The Question of Medicaid Planning

To expand upon our previous post on Gifting, today we are addressing Medicaid. Often questions regarding gifts are tangential to questions about qualifying for Medicaid. Taking time to educate clients on the benefits, and limits, of Medicaid is the first step to deciding if Medicaid is appropriate for a client's circumstances.

With the rising cost of healthcare, especially as it applies to long-term care for elderly individuals, our clients often inquire about Medicaid and its rules and limitations. While Medicaid is the “best insurance money can’t buy,” qualifying for coverage under Medicaid comes with significant asset and income limits. In addition, the facilities which accept Medicaid as a payment over private pay options are many fewer, and may be of lesser quality. Still, a common concern for clients is that significant medical costs incurred in their later years may wipe out assets they worked for their entire lives, leaving them unable to pass on any inheritance to loved ones. Questions initiated by the client, and sometimes by children worried about an inheritance, often center around protecting assets or about giving money away during lifetime.

It is important to clarify that qualifying for Medicaid is not about keeping the government from taking a person’s money, but reaching specific limits of assets before Medicaid coverage is available. In addition it is important for clients to understand that all health care is not the same and there are significant differences between providers. This is the point in most conversations about Medicaid where we discuss the differences between private-pay facilities and facilities funded primarily by Medicaid. We remind our clients that while a private-pay facility generally has a higher cost, the quality of life in those facilities tends to be markedly better. Whether because the facilities have more staff per patient, better amenities, or even simply nicer rooms, a private-pay facility is going to provide generally better care.

This conversation provides us with a gateway to remind people that the funds they will potentially spend on their care are the funds they worked hard to earn during their life. This leads to more in depth discussions about what is motivating inquiries about Medicaid and what is more important to the client, the quality of their care or passing more wealth on to their loved ones. It also provides us with the opportunity to discuss whether the client has reason to believe that they will need the types of long-term healthcare that Medicaid covers. This is because many people believe that Medicaid is an advanced version of Medicare and covers more costs than it actually covers. Often people begin asking questions about Medicaid long before they actually have need for such care and when they may never have healthcare need that Medicaid would cover.

Medicaid planning is a complex area of law with many potential benefits, but it is not something that everyone should be doing. There are a number of things that can be done to prepare a client for a potential Medicaid need, but it is first and foremost important to make sure that clients have the information they need to determine if Medicaid is appropriate to their circumstance. Even if Medicaid is appropriate, the rules that govern eligibility create many potential pitfalls for the unwary, it is important to avoid taking steps that could actually inhibit qualification for coverage in an effort to speed up coverage. As with so many things we discuss, the advice of an experienced attorney is invaluable.

Matt and Al

Window Closing on Discounts for Intra-family Gifts

We've been quiet for a couple of weeks, something we intend to avoid in the future, however today's blog addresses the Proposed Regulations announced yesterday by the Treasury Department and the IRS with respect to the ability to claim a discounted valuation for Intra-family gifts. If you or your clients are considering transferring partial ownership of a family business on to children it may be beneficial to do so sooner, rather than later.

In previous blogs we discussed the strategy of using a Family Limited Partnership or Family L.L.C. to transfer interests in either family owned businesses or other types of assets, such as real estate, to children while allowing parents to retaining control of the entity during their lifetime. A major benefit of such transfers is the ability of the parent to claim a significant discount in the valuation of the transferred assets for the purposes of Gift Tax liability. On Tuesday August 2, 2016, the Treasury Department and the Internal Revenue Service announced Proposed Regulations that address this strategy and, if put into effect as written, will significantly reduce the ability of family business owners to take advantage of this strategy.

Under current regulations, it is possible for a parent to transfer interests in a family business to the other family members while retaining operational control of those businesses. The transferred interest does not contain voting rights and specifically indicates that the family member does not have the right to sell or otherwise alienate the interest. The lack of control over the operation of the business and inability to sell the interest reduces the value of the interest and allows for a discount in the value for purposes of gifting. This discount allows the client to transfer a greater value of assets to their loved ones at a lesser cost for gift tax purposes. When it has challenged transfers of this nature in court, the IRS has consistently argued against the size of the discounts. 

The Proposed Regulations generally provide that if a parent transfers an interest in a corporation that the parent controls to any other member of the family any "applicable restriction" shall be disregarded in valuing the transferred interest. The Internal Revenue Code defines “applicable restriction” as “any restriction that effectively limits the ability of the entity to liquidate, but which, after the transfer, either in whole or in part, will lapse or may be removed by the transferor or any member of the transferor’s family, either alone or collectively.” In plain English, the Proposed Regulation provides that if a parent transfers an interest in a family owned business to their child with the restriction that the child cannot alienate their interest in the business without the parent’s permission, that restriction is ignored for purposes of valuing the transferred interest. The removal of such restrictions from consideration in valuing the interests transferred will have a significant impact on the strategy of transferring interests in family owned businesses.

While the Proposed Regulations will significantly limit the valuation discount available to clients when making transfers of family-owned businesses, it does not entirely eliminate the benefits of such transfers. Until these regulations go into effect and are tested in real-world situations, it is unclear what level of discount the IRS will argue is reasonable with respect to other restrictions placed on interests transferred to children that do not relate to the child's ability to alienate the interest. Additionally the strategy of transferring minority or non-controlling interests in family businesses to children is still very beneficial, especially when those business interests contain assets that are likely to appreciate significantly in coming years. Such transfers are also still relevant in the context of succession planning for family businesses, as an equity interest in the family business is often necessary to ensure that future generations are fully invested in the operation of that business before they are given control of the company.

There is still an opportunity to take advantage of the valuation discount, but the window for doing so may be closing. Before these Proposed Regulations can go into effect they must first go through a 90-day public comment period, after which there may be changes, but even if there are no changes, portions of the regulations will not take effect until 30 days after the government issues a final version of the regulations.

The strategy of using a Family L.L.C. to obtain a discount in the valuation of assets transferred to children is a complex legal strategy that business owners should not attempt without consulting an attorney and accountant who are familiar with the process. Avoiding significant issues with the IRS in implementing this strategy requires sound valuations of the business and working with advisors familiar with the process of justifying such valuations. If you have additional questions, concerns, or interest in discussing whether this strategy may be appropriate for your circumstances, or the circumstances of one of your clients, we encourage you to contact us quickly, as the time available to take advantage of this strategy is very limited.

Alan and Matt

Gifting $5 Million Without Using $5 Million Worth of Lifetime Exemptions

A few weeks ago we discussed the concept of using limited liability companies ("LLC's") for gifting purposes. We have been working with clients using such a strategy and this gives us an opportunity to explain how the concept works.

