen if a minor child who was left behind needed immediate attention for a health care problem.
Under Massachusetts General Laws, Chapter 201F, parents can give written authorization to allow their minor child’s caregiver to make educational and/or health care decisions. The caregiver must certify that the child is living with the caregiver. The authority given in the affidavit to the caregiver does not eliminate the parent’s legal right to make all final decisions, and the parent can override the decisions of the caregiver.
Executing a Caregiver Authorization Affidavit appears to be an easy and effective way for a parent to give temporary decision-making authority to the person with whom their minor child will be staying during the parent’s absence.
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Massachusetts Estate Planning, Probate & Elder Law 