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Inherited IRA/Secure Act

Inherited IRA/Secure Act

If a participant/owner of an IRA designates an individual as a beneficiary, who is a non-spouse of the participant, then upon the participant’s death the individual beneficiary can make a tax-free transfer from the trustee of the deceased participant’s account to the trustee of an Inherited IRA account of the beneficiary. Unlike a beneficiary who is the spouse of the participant, the non-spouse beneficiary cannot treat the inherited IRA as his or her own IRA, the non-spouse beneficiary cannot make any contributions to the Inherited IRA, or roll over any amounts into or out of the Inherited IRA. The required minimum distribution (RMD) rule is that the non-spouse beneficiary cannot wait to take distributions until the age of 70 ½ but must begin taking RMD distributions the year after participant’s death based upon the beneficiary’s life expectancy not that of the deceased participant’s life expectancy. Therefore, if the non-spouse beneficiary is much younger than the participant the IRA fund is able be paid out over a longer period of time.

With respect to creditors in bankruptcy, retirement plans are exempt from attachment by creditors under the Bankruptcy Code.  However, in the 2014 case of Clark vs. Rameker 134 S.Ct. 2242 (2014), the United States Supreme Court decided that an Inherited IRA did not qualify as a Retirement Fund for purposes of the exemption under the United States Bankruptcy Code because they are distinct from retirement funds as the beneficiary cannot treat such fund as their own as discussed above.

The question that arises is whether the Clark case would affect non-bankruptcy creditor situations (divorces, lawsuits, or other creditors). Some states provide no exemptions for creditors for retirement plans, and some states allow exemptions for retirement plans, and in other states there is uncertainty on that issue. As a result, many commentators and financial advisors suggest that an inherited IRA could be creditor protected if an accumulation trust is named as beneficiary of the IRA.  In so doing, the trustees will be in charge of distributing income to the trust beneficiaries (if that occurs the taxes would be at the trust rate rather than the individual rate but the income would not be available for creditors). Generally a trust is a not a “designated beneficiary” of an IRA and as a result withdrawal needs to be made within five years from the year after death of the participant, unless the trust meets the criteria of a “see-through trust”. To meet such “see-through trust” designation the trust must be valid under state law, must be irrevocable, the beneficiary individual of the trust must be identifiable, and documents must be submitted to the plan administrator. If the criteria is met then the beneficiary of the trust becomes the “designated beneficiary” for RMD purposes and he or she will be taxed individually on IRA distributions received based on the life expectancy (if multiple beneficiaries the RMD will be based on the oldest beneficiary’s life expectancy).

The Secure Act which was signed into law on December 20, 2019, and effective for participants who died after 2019, makes changes to the RMD rules. Life expectancy is eliminated and in lieu of the life expectancy rule the new payout period must be completed within 10 years of the year after death (with a few exceptions). Thus for an individual beneficiary of a qualified trust as discussed above who becomes a “designated beneficiary” all funds of the inherited account need be distributed within the 10th anniversary from the year after the death of the participant. This could harm creditor protection situations.

The Secure Act also increases the age at which an individual who owns an IRA must begin taking required minimum distributions. Now instead of 70 ½ the age is 72. This applies to those owners of IRA accounts that will attain a 70 ½ on or after January 1, 2020.

Estates and trusts final year excess deductions

New IRS law under section 67 (g) provides as follows:
“(g) Suspension for taxable years 2018 through 2025… no miscellaneous itemized deduction shall be allowed for a taxable year beginning after December 31, 2017, and before January 1, 2026.”
In July 2018 the Office of Chief Counsel issued Notice 2018-61 which states that the Treasury Department and the IRS intend to issue regulations providing clarification of the effect of newly enacted section 67 (g) regarding the deductibility of certain expenses incurred by estates and nongrantor trusts; and requests comments on that new law along with and issues relating to section 642(h) (2).

Section 642 (h) (2) provides:
If on the termination of an estate or trust, the estate or trust has…
(2) for the last taxable year of the estate or trust deductions (other than the deductions allowed under subsections (b) or (c)) in excess of gross income for such year, then such carryover or such excess shall be allowed as a deduction, in accordance with regulations prescribed by the Secretary, to the beneficiaries succeeding to the property of the estate or trust.

The Notice further provides on page 6 that “The Treasury Department and the IRS intend to issue regulations clarifying that estates and non-grantor trusts may continue to deduct expenses described in section 67(e)(1) and amounts allowable as deductions under section 642(b), 651 or 661, including the appropriate portion of a bundled fee, in determining the estate or non-grantor trust’s adjusted gross income during taxable years, for which the application of section 67(a) is suspended pursuant to section 67(g). Additionally, the regulations will clarify that deductions enumerated in section 67(b) and (e) continue to remain outside the definition of “miscellaneous itemized deductions” and thus are unaffected by section 67(g).
No regulations regarding the above have been issued as of yet.