     Among other assets, John and Jane have commercial buildings valued at $10,000,000, which are likely to double in value over the next 10 years. The clients also have two children and six grandchildren, all of whom are adults. They were not opposed to lifetime gifting to remove assets and the future appreciation from their estates, but they wanted to maintain control of the assets.

     We suggested that John and Jane transfer the buildings to an LLC, in exchange for a 2% voting interest in the LLC and a 98% nonvoting interest in the LLC, which they then divided equally between themselves. We then discussed what portion of the interests they wanted to gift to their children and grandchildren. Since one goal was to ensure that John and Jane maintained control of the buildings, they will definitely retain ownership of the voting interests. They also wanted to enjoy some of the annual income generated by the buildings, so they will need to retain a portion of the nonvoting interests. Ultimately, John and Jane chose to gift 50% of the nonvoting interests to their children and grandchildren.

     Since John and Jane gifted nonvoting interests, which do not give the owner of that interest control of the business, the IRS will allow a discount of the value of the interest gifted for gift tax purposes. Thus, even though John and Jane gifted an equivalent of $5,000,000, because of the discount (conservatively at 20%) the deemed gift was only $4,000,000. John and Jane each used their annual exclusion gifts of $14,000 to make gifts to each of the children and grandchildren, for a total of $224,000 ($14,000 x 2 grantors x 8 descendants). The remaining gift of $3,776,000 was divided equally between John and Jane's lifetime exemptions against estate tax and we filed a gift tax return providing the IRS with a record of the transaction.

    As an additional protection against creditors and any potential divorce, we also established irrevocable trusts for each of John and Jane’s children and grandchildren to hold the gifted nonvoting interests. These trusts have flexible provisions regarding the distribution of income and principal to the beneficiaries, while also creating a nest egg for later in their lives. 

     The net result of this strategy is that John and Jane maintain control of the buildings during their lifetime and removed assets presently valued at $5,000,000 from their estates using only a portion of their lifetime exemptions. In addition, the transfer removes all of the appreciation on the gifts from John and Jane's estates, saving approximately $2,000,000 of estate taxes at their deaths (appreciation of $5,000,000 x 40% estate tax). In addition, income earned by the gifted interests is now reported on eight different income tax returns and presumably taxed at lower tax rates.

     In this situation, an estate tax savings was one of the desired results. However, even if clients do not have an estate tax issue, gifts of LLC interests to irrevocable trusts can provide children and grandchildren with an income stream, while protecting the interests from creditors or possible marital issues. This strategy is not without additional cost, as appraisals of both the asset value and the minority discount must be completed by a qualified appraiser. In addition, attention must be paid to the administrative requirements and tax filings of both the LLC and the irrevocable trust. As always, clients should seek the advice of a qualified professional before engaging in the strategy.

Keeping Family Vacation Homes in the Family

A warm day like yesterday often triggers thoughts of summer and good times at the family cottage. With these thoughts in mind, clients often wonder how to structure the transfer of ownership of a family vacation home to their children and grandchildren either during lifetime or at death.

     Gifting or bequeathing a family vacation home is not an easy matter and requires significant planning in order to treat all family members fairly. Clients need to balance their desire to make a well-intentioned gift with the possible unintended burden on beneficiaries, which may cause strife among loved ones. Additionally, the transfer of such high-value assets brings with it potential estate and gift tax implications. While a client certainly must consider tax issues and the possibility of an increase in property taxes because of the transfer, we will leave these for another time and focus primarily on the family issues. 

     While a parent may hope that common ownership of a vacation home will keep their family together, it is entirely possible that not all of their children have the same warm memories of summers at the lake. In addition, those children’s spouses and children may have different ideas on how to spend family vacations. Add to all of this the fact that many adult children have moved away to pursue their careers (or avoid sometimes harsh Michigan winters) and may not be able to enjoy the use of a vacation home. It is important to discuss these issues with all of the family members to determine which children are interested in owning a part of the "family cottage".

     While there is not enough time to discuss all of the issues, important points to consider when transferring the vacation home include:

• What will the ownership structure be? This could include ownership jointly, as tenants-in-common, by a trust, or by an LLC?
• Who will manage the property? Family dynamics are important - not all of the family members may want to get involved in the day-to-day decisions.
• How will use of the vacation home be determined?  A plan should be in place for fairly selecting weeks of use for each of the family members.
• How are repairs and improvements, including cost, dealt with? Some family members may always be looking to upgrade the facilities while others may be happy to keep things simple and inexpensive.
• Should there be rules about allowing guests to use the cottage, especially without a family member present?  Allowing many non-family guests to use the cottage can cause considerable wear and tear on it and create friction among family members.
• Is there a procedure for allowing a family member to sell or gift the ownership interest?  Either during lifetime or at death, family members often desire to transfer their interest to a spouse, or children. If not planned for, this can result in a significant fractionating of a family member's interest and increasing the total number of "owners" for purposes of use and expenses. It might also result in pieces of the vacation home being owned outside the intended family.

     While continuing family ownership of vacation property is a laudable goal, much thought should be put into the process to make sure that the intended result of family harmony does not actually result in disharmony. As with any other tax or gift planning strategy is important to understand each client individual circumstances and consult with their professionals to ensure that the planning will not have unforeseen consequences.

The Changing Role of the Irrevocable Life Insurance Trust

Today we look at an advance trust, the Irrevocable Life Insurance Trust, whose role in the the estate planning process continues to evolve in response to changes in the tax code.

     With the Estate Tax Exemption now over $5,000,000 for an individual and $10,000,000 for a married couple, the Irrevocable Life Insurance Trust (ILIT), a once common tool for offsetting estate tax liability, is used less often. While the benefits of an ILIT as a tool to offset the estate tax liability have decreased for the majority of individuals, there are other situations where an ILIT can still be a very useful tool in estate planning.

     An ILIT is designed to own a life insurance policy, normally on the life of the Grantor, without the proceeds from that policy being included in the Grantor’s estate for the purposes of estate taxes. The premiums for the insurance policy are paid by the Trustee, most often with contributions made to the trust by the Grantor using the Annual Gift Tax Exclusion. In order for these contributions to qualify for that exclusion, they must be what the IRS regulations refer to as "present gifts". This means that the recipient of the gift must have the ability to take the gift outright and free of trust if they so choose. The terms of the ILIT require the Trustee to give the trust beneficiaries written notice of a limited window of time during which they may withdraw their gift from the trust. After that time period passes, the gift becomes a trust asset and the Trustee can use it to pay the premiums on the insurance policy owned by the trust. This notice is often referred to as a "Crummey Notice", and is named after a tax case named Crummey vs Commissioner.

