Too Many Irons in the Fire – Malpractice XIII

Trustees should be independent and remember their fiduciary duties.

Tim and Julia Brennan, both 66 years old, created a standard charitable unitrust and sold some highly appreciated bank shares through it three years ago.  It made great sense as a way to minimize their capital gains liabilities, and passing the remainder to a charity was an acceptable cost, even though neither was particularly charitably oriented.  Their financial advisor on the transaction convinced them that the “perfect investment” tool inside their CRT should be a deferred variable annuity.  While using a deferred annuity is frequently a legitimate planning tactic inside a NIMCRUT that operates as a “spigot” trust, it is generally not the best tool inside a traditional CRUT. Why not?  Because there is no need for the trustee to accept the compromise of highly taxed ordinary income payments instead of more tax efficient tier two capital gains.  Using a deferred annuity turns a capital asset into an ordinary income stream, and since the top rate for tax on ordinary income is nearly twice that of capital gains, there is an unacceptable penalty for the use of this product.  If this was a net income trust there would be a need to control distributable net income, but a commercial deferred annuity usually does not work that way inside a SCRUT or CRAT.  While there may be reasonable differences of opinion about the best funding mechanisms, in the Brennan case, their financial advisor seemed to have motives that put his needs ahead of his clients’

Where did this train wreck fall off the rails?  Prior to helping the Brennans set up their charitable remainder trust, the life insurance agent had no experience with CRT management issues or the obscure rules associated with §664 trusts, but he knew there were opportunities to provide wealth replacement in the form of a life insurance contract.  The agent attended an advanced marketing program and learned that in addition to the insurance, a variable annuity was touted as the “perfect investment” inside a CRT.  Unfortunately, the marketing staff was more interested in pushing product instead of solving problems, and they neglected to disclose the down side of using an annuity inside the charitable remainder trust. 

What down side?

The first problem that popped up was that this annuity contract had a limit on the number of distributions and the value of penalty free withdrawals.  Where this developed into a serious problem was when the equity market free-fall in 2000 through 2002 dropped the annuity value to a level that restricted the required quarterly unitrust distributions.  Once the annuity dropped in market value by over 50 percent, then the required payments triggered the insurance company’s penalty.  Because the annuity company had no experience with charitable trusts, it was issuing a 1099-R for all of the payments made to the income beneficiary, but that causes a problem because income beneficiaries should receive a K-1 from the CRT, not a 1099 from the carrier.  The second problem was that the agent who sold annuity had himself named trustee, and he convinced the Brennans that because the annuity was not liquid enough to make the required distributions, the trust would not be able to meet its obligations.  The third problem is that the trustee neglected his fiduciary responsibilities, i.e., the duty to look out for both the income beneficiary and the charitable remainder beneficiary.  By keeping the charitable trust invested in an underperforming annuity, he harmed both beneficial interests.  The trustee, as an insurance producer, knew that if the trust terminated the contract he might be required to refund the sales commission on the initial purchase and lose the ongoing trail commission, so there was an existing conflict of interest that may have influenced his decision to do nothing about dumping the annuity.  This is one reason why insurance carriers and the National Association of Securities Dealers (NASD) prohibit a registered representative from acting as a trustee for a client’s trust.

Even if the CRT is a properly drafted irrevocable trust, as long as it does not operate as a CRT it is not going to qualify as a tax-exempt charitable remainder trust.  It is important to understand that standard unitrusts and annuity trusts do not have discretionary authority to pay less than the appropriate amount as stipulated by the trust document.  Occasionally trustees make errors, and make incomplete distributions, but an ongoing pattern of missed or improper payments exposes the trust to grantor status and loss of its charitable remainder trust protections *

* Atkinson v. Commissioner, No 01-16536 (11th Cir.,Oct. 16, 2002), Atkinson v. Commissioner, 115 T.C. 26 (2000)

Paving over Farmland – Malpractice XII

Keep those tax notes updated.

John and Julia Ramirez have a citrus grove in what is turning into a rapidly growing neighborhood.  They have drawn the unwanted attention of a number of buyers seeking large tracts of agricultural land for its commercial and residential potential.  Additionally, because they possess senior water rights, a nearby city has been pressuring them to sell the rights to develop wells and add capacity to the city’s water system.  Rising property tax rates and increased suburbanization have added further pressure to sell out and move on, especially when they routinely find youngsters prowling around their equipment and getting into mischief.  These liability concerns have forced them reluctantly to accept the inevitable and sell out to commercial developers, and one of their advisors has suggested a charitable remainder annuity trust and a private foundation to minimize the tax hit on the transaction.