Tax Apportionment /2036

Turner Cases
In the first case of Turner (Tax Court Memorandum 2011-209), the Court found that the transfer of assets to the limited partnership was includable in the decedent’s estate under section 2036; “the possession or enjoyment of, or the right to the income from the property…” The Court based its decision on a number of facts: the transferor did the following: receiving disproportionate distributions from the partnership; using personal funds to invest on behalf of the partnership; comingling personal partnership assets; using partnership assets to pay legal fees for his own estate planning; using partnership assets to pay insurance premiums on policies held in a different trust. As a result, the Court held that proper procedures were not followed; that there was lack of respect for legal boundaries of a separate entity; and the partnership entity was used as a personal account. Further, there was no significant nontax purpose for the formation of the limited partnership, and the assets were not properly titled. Additionally, Section 2036 also applied because there was no bona fide sale.
In the second case of Turner (138 T. C. 306 (2012), the decedent’s Executor argued that the decedent’s trust provided a formula clause so that his spouse was to receive sufficient assets to reduce the estate tax to zero, and therefore, the marital deduction should be increased to reduce the estate tax liability as increased in Turner case of 2011 under section 2036. The IRS argued that under section 2056 the marital deduction only applies to assets that actually pass to the spouse. The Court found that section 2036 is a phantom inclusion statue that includes the assets in the decedent’s estate and often occurs with a family partnership when the interests are already given away and under state property law no longer included in the decedent’s probate estate, and such asset cannot pass to the spouse and therefore not allowed as a the marital deduction.
In the third case of Turner (151 T. C. 10 (2018), which was decided November, 2018, the estate argued that although the Last Will did not contain an apportionment clause under section 2007B of the Internal Revenue Code (regarding property included under section 2036), the estate had a right to reimbursement for estate taxes paid on property included in the gross estate under section 2036, because unless that apportionment section is waived, it is preserved. And, if transfer taxes are paid from any property which was to transfer to the surviving spouse , it would reduce the marital deduction and reduce assets to the spouse. The Court found that it’s reasonable to assume that the decedent was to do what was necessary to ensure that whichever property is passing to his surviving spouse and qualifying for the marital deduction not be impaired by estate taxes, and therefore the Court found that the executor must exercise a right of recovery under section 2207 B of the Internal Revenue Code regarding tax apportionment. Thus, the estate should attempt to retrieve the estate tax amount from the transferee of the partnership assets.
Obviously, rather than a court determining such provisions of tax apportionment, it should be specifically included when preparing testamentary documents.

Power of Attorney

The Philadelphia Orphans Court in the Estate of Gloria Capobianco , 8 Fiduc. 3rd pages 201-206 (O.C. Philadelphia Co.July 2018) cited numerous sections under Chapter 56 under Title 20 of the Pennsylvania Statutes, and held that the trust as created by the agent under a power of attorney is invalid.

Gloria Capobianco died intestate on June 3, 2016. On November 1, 2005, she named her son as agent under her power of attorney. On April 24, 2016, she had to be placed in a medically-induced coma. On May 27, 2016, the agent, her son, under the power of attorney, created a trust and named himself and only two of his six siblings as beneficiaries of the trust, and transferred the decedent’s home and tangible personal property to the trust. The agent stated in court filings that he transferred the assets to the trust to protect such assets from being counted for the purposes of Medicaid.
One of the siblings that was not named as an heir of the trust objected to the accounting.

The Court stated that as a result of the decedent dying intestate all of her children were heirs equally of the estate in accordance with the Pennsylvania intestate law. The Court cited 5601.3 which provides that an agent is required to act according to the principal’s reasonable expectations, the agent must act in good faith, and only within the scope of the authority granted by the power of attorney. Furthermore, the agent must act loyally for the principal’s benefit.

The Court stated that an agent has a fiduciary duty to attempt to preserve the principal’s estate plan under 5601.3(b)(6), and the agent, in the case before the Court, did not have the authority to deviate from the principal’s estate plan.

The Court decided that there was no purpose in creating the trust except to eliminate four heirs as beneficiaries, and therefore the Court sustained the objections to the accounting and held that the trust is invalid.

Estate and Gift Tax Changes

For 2018 the gift tax exclusion is now at $15,000 per donee increased from $14,000 in 2017.

The Tax Cuts and Jobs Act was enacted on December 22, 2017, and basically doubles the estate, gift and generation skipping transfer tax exemptions to approximately $11,200,000 per person and approximately $22,400,000 per married couple. These increased exemptions only last until December 31, 2025, and without future legislation the amounts will return to the 2017 levels. Also, it is possible that before 2026, a new congress and administration may change the law and lower the exemptions. These increased exemptions provide many opportunities for planning, such as changing bypass or credit shelter trusts, and/or utilizing the additional gift tax exemptions before the law reverts. Those with significant assets should have their estate plans reviewed in conjunction with these changes.

Deceased Spouse Unused Exclusion

In case an election to transfer decedent’s federal estate tax exclusion to surviving spouse (DSUE; portability) was not filed after 2010, recent IRS Revenue Procedure 2017-34 allows an executor to file and elect portability until the later of January 2, 2018, or 2 years after the decedent’s date of death.