     A keen observer might ask what is to keep the ILIT beneficiaries from simply withdrawing their gifts immediately and leaving the Trustee without any assets to pay the policy premiums. The answer to this question lies in the beneficiaries' understanding that not withdrawing this gift from the trust in the short term will result in a larger benefit in the long term. If that logic fails, the Grantor can simply refuse to make gifts subject to the Crummey withdrawal rules, not providing the beneficiaries with the ability to withdraw gifts. The negative of this strategy is that the gifts do not qualify for the annual exclusion.

     An ILIT's benefit is that the proceeds from a life insurance policy owned by the trust is not considered to be in the estate of the grantor and therefore not counted for calculation of estate tax liability. For those couples with estates in excess of the $10,000,000 estate tax exemption this means a pool of assets that can offset the portion of an estate used to pay the tax bill. For those clients who do not have a taxable estate, there are also benefits.

• For clients who own small, or not so small, businesses that they intend to leave or sell only to children active in the business, an ILIT allows them to create a pool of assets that can pass to the children who will not inherit the family business, creating equity among children and minimizing interfamily squabbles after death, without increasing the size of the client’s estate and risking potential estate taxes. 
• An ILIT also can be used to provide assets for the benefit of a second spouse, protecting client's other assets for the benefit of children of a prior marriage 
• If a client has substantial charitable inclinations, an ILIT can be used to provide children or other loved ones with a certain amount of inheritance while leaving the remainder of an estate to the client’s favorite charities, creating a charitable estate tax deduction. 
• As with other trusts,  for those clients who want to make gifts, but retain some control over the gifted assets, an ILIT allows them to provide and additional benefit to their loved ones while retaining control over the circumstances under which those loved ones may receive distributions from the trust.
• The ILIT also can leverage the grantor’s generation skipping transfer (GST) tax exemption because the grantor’s GST tax exemption can be allocated to an ILIT holding a life insurance policy that may substantially increase in value. As a result, numerous generations may benefit from the trust assets free of federal estate and GST tax.

     While the value of using an ILIT has been reduced by the current ever-growing Lifetime Estate Tax Exclusion, there are still circumstances where an ILIT may be useful to clients. Like any other tax and estate planning strategy, it is important to consult with experienced professionals before deciding to make use of the technique in order to ensure that clients do not expose themselves to unintended consequences.

The Benefits of Intra-family Lending

With this blog, we return to the subject of gift planning. Clients like the idea of reducing taxes with gifting, but the problem is they actually have to give away an asset. When the client expresses an interest in gift planning, We ask them "What amount of assets do you have to own to feel comfortable giving away something?" The answer is usually "just a little bit more!”

     A common issue that arises when we discuss gift planning with a client is the desire to assist their children without giving up control of the assets. One strategy used in this situation, which allows clients to provide funds for family members' use while still protecting the client’s own interests, is intra-family lending. 

     An intra-family loan works much like any other loan, parents loan money to a child for a specific amount of time and at a specific interest rate. For example, a client agrees to lend $200,000 to her son to help finance a business purchase. The son signs a promissory note with specific repayment terms and a mortgage on the new business as security for repayment of the loan. This intra-family loan allows the son to purchase a business he could not otherwise afford and begin securing his own financial future. The client, over time, will get an annual interest payment as well as a return of her principal. If the child's business earns more than the principal and required interest, the child benefits from the loan, and the client has effectively transferred wealth to her son that he would not otherwise have had. 

     While the annual interest payment and opportunity to run their own business are clear benefits to the client and her son, the benefits of an intra-family loan, as opposed to a bank loan, also include:

1. The parents' ability to set an interest rate far lower than any interest rate available through a bank. While the Internal Revenue Service regulations require that the interest rate of the loan equal a minimum rate set by the IRS each month, the current annual rate is just 2.19% for loans with a duration of more than nine years and significantly lower for shorter loans. If the parents desire, they can charge an interest rate greater than minimum rate but lower than current bank savings rates, increasing the parent’s benefit and still give a benefit to the child.
2. The parents give the child the opportunity to have access to an eventual inheritance much earlier, with much less risk. The parents can also assess the child's abilities to handle the money and perhaps modify the distribution provisions of their estate plan. 
3. In the event parents want to provide their child with an additional benefit, they can use their Annual Gift Tax Exemption to provide their children with the funds to reduce the principal of the loan, without the worry that the child will frivolously waste such gifts.

     To protect the client and avoid potential problems, it is important that clients document any intra-family loan's amount, term, interest rate, and repayment schedule in a formal written contract. This is important not only to ensure a return of the parent's money, but also for protecting the client against an IRS claim that the transaction was a gift, not a bona fide loan.  Courts have held that the existence of a written document evidencing the debt, the charging of a specific interest rate, the existence of a set repayment day, and proof of actual repayment of the loan are all criteria that favor the position of a transfer was a bona fide loan.

     Intra-family lending is a very useful technique for clients who want to provide gifts to their children, while retaining control of their own assets. As with all tax related strategies, clients should seek the advice of a qualified professional before engaging in an intra-family loan. Proper planning can provide benefits to both the borrower and the lender.

The Grantor Retained Annuity Trust as a Tool for Wealth Transfer

     We often discuss the benefits of Living Trusts as part of an estate plan, but there are other types of trusts that may provide our clients with significant benefits as part of a larger estate plan, depending upon the client’s particular situation.

     A Grantor Retained Annuity Trust (GRAT) is one method for wealthy clients to maintain an income stream yet transfer property (often which is highly appreciating) to a child with minimal Gift or Estate Tax. A GRAT allows the client to transfer assets into an irrevocable trust and retain the right to annuity payments for a fixed term of years or their lifetime. When the set duration ends, the remainder of the trust, including any appreciation, can go to a named beneficiary. Alternatively, it is possible to structure the GRAT to return the principal and a certain amount of income to the grantor, and distribute the excess income to the remainder beneficiary. While it is possible that the trust will earn insufficient income to cover the required annual payment and thus the Trustee must make that payment from the principal, with proper planning the GRAT is a powerful tool for wealth transfer.

     When using a GRAT to transfer assets, the gift tax value of the assets is determined at the time of trust creation and funding by subtracting the value of the annuity interest from the fair market value of the assets transferred to the trust. The value of the annuity interest will depend on the interest rate used, the value received by the grantor, and the value of the remainder beneficiaries’ interest. The IRS Regulations set rules for determining what interest rates may be used in the calculation of valuations, especially when family members are involved.