Generally, a CRT is a good idea to defer capital gains recognition, especially if the family has charitable inclinations.  However, a CRAT is a poor choice for most real estate sales because of its limitations and rigidity.  A better choice would be a custom drafted unitrust (CRUT) because it offers more flexibility.  Whether they choose a standard CRUT, “FLIP-CRUT”, or a NIMCRUT depends more on the family’s need for control, flexibility and a predictable income stream, as the income tax benefits and basic structure is the same for all three variations of the CRUT. 

Besides recommending the wrong charitable trust, their advisor’s assumptions about using a private foundation as a remainder charity are probably incorrect as well.  Although private foundations previously offered a fair market value income tax deduction for gifts of appreciated assets, after 1998, the rules changed and the more favorable tax treatment is now limited to just cash and appreciated qualified (publicly traded) securities.  If land is used, the income tax deduction is restricted to basis or cost when private foundations are the eventual recipients.  A better choice for tax efficient gifts with hard to value assets like farms, commercial real estate, or residential property would be a CRT with a public charity or, if ongoing family influence is desirable, a donor advised fund inside a community foundation is used instead. 

Why would a donor advised fund be a better choice?  It is simple, easy, and less hassle.  The umbrella charity provides oversight and compliance, spreads the cost of operation over many funds, offers economical management, and still provides for a donor to make recommendations in support of his or her charitable interests.  Many legal and tax commentators routinely suggest the use of a private foundation when contributions exceed $5 million, others suggest that $10 million is more appropriate when families seek to create legacies and provide for ongoing family management.  However, when transferred assets are more modestly valued, then the donor advised fund offers the same immediate tax treatment as that of a public charity with some of the advantages and donor continuity of a private foundation.  Remember to consider all of your options; charitable planning involves irrevocable tools and for this planning to work, articulate specific philanthropic goals.  Too many planners and families allow tax deductions to drive the process instead of treating it as an ancillary benefit.

* closely held stock, commercial real estate, farms or ranches, life insurance policies with cash value, patents, personal residences and vacation homes, retirement plan assets (via beneficiary designation), securities, unimproved property

** art, collectibles or other tangible personal property, equipment or inventory, royalties, copyrights, ordinary income assets

*** Electing “step-down”, uses basis against AGI instead of FMV with 3% itemized deduction reduction rule.

©2003 — Vaughn W. Henry

Vaughn W. Henry

Henry & Associates

CONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR YOUR OWN CRT SCENARIO or try your own at Donor Direct Please note — there’s much more to estate and charitable planning than simply running software calculations, but it does give you a chance to see how the calculations affect some of the design considerations. This is not “do it yourself brain surgery”. When is a CRUT superior to a CRAT? Which type of CRT is best used with which assets? Although it may be counter-intuitive, sometimes a lower payout CRUT makes more sense and pays more total income to beneficiaries. Why? When to use a CLUT vs. CLAT and the traps in each lead trust. Which tools work best in which planning scenarios? Check with our office for solutions to this alphabet soup of planned giving tools.

Estate Planning Isn’t Just for the Elderly

You don’t need to be rich and famous to need an estate or financial plan.  While some people have the expertise and time to manage their affairs, others are more comfortable with the advice and counsel of professional consultants.  In either case, decisions need to be made ahead of time so you’re not stampeded into making bad choices when things start to go wrong.  First off, decide how comfortable you are with your current financial situation.  Then decide whether you need professional assistance to sort through your options.  One of the earliest questions you need to address is what happens if you are unable to manage your affairs competently down the road.  Besides accidents and acute emergencies, there are chronic and progressive illnesses that prevent people from being able to enforce their wishes and keep on top of their finances.  In either case, do you have a trusted family member, friend, or a professional advisor who can handle your money if you become incapacitated or ill?  Have you made any decisions, and shared them with family members, about the level of care and extraordinary treatments needed should you become seriously ill? 