Estate and Gift Tax Limits Increase

The IRS has announced that the annual gift tax exclusion for 2018 will be $15,000 per donee, up from $14,000 per donee. Also, the estate and gift tax exemption will be $5.6 million per person for 2018, and that amount is up from $5,490,000 per person. Therefore a married couple will have a total of $11,200,000 exempt from federal estate tax or gift tax.

Creditor Claiming Trust Assets

In the trust creditor case of the Clegg Trust, 6 Fiduc. 3rd pages 69-79 (O.C. Philadelphia Co. Dec. 2015) the Trust held a life insurance policy and allowed the Trustee to pay the premiums. The trust contain provisions to limit creditors from claiming trust assets of beneficiary debtors under a spendthrift clause. To avoid loss of the federal gift tax exclusion under 2503 of the Internal Revenue Code the beneficiary had a limited right of withdrawal over certain assets and the power over certain assets after the lapse of the withdrawal period under “hanging powers”. The issue was whether a creditor of a trust beneficiary could claim trust assets. The Court cited section 7741 of Title 20 of the Pennsylvania Consolidate Statutes which limits a creditor from reaching trust assets where there is a spendthrift clause. The Court stated that spendthrift trusts are not sustained for the interest of the donee, but because the donor possessed an individual right of property in the execution of the trust; it is the intent of the donor which is important. Therefore, the creditor was not entitled to claim an interest in the trust assets under the spendthrift clause. The creditor then claimed that it had a right to make a claim of the trust assets which the beneficiary had a power to withdraw which did not lapse under section 20 Pa.C.S.A.7748. However, the Court denied the claim as the Court cited the “Power of withdrawal” definition under section 7703, which provides:

“Power of withdrawal. The unrestricted power of a beneficiary acting as a beneficiary not as a trustee, to transfer to himself or herself the entire legal and beneficial interest in all or a portion of the trust property. However, a power to withdraw the greater of the amount specified in section 2041 (b)(2), 2503(b) or 2514(e) of the Internal Revenue Code of 1986, or any lesser amount determined by reference to one or more of these provisions, may not be treated as a power of withdrawal.”

The claim of the creditor was denied.

Recent Powell Case

On May 18, 2017, the Tax Court (148 T.C. No.18) decided against the taxpayer with facts that involved a deathbed transfer. Assets were transferred from decedent’s revocable trust to a family limited partnership by her son under decedent’s power of attorney. Decedent’s son became the general partner and the decedent received all of the limited shares. Decedent’s son, under the power of attorney of decedent, then transferred all the limited shares to a Charitable Lead Annuity Trust. The decedent died 7 days thereafter. Understandably the deathbed facts were terrible for the taxpayer. The Court decided to tax the assets under section 2036 (a) (1) (decedent with her son as both general partner and the agent of her power of attorney could retain enjoyment of income), and surprisingly, under 2036 (a) (2) (decedent with her son could dissolve the partnership and also with her son, the general partner and power of attorney agent, could control distributions). The Tax Court in Powell agreed with the reasoning in the Strangi case decision that Byum fiduciary requirements did not apply in Powell.

Petition for Accounting and Surcharge

In the case of Guardo vs. Buzzuro, 7 Fiduc. Rep. 3rd page 14-19 (O.C. Monroe Co.2016), the Court was presented with a Petition to Compel an Accounting and Declaratory Relief by the Petitioner against Respondent/guardian. Respondent lived with her Aunt for 4 years from September 2010 through March 2014, and handled many of her finances. Her Aunt died in July 2014. Petitioner provided an accounting provided by the estate showing unaccounted funds and missing documents. Petitioner alleged that Respondent mismanaged decedent’s money while living with decedent for approximately 4 years. Respondent responded that she did not mismanage or convert funds and she did not know she was to keep extensive records.

The Court stated that the statute provides that the agent shall file an account whenever directed to do so by the court. 20 PS 5610. The Court stated that when money is unaccounted for in an estate the court could order the funds be repaid by the fiduciary in the form of a surcharge, and the burden to prove the wrongdoing is on the party who seeks the wrongdoing, and when sufficient discrepancy appears in the record then the burden shifts to the guardian or executor. The Court stated that a fiduciary acting under a power of attorney or as a guardian or caregiver is no different than an executor in such circumstances.

During a hearing the Responded was resolute in her position that written records were unnecessary because she handled many matters in cash and did her best to care for decedent. Even though the Respondent testified that records were not kept because she had no formal training or accounting skills, “the records are so bare that they do not meet the minimum of common skill or prudence.”

The Court stated that a surcharge against a fiduciary can only be initiated by an accounting by the fiduciary in question (which is the normal pattern), and the opposing party can file objections, and the court can then determine the amount of the surcharge, if any. And of course a party can appeal. In re Smith, 2006 Pa. Super.5; In re Estate of Bechtel, 92 A. 833 (2014); In re Novosielski, 605, Pa. 508, 992 A.2d 89 (2010).

The Court concluded that evidence was produced that warrants the filing of a formal accounting while the respondent was acting as the fiduciary, and that although the respondent may not be able to do so, the respondent should be given the opportunity to make a full accounting. Therefore, the Court granted the Petition to Compel the Accounting and deferred the request for Declaratory Relief until the accounting issue is resolved.