     As an example, if a 60-year-old client sets up a GRAT to last two years and uses the following provisions:

• Contributed Asset Value: $1,000,000, 

• The §7520 interest rate required by IRS Regulations: 2%,  

• The asset earns 5% per year 

• The asset appreciates at 5% per year 

Over the term of the Trust, the client will receive two annual payments of approximately $515,000 and the remainder beneficiary will receive approximately $130,000 at the termination of the GRAT. Since the value of the annuity interest exceeds the fair market value of the assets transferred into the GRAT there is no Gift Tax liability to the client, nor do they use any of their Lifetime Gift Tax Exemption. If the client funds their GRAT with assets anticipated to appreciate faster than 5% per year, the benefit to remainder beneficiaries is even greater

     Since the GRAT permits payment of both income and trust principal to satisfy the annuity payments, it is important to treat the GRAT as a grantor trust for income tax purposes. This means the client retains liability for taxes on income and realized gains on trust assets even if these amounts are greater than the trust's annuity payments. This further enhances this tool's effectiveness as a family wealth-shifting and estate tax saving device because the client pays the income tax, thus reducing the their estate.

     In the right circumstances, the GRAT can be a powerful tool to transfer assets with minimal gift or estate tax consequences, but clients should carefully review their financial situation with both an experienced attorney and financial advisor before entering into such a transaction.

Gifting Strategies for Medical and Education Expenses

     As we touched on in our last blog, many strategies exist for using gifting as part of an estate plan. Today’s blog addresses some of the simpler planning opportunities available through gifting. In future blogs we will focus on the more sophisticated strategies.

     Tuesday’s blog discussed the Annual Gift Tax Exclusion, but it is important to note is that there is another, unlimited Gift Tax exclusion permitted for amounts paid by one individual in two circumstances:

1. On behalf of another individual directly to a qualifying educational organization as tuition for that other individual.
2. On behalf of another individual directly to a provider of medical care as payment for that medical care.

     A "qualifying educational organization" is one that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where it regularly carries on educational activites. It can be a primary or secondary school, including a vocational high school, college, university, or a normal, technical, mechanical school and similar institutions. . The Internal Revenue Code (the "Code") permits an unlimited exclusion for tuition expenses of full-time or part-time students paid directly to the qualifying educational organization providing the education. The Code does not permit an unlimited exclusion for amounts paid for books, supplies, dormitory fees, board, or other similar expenses that do not constitute direct tuition costs.

     "Qualifying medical expenses" are limited to those expenses defined in Code §213(d), but include expenses incurred for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body or for transportation primarily for and essential to medical care. In addition, the unlimited exclusion from the Gift Tax includes amounts paid for medical insurance on behalf of any individual. The unlimited exclusion from the Gift Tax does not apply to reimbursement for amounts paid for medical care by an individual. 

     While contributions to a qualified tuition program, such as a §529 plan do not qualify for the tuition exclusion above, they do enjoy treatment as a "present gift" that can qualify for the gift tax annual exclusion (currently $14,000 per year). The rules also allow the taxpayer electively to spread the contributions made in a single year over a five-year period. This means that grandparents can make a gift of $70,000 each ($14,000 times 5 years) to a §529 plan for a grandchild, for a total of $140,000 in one year, essentially "frontloading" a grandchild's education and allowing for a greater appreciation of the account. These gifts remove funds from the grandparents' estates, saving estate taxes on their deaths.  

     By using these gifting strategies, individuals can help their loved ones currently and reduce possible future estate taxation. Next week we will start discussing some of the sophisticated strategies used to increase the benefits of lifetime gifting in estate tax planning. 

Understanding the Estate and Gift Taxes

     One of the most misunderstood areas of estate planning involves the impact of Federal Estate and Gift Taxes. While most people understand they pay Federal Estate Tax on inherited assets and Federal Gift Tax on gifts made, few people truly understand what creates liability for these taxes and who is responsible for paying them.

     The first point to understand is that Federal Gift and Estate taxes are integrated into a single transfer tax under a unified rate schedule and with a unified credit that imposes a single tax on transfers during life and at death. The Internal Revenue Service group gifts and inherited assets together for purposes of determining total tax owed and the amount of assets excludable before payment of either Federal Gift or Estate taxes

     Let us begin with the Estate Tax. The estate of a deceased individual pays Estate Tax on the assets transferred to non-spouses at the individual's death. The estate tax rate is a sliding scale that tops out at 40%.  The Tax Code includes an Exclusion, which currently allows an estate to transfer $5,430,000.00 before incurring any Estate Tax liability. In addition to this large Exclusion, the Tax Code provides that any assets transferred to a surviving spouse are exempt from tax liability. In addition, any portion of the Exclusion that the estate of the first to die of a married couple does not use can be used by the surviving spouse's estate at his or her death. This ability, commonly known as Portability, means that a married couple will need to transfer nearly $11,000,000.00 at death before paying any Estate Tax. The Tax Code ties the Exclusion amount to the cost of living and therefore each year the Exclusion grows allowing ever-greater tax-free transfers.

     A person can choose to make gifts during lifetime instead of making bequests at death, making Gift Tax an important consideration. The person making the gift is liable for paying the Gift tax, if any is due. As indicated above, Gift and Estate taxes are integrated into a single transfer tax, so that the exclusion from tax becomes a "lifetime exclusion" rather than an exclusion at death. Any exclusion used during lifetime against Gift taxes will reduce the exclusion available against Estate taxes. 

     As noted above, we offset any Gift Tax against the Lifetime Exclusion before any tax becomes due. There is also another exclusion against Gift Tax--the "Annual Exclusion. A The Annual Exclusion on Gift Taxes allows any person to give up to $14,000 to any number of people, each year without creating any Gift tax liability. This means that a husband and wife together can give the each of their three children and their spouses $28,000 each year, reducing the parents' taxable estate by $168,000 each year without paying any tax on those transfers, and without using the Lifetime Exclusion. If our couple wanted to give their children additional amounts in a year, every dollar over $14,000 per beneficiary then reduces the parent’s Lifetime Exclusion.

     As an example, if the parents want to make a $200,000 gift to each of their three children so that the children can purchase a home, the parents can give a total of $28,000 to each child and $28,000 to each child’s spouse tax-free using the Annual Exclusion. The remaining $432,000 in gifts to the children and their spouses will reduce each of the parent's Lifetime Exclusion by $216,000 and reduce their remaining Estate Tax Exclusion by the same amount.

     In estate planning, we employ strategies that can increase the benefit of each of these Exclusions for people able to make substantial gifts. We will discuss some of these in our next blogs. 

Fairness and Gifting Across Multiple Generations

     Last Thursday we discussed a variety of ways to address clients' concerns regarding lifetime gifts made to their children. Issues such as these stem from the clients’ common concern for treating their beneficiaries equally. Another frequent sticking point when addressing fairness in distributions is a client’s desire to leave bequests to both their children and grandchildren. As clients begin to contemplate leaving gifts to multiple generations, the complexity of achieving fairness multiplies.

     One option when choosing to include grandchildren in trust distributions is to provide that each living grandchild receive a fixed sum prior to dividing the remaining trust assets among the client’s children. This ensures that the client treats each grandchild equally and that each child receives an equal share of the remaining estate. Alternatively, some clients elect to divide their entire trust estate equally between their children, but stipulate that from each child's share a specific dollar amount or percentage is set aside in trust for that child's offspring. While both of these methods ensure that each grandchild receives an equal gift, the second method reduces the gift to each of the client's children proportionate to that child's number of offspring.

     The second method for dividing the trust estate between the client's children and grandchildren requires the trustee to establish an equal share for each of the client's children as well as an additional equal share for the benefit of the client’s grandchildren. The share for the grandchildren is then subdivided, giving each individual grandchild in equal sub share. As with the first option discussed, this method ensures that every member of the same generation receives the same size gift but avoids making a fixed denomination gift to grandchildren that can potentially overwhelm the client's intention to provide for their children.

     A third method for making distributions that include grandchildren involves again dividing the trust assets equally between the clients’ children and then holding each child's share in trust. The terms of these trusts may vary, but a common choice is to provide that a portion of the income from each child's trust is distributed to that child automatically each year, while the remaining income and principal may be used for the grandchild's needs subject to an ascertainable standard. Following the death of the child, each of their offspring receives an equal share of any assets that remain in the trust. This technique, while requiring more substantial involvement from the trustee, allows the client to provide an annual gift to their child while also providing for their grandchildren's long-term needs.

     As you can see from these examples and as we have said before, distribution provisions are limited only by the client's imagination and our ability to draft to those desires. What is important to remember is that clients should not lose sight of their planning goals in order to ensure fairness among their beneficiaries. Engaging in the estate planning process and establishing a living trust serve to provide structure, guidance, and peace of mind to the client and their loved ones. When engaging in planning, clients should work with an experienced professional who takes the time to understand their family situation and assist them in creating documents that address the clients' wants and needs.

Adjusting Estate Plan Documents for Lifetime Gifts or Loans

Clients are often concerned with ensuring that they treat each of their children equally. Clients worry that imbalanced gifting between children, for example providing more funds to one child to attend a private university while their sibling attended a state school, providing one child with the funds to assist with the down payment on a house, or assisting one child with launching a business, will cause tension if not balanced out in the long run. This concern leads to a discussion about which children previously received gifts or loans from the parents and how to adjust the distribution of trust assets to children to be fair to siblings who did not receive such gifts and loans.

One of my favorite phrases with clients is "the only limitation on what you can do is your imagination." I have one client who has chosen to add a provision to his trust that states that all distributions to children whether as a loan or a gift are to be treated as a gift and shares of the children are specifically not to be adjusted for anything received during lifetime. Other clients want options that provide greater equality, but are more complex. While I am happy to provide those options, I will often suggest to a client he or she may want to consider what is "fair" for each child rather than what is "equal.”

There are a number of ways to adjust distributions to account for gifts or loans to children during the client’s lifetime. One example is to have the trustee add all loans and/or gifts made during the client’s lifetime back into the estate at death for calculation purposes. The trustee then provides an equal division for all children, adjusting each child's share for loans and/or gifts they received during lifetime. If clients elect to use this method to adjust bequests, careful records should be kept, to ensure that children are not penalized for loans that were previously repaid.

Another option is to provide a specific dollar amount for each of the children who did not receive loans or gifts during lifetime, which the trustee distributes from the estate before the equal division occurs. Again, good record keeping is important with this method to avoid creating an imbalance in favor of a different child.

There are number of other options, but it is clear that such clauses should be added to a client's documents only after a discussion with the client and careful drafting by a qualified professional.

Alan Ferrara

Planning for the Terminally Ill Client, Part II

     As we discussed last time, when a client becomes seriously ill or is diagnosed with a terminal illness it is obviously a trying time, but a complete review of their estate planning documents is important. We previously discussed the Durable Power of Attorney and the Patient Advocate Designation, but a client's Trust and funding documents also require review.
     The client may have neglected to update their Living Trust despite changes in the client's financial situation and family situation. Their estate planning documents require revisions because of these changes in order to avoid adverse consequences. Items to consider include:

1. The value of assets in the Trust may have increased dramatically since the last time the Trust was reviewed. Distribution terms for spouse and children may need to change because of the increase in assets. 
2. If the spouse or the other family members have been identified as being spendthrifts, the terms of distribution may need significant revisions. Rather than allowing for automatic distributions within the spouse's total discretion, an "ascertainable standard" as defined by the IRS, may be more appropriate so that the Trustee has the ability to pay or withhold principal and/or income for the spouse's benefit. 
3. The children who are beneficiaries may have creditor issues, unhappy marriages or destructive dependencies, which may require restrictions on distributions to protect them from themselves. 
4. If the client has remarried since the last time the Living Trust was reviewed and modified, provisions may be needed to protect the children of the prior marriage. While it is normal for the client to want to protect the current spouse as long as the spouse is alive, the trust should provide for the eventual distribution of principal to the client's children. Otherwise, the second spouse may be able to distribute assets to her family, disinheriting the client's children. 
5. Because of the increased size of the estate, or because of changing charitable inclinations, a client may want to make charitable contributions at death. 
6. The client may no longer be comfortable with those persons designated as Trustees and Successor Trustees to administer the trust assets for the benefit of spouse and children. 
7. A client may want to revise the trust to protect the current spouse demanding children or a second spouse. 

     In addition to carefully reviewing the trust distribution provisions, a client should review the ownership of assets to confirm that all of the assets have been transferred to the Living Trust or beneficiary designations revised where appropriate, in order to avoid probate upon the client the death. If not, these transfers should be made soon as possible.
     Once these changes are handled, the client can be comfortable that if the worst happens, loved ones will be protected.

Alan Ferrara

Buy Sell Planning As an Important Part of Estate Planning

When assessing a client's estate planning needs, it is important consider any business interests owned by the client. Business interests are frequently one of the client’s most valuable assets and absent other planning, pass according to the provisions of a client's Will or Living Trust. Unfortunately, often a direct transfer of the business interest to beneficiaries is not optimal for the operation or continuation of that business after the death of the client.

For example, if the surviving spouse or children have not been active in the business, their lack of operational experience can cause reduce the business’ value quickly or even cause the business to collapse completely, rendering it valueless. If the business is a large part of the client's assets and provides a good income stream, this scenario will pose a serious problem for the spouse and minor children if the business is lost. Another potential issue arises when only some, but not all, of the client’s children, are active in the business. If all the children receive equal shares of the business, the non-active children may try to manage the business without knowledge, again causing the value the business to decrease significantly. Alternately, the non-active children may demand the purchase of their interest by the children active in the business, creating substantial cash-flow problems.

However, by engaging in Buy Sell planning it is possible to significantly reduce the likelihood that such problems will arise. Buy Sell planning is also important when the client is not the sole owner of the business. In situations where a portion of the business is owned by a nonfamily member, but the deceased client's interest now goes to beneficiaries a Buy Sell Agreement can protect the nonfamily member and the business from new owners who,

• Have no interest in being a part of the business;
• Want to be part of the business but have no idea how to run it; or
• Are unrealistic about the value of the business.

All of these situations can decrease the value of the business, create cash flow problems if the beneficiaries demand a salary, or simply wish for cash in exchange for their interest.

All of these situations are common, however by executing a Buy Sell Agreement the business owners can proactively limit the chance that a sudden change of circumstance for one owner can bring down an entire business.

The primary benefit of a buy sell agreement is the protection provided to the health of the businesses. A Buy Sell Agreement typically provides that under certain circumstances, one of the parties has the right or obligation to purchase the interest of the other party for whom a triggering event occurred. The agreement typically provides for specific events, such as death, disability, desire to sell, or retirement that trigger the parties’ obligations to one another. Additionally the Buy Sell Agreement provides provisions for determining the value of the business interest and terms for the payment of the price over a fair time span to all the parties. Further, beneficiaries can receive fair value for their business interest over a reasonable period, without adversely affecting the health of the business. It is important to review and update the buy sell agreement periodically as the situation changes.

In circumstances where the potential for conflict exists between siblings or with non-family owners, the parties will "fund" the agreement with life insurance, to be paid in the event of the death of one of the parties. The life insurance proceeds pay the deceased's estate for the deceased’s share of the business and beneficiaries involved in the business operation or the non-family owner are free to run the business without interference. To the extent that the value of the business exceeds life insurance, the Agreement provides for the payment of the remaining value over a reasonable time, with reasonable terms.

I often meet resistance when I discuss a buy sell agreement with some of my business clients. That resistance usually melts away when faced with one of two questions:

1. "Do you want to be partners with your partner's spouse, if your partner passes away?
2. Will your children’s collective efforts result in the continued success of the business?

While client’s may like a partner’s family members, they are generally not interested in being partners with them and when they truly take the time to consider their children’s interests most clients acknowledge that ownership is better passed to particular children.

A business interest is often a large part of a client’s assets. A properly drafted Buy Sell Agreement is important to insure that beneficiaries benefit from that asset in the best possible manner. Having a Buy Sell Agreement allows a client's family to be treated fairly as part of the purchase agreement and allows the remaining parties to continue running the business with no management interference while purchasing the business interest for a fair price and at reasonable terms. This is why any complete discussion of estate planning issues is not complete without addressing the client’s business interests.

Pitfalls of Personal Property Distribution

     Personal property, everything that a person owns that does not have an ownership designation or title, can become the most difficult part of distributing an estate. Even if there are no arguments as to who inherits the property, personal representatives and trustees, may face substantial issues in distributing personal property. 

     One category of items where questions typically arise involves the distribution of firearms. In the majority of circumstances, the fiduciary can transfer firearms to designated beneficiaries when those individuals acquire the proper transfer paperwork from their local law enforcement agency. Problems, however, arise if beneficiaries reside in other jurisdictions, or if the designated beneficiaries cannot legally own firearms. 

     In the case of an out-of-state beneficiary, it is important for fiduciaries understand that federal law prohibits the transportation of firearms across state lines for delivery to another person without a proper license. An exception allows a beneficiary to transport such firearms, but that exception does not extend to personal representatives or trustees. Therefore, a beneficiary who stands to inherit firearms must come to the state where the deceased individual resided to claim their inheritance. If this is not possible, fiduciaries are advised to arrange for the transportation of inherited firearms through a licensed gun dealer. 

     In addition to problems arising with the physical transfer of firearms, fiduciaries must also confirm that the individuals named to inherit firearms are eligible to own such weapons under state and federal law. Failure to do so may expose the fiduciary to felony charges for disposing of the gun to a prohibited person. Federal law provides reasons why an individual may be ineligible to own a firearm, including: 

• Being convicted, in any court of, a crime punishable by imprisonment for a term exceeding one year; 
• Being a fugitive from justice; 
• Being an unlawful user of or addicted to any controlled substance; 
• Having been adjudicated as a mental defective or having been committed to any mental institution; 
• Being illegally or unlawfully in the United States 
• Having been discharged from the Armed Forces under dishonorable conditions; 
• Being subject to a court order that restrains such person from harassing, stalking, or threatening an intimate partner of such person; or 
• Having been convicted in any court of a misdemeanor crime of domestic violence. 

States may have additional restrictions against gun ownership. In these circumstances, the fiduciary must dispose of the firearms in a manner that complies with the decedent’s instructions but does not expose the fiduciary to liability for violating state or federal law. In many circumstances, the controlling document provides that the fiduciary may sell items of personal property and deliver the proceeds to beneficiaries. If this is not an option, the fiduciary should appeal to the Probate Court to amend the provisions of the controlling document in order to avoid exposing the fiduciary to liability for an illegal gun distribution. 

     In addition to firearms, fiduciaries should be aware of other regulated items that may appear in the personal property of an estate. This may include items made from parts of endangered species. Significant restrictions apply to the sale and transfer of such items. 

     A recent example of one such item occurred when the beneficiaries of a New York art dealer, Ileana Sonnabend, inherited Robert Rauschenberg's mixed-media work, Canyon. The piece, which contains a stuffed bald eagle affixed to the canvas is valueless because it is a felony under the Federal Bald and Golden Eagle Protection Act to sell any item made with any part of a Bald or Golden Eagle. The IRS determined that, despite being unsellable, Canyon had a fair market value of $65 million and sent the Sonnabend Estate an invoice for $29.2 million in estate taxes. The case eventually settled when the Estate agreed to donate the piece to the New York Museum of Modern Art, for public exhibition, in exchange for the IRS rescinding the tax assessment. While very few instances of personal property will rise to this level, artwork made out of ivory, the feathers of endangered birds, and items of archaeological significance may appear in the estates of older individuals who obtained such items when the transfer of such items was not subject to regulation. If the fiduciary discoverers any items of this nature in the process of inventorying the assets of an estate, it is important to contact professionals who have an expertise in the transfer of such items in order to protect the fiduciary from exposure to any criminal liability for the transfer of such items. 

     The distribution of personal property is not always as complex as the scenarios discussed in this writing, but it is important to discuss with clients the scope of their personal property in order to establish a plan that reduces any potential liability for future fiduciaries. It is also important to work with fiduciaries to ensure they are aware of the laws that may expose them to personal liability as they execute those roles 

     If you have questions or concerns regarding specific items please do not hesitate to contact us and we will be happy to discuss those questions and assist in creating a plan that addresses those concerns

Funding Retirement Benefits to a Living Trust

As part of the trust funding process, I normally suggest that clients change the beneficiary designation of their IRAs and retirement benefits. Most of the time, I suggest that their spouse be the primary beneficiary and the Living Trust be the secondary or contingent beneficiary, because spouses receive better distribution rights under federal law with respect to retirement benefits. If the spouse predeceases the account owner, or if it makes sense for other reasons for the spouse to disclaim the retirement benefits, the benefits then fall to the Living Trust where, in all probability, the spouse remains the primary beneficiary and if the spouse has already died, the beneficiaries of the Living Trust become beneficiaries of the retirement benefit.

After contacting their financial professional, clients will often call me concerned because their financial professional warned them against designating the Living Trust as beneficiary of the retirement benefits because their children will not be able to "stretch out" the IRA over their lifetime, and the entire benefit will be taxable immediately. While this advice may be well meaning, it is often incorrect.

The Internal Revenue Code (the "Code") and Regulations provide that a "designated beneficiary" can use the provisions which allow a beneficiary to take minimum required distributions (MRD's) over their life expectancy. Normally, only an individual can be a "designated beneficiary", therefore a Living Trust ordinarily is not a "designated beneficiary" because it is not an individual. There is an exception to that rule and, if the trust document meets certain requirements, then the Living Trust is considered a "see-through" trust and the regulations treat the beneficiaries of the Living Trust as designated beneficiaries of the decedent's retirement account. To achieve “see through” status, the Living Trust must meet the following requirements:

1. The trust is a valid trust under state law, or would be but for the fact that there is no corpus.
2. The trust is irrevocable or will, by its terms, become irrevocable upon the death of the account owner.
3. The beneficiaries of the trust with respect to the trust's interest in the employee's benefit are identifiable from the trust instrument
4. Required documentation has been given to the Plan Administrator. The Plan Administrator must receive a copy of the trust instrument and a list of all beneficiaries of the trust with a description of the conditions on their entitlement.

If the trust meets all the requirements then the Living Trust beneficiaries are deemed “designated beneficiaries", entitled to receive their MRDs over their life expectancy.

The next issue when a Living Trust is the beneficiary of IRA benefits usually arises at the account owner's death. At that point, clients want to know whether the beneficiaries can split the “inherited IRA” into separate IRAs and make their own decisions about how distributions are made. Generally, "inherited IRAs" received by beneficiaries other than a surviving spouse, cannot be rolled over to their own IRA, but the account can be split into separate IRAs for the trust beneficiaries using the designation "John Doe IRA for the benefit of Beneficiary A", etc. Beneficiaries can then decide the manner in which they want their IRA distributed. One beneficiary may take a lump sum distribution, pay the tax and invest or spend the rest. Alternatively, a beneficiary can decide to take MRD's over their designated life expectancy, deferring income tax until future distributions are made.

Along with the question of splitting an “inherited IRA”, is the question of whether the MRD's are based on each beneficiary's own life expectancy or on the life expectancy of the oldest beneficiary.

Regulations §1.401(a) (9)-8, A-2 provides the general rule that if the account owner's benefit is divided into separate accounts no later than the last day of the year following the calendar year of death, distributions subsequent to the division are treated as separate accounts and each beneficiary of each separate account can use his/her own life expectancy in determining minimum required distributions each year. However, this rule does not apply to beneficiaries receiving a "separate share" through a trust that was the beneficiary of an IRA. Therefore, even if beneficiaries split the IRA into separate accounts for each beneficiary, all the beneficiaries must use the life expectancy of the oldest beneficiary of the Living Trust in determining their MRD's.

The law and regulations governing “inherited IRAs” is both vast and complex, before designating beneficiaries of retirement benefits, you should consult with a professional expert in that area. At the death of the account owner, it is important to seek additional advice as to the best way to retitle the accounts or distribute the assets. These experts should take the time to understand your unique situation and provide you with an understanding of the consequences of decisions, not just provide you with the forms needed to make changes.

Talking About an Estate Plan

As we discussed previously, the estate planning process does not end with the signing of the documents. One aspect of the process that is the client’s responsibility involves discussing planning with those individuals named to make decisions and potentially with beneficiaries.

In our practice, we have found that the best plans are ones where everyone involved knows the plan and there are no surprises. This does not mean that the client need to discuss every detail of their estate with every person named in the documents. However, providing those whom the plan most affects with sufficient information makes execution of the plan significantly easier.

First, it is important to inform those people who have been designated to make decisions upon the client’s incapacity. We encourage our clients to discuss this prior to the signing, therefore avoiding a situation where a named individual intends to immediately step aside. Talking with your named designates ensures that all of the individuals named in an estate plan are willing to act if called upon, and decreases the chance that the probate court will become involved in naming a successor designee. Additionally, it is important to inform those designees where those executed documents are kept so they can be located easily in the event the need to step in arises.

In addition to informing those individuals named as designees of their potential roles and duties, it is also important to discuss with these people the client's concerns and desired treatment if called upon to act. It is important to provide designees with sufficient information regarding values, beliefs, and wishes so that they are able to make decisions that they feel are in the client's best interest and reflect decisions that the client would make were they not incapacitated. Frequently these discussions will touch upon sensitive topics such as the circumstances under which the decision to withhold medical treatment is appropriate. Many clients express a reluctance to have such discussions due to their sensitive nature. If a discussion does not occur, at a minimum we recommend providing a letter with instructions regarding those issues. The letter can be kept with the Patient Advocate Designation.

The importance of establishing guidelines for designees is not limited to those named as Patient Advocate. Should a client become incapacitated, those who will act on their behalf as Successor Trustees under the Trust and Attorneys in Fact under the Durable Power of Attorney must also be aware of the client's overall goals. Both of these roles may involve providing access to assets for dependents, continuing the client's charitable gifting, and the operation of the client’s business. If those individuals named are not familiar with the client’s desires, it makes acting on behalf of the client significantly more burdensome. Again, the client can provide many of these details in a separate writing that is kept with the relevant documents. Important information to be contained in this writing includes specific instructions as to what should be done with particular assets should the client become incapacitated, instructions for the continuance or modification of charitable giving, and instructions regarding the operation of businesses to name a few.

In addition to designees named in documents, others may benefit from receiving advanced information about the terms of an estate plan. Providing beneficiaries with information regarding potential inheritances establishes reasonable expectations and reduces the chances that a beneficiary will challenge the terms of the estate plan. How much information a client chooses to give to a beneficiary depends on the family situation. There is no correct answer to this question, as the right amount of information can vary significantly from client to client and even from beneficiary to beneficiary. Where some beneficiaries have sufficient experience and maturity to provide them with the full details of their potential inheritance, others may misuse such information and engage in patterns of reckless or irresponsible behavior.

It is been our experience however, that beneficiaries who are informed of distributions for their benefit in at least general terms create the least amount of problems following a death. When beneficiaries have an understanding of the donor's reasoning in making the gifts they make, there is often less conflict following the death. This is not to say that a discussion of potential distributions solves all problems. There are individuals who, upon learning of their share of an estate, will always feel they have been treated unfairly.

In addition to discussing the specific distributions laid out in the in the estate plan it is also frequently beneficial for a client to discuss the distribution of their personal property. By learning which items of property their loved ones feel will provide a connection to the client after death, the client is better able to ensure that their loved ones are able to retain those items and the memories associated with them. When a client discovers that multiple loved ones have an interest in the same items, it is possible to head off conflicts by designating particular individuals to receive particular items so that disputes do not occur following a death, avoiding further pain during an already difficult time.

Discussing estate planning, medical concerns, and death are difficult subjects. However like much of the rest of the estate planning process, by engaging in these discussions while people are healthy and active, it is possible to avoid a great deal of trouble should a person become incapacitated or after they have passed away. In our practice, we strive to provide clients with peace of mind that their loved ones will be cared for following their death. By encouraging our clients to engage in discussions regarding their planning we hope to avoid potential pitfalls and awkward situations as well as additional grief, strife, or problems after a client's death.

Keeping a Vacation Home in the Family

A number of my clients have family vacation homes or cottages that they and their children have enjoyed for many years. After getting so much enjoyment from owning the cottage those clients often ask how they can set up their estate planning documents to ensure that when they die, that ownership experience passes onto their children and grandchildren. While, in theory, this may be a good idea, it often creates significant problems if a not fully thought out and planned.

One issue that often causes an issue is the gift tax consequence of transferring a valuable piece of property. However, because of the most recent tax legislation, most people have a sufficient exemption amount so that gift tax is not an issue.

Transferring cottages to other family members can create thornier issues because of personal relationships. While family members may have enjoyed their time at the cottage, for many reasons they may have no interest in owning the cottage with their siblings or other family members. Issues that can arise include:

1. What is the most efficient manner of ownership of the cottage?
2. How to insure that the cottage remains in the "family"?
3. How to establish rules for the management and use of the cottage?

Generally, traditional forms of joint ownership, such as tenancy in common and joint tenancy with rights of survivorship, are inefficient methods for family ownership of the cottage. The primary risk in these types of ownership is that over time the ownership interest is subdivided or fractionalized as it is passed down to subsequent generations. While it is the dream or wish of the parents that the children continue to enjoy the cottages they have in the past, as family members grow into adulthood they may have different ideas. A family member might not have had a great experience at the cottage, may live too far away to be able to enjoy it, cannot afford the share of the cottage expenses, or may simply prefer the value of the cottage in cash to use as they may choose. With tenancy in common or joint tenancy, a family member may try to use his or her partition rights under state law, forcing the sale of the cottage or vacation home.

Co-ownership of the cottage may lead to other conflicts, such as:

1. Who controls the operation of the cottage?
2. How are operating, maintenance or repair expenses shared?
3. Who determines when and what improvements to make and how to pay for those improvements?
4. How are the most desired dates for cottage use determined or allocated among family members?
5. Are pets allowed?
6. Can family members rent their time to third parties?
7. Are nonfamily members, such as spouses and siblings, allowed to own an interest in the vacation home?
8. What happens if a family member wants to sell his interest in the cottage?

While many of these issues do not exist while the parents are alive because the parents pay all expenses of the cottage and determine how it is used, after the death of parents, these issues and others can create family disagreements or even permanent rifts.

 If the parents are still interested in trying to establish a "family cottage," a limited liability company (LLC) is an ideal ownership vehicle. An LLC has a perpetual existence. Parents can transfer the property to an LLC and then gift interests in the LLC during lifetime or at death to other family members. The LLC as an entity can protect owners from lawsuits by users of the cottage if injured on the premises. It can also prevent owners from being able to use the right of partition in order to sell the property. If used with a properly structured operating agreement, it can promote shared use and fair governance of the property.

It is possible to use an LLC operating agreement to meet the goals of the family, and should include:

1. A determination of who is the manager of the LLC--all members or a named managing member.
2. A procedure for determining what maintenance or improvement is to occur on the property and a method of allocating associated expenses.
3. A method of equitably allocating among family members the dates for using the cottage, especially during holidays, school vacations and most ideal seasons.
4. Rules for members using the cottage, including restrictions on allowance of pets, ability to invite guests, and the ability to rent out the member's time to outside parties.
5. A method for penalizing a member for violation of usage rules and/or failure to pay the required contribution for expenses.
6. A method for determining the transfer of member interests, including price and terms, for any member desiring to sell their interest. This could include a restriction on any sale to a non-family member.

While gift and estate taxes are unlikely to cause an issue, the consequences in regards to property taxes should not be forgotten when considering the transfer of a vacation home. Under Michigan law, if you convey less than 50% of ownership in real estate to others, there is no change in the property tax assessment rules for determining taxable value. Parents can gift up to 49% of the property to family members without any real estate tax consequence. If they prefer, the parents can first transfer the property to an LLC and then transfer 50% of the LLC to family members.

Because property values are still somewhat depressed, this is an opportune time to transfer the vacation property to family members and move value and future appreciation to family members and out of the parents' estate, while continuing to allow parents to maintain control of the asset.

While parents have the best interests of their family at heart, trying to maintain a vacation home in the family for a number of generations can create a nightmare scenario. It makes good sense to discuss this strategy with qualified counsel and the family itself to make sure there is sufficient interest to maintain the family cottage for future generations and to properly structure the transaction.