It’s Not Always about Money

Often, arranging your affairs is more about preserving dignity and control.  Sometimes estate planning is a function of life planning; doing simple things like modifying your residence to accommodate your physical restrictions will make things easier.  For example, many people choose to widen doorways, lower light switches, install rails and bars in bathrooms, or to build ramps or lifts for stairs in order to make the home more comfortable.  Occasionally there are other emotional concerns about losing independence.  Distasteful as it may be, address them now, rather than later.  For example, do you still feel safe driving, even at night?  The problem is that many older drivers deny they have a problem or are so cognitively impaired they fail to recognize the cues that signal problems, e.g., forgetting to turn on headlights at dusk, getting lost in familiar neighborhoods, failing to recognize mechanical problems like low tire pressure, responding too slowly to emergencies, and so on.  Family members and advisors need to step in and offer to help structure or organize things so you can minimize danger to self and others.

Other difficult questions the elderly often avoid include quality of life issues.  Is there adequate health and long-term care insurance?  Is hospice or home care an option with your coverage?  Some of this preparation involves discussions with medical providers about some very personal values.  For instance, when you’re very sick, how much information do you want your physician to relate to you and your family about diagnoses, treatments, and recovery outcomes?  How involved do you want to be in decision making for your health care?  Will you authorize and insist on pain medication if circumstances dictate its need, even if it’s not part of your medical treatment?  Values planning issues involve medical, personal, emotional, and spiritual matters, so you need to discuss this with your family and physician if you expect procedures to be done according to your wishes.  Not only will you want to stipulate how you want to be treated, part of a good estate plan allows you to tell family important things they should know.  Itemize your thoughts in an “ethical will” where you not only tell heirs what you want them to receive, but why you want them to receive it and how your life developed over time.  It’s a great opportunity to leave your family a little something about yourself.

Have you made a list of all the important information that would be useful in case of family health emergencies?  Have you discussed your funeral arrangements?  A little preparation will save a lot of grief and expense; so make your choices now and regain control of your life planning.  There is no time like the present to get started; you’ve put it off too long.

Information Checklist

1. Birth certificates, marriage certificates, passports and other important identification documents, any court documents dealing with a name change or adoption proceedings
2. Marriage contracts (pre-nuptial and post-nuptial, divorce or separation agreements)
3. Life insurance policies (have you checked to see if beneficiary designations current and accurate?)
4. Identify other insurance policies (disability, affinity programs, health, property & casualty, and annuity contracts), insurance agent contact information
5. Stock and bond holdings, consolidated investment account statements, broker contact information
6. Powers of attorney for health care and property, living will or advance directive documents, while not helpful after death, they are extremely important if there is a disability or incompetence.
7. Your will and codicils (have you identified guardians for minors and elderly parents?).  A list of personal items and the intended recipients, as it is often the family heirlooms that cause family rifts.  If any mementos are given away early, mark them off the list so they will not be reported missing or stolen.
8. Trust documents and amendments (properly titled property in the name of the trust)
9. Trustee, and successor trustee contact information if any, and contact information for your lawyer
10. Mortgage documents, due date and amount of mortgage payment or rent, location of deeds and property titles, including cemetery plots, any lease information
11. Contact information for service people.  Identifyautomatic debits or deposits and which accounts are involved (electric utilities, gas, pension payments, etc.), automatic deliveries or pick ups that need to be modified (trash, fuel oil or propane, mail, newspaper)
12. Bank account information, checkbooks, passbook savings, account statements and PIN numbers, contact information for bankers or brokers, inventory of contents and location of safety deposit box and the key, credit card and ATM account numbers and their expiration dates; if there is a safe, who will have the combination
13. Airline mileage points and phone numbers, life insurance provided by affinity groups, travel or credit card companies
14. Partnership agreements, recent appraisals, corporate or partnership buy-sell arrangements, business continuity planning documents
15. Pension, profit-sharing, IRA and other retirement plans (are beneficiary designations current now that new rules apply to changing required distributions), retirement plan administrator contact information.  If there’s a desire to support a charity with a bequest, these retirement plans make great, tax efficient ways to fund philanthropic interests with simple beneficiary designations.
16. Contact information for your medical providers, current medications and dosages, Medicare claim number and Medigap policy number
17. Employment contracts, deferred compensation or “golden parachutes/handcuffs” type agreements
18. Any life income arrangements (commercial immediate annuities, charitable trusts, life estates)
19. Social Security card
20. Veteran’s benefits updated and military discharge paperwork, e.g., DD-214
21. Organ donation instructions, funeral arrangements and burial instructions
22. Directions for pet care
23. Recent income and gift tax returns, contact information for your accountant, current 1099’s and W-2’s, expense and income worksheets for this tax year
24. Inventory of capital assets (real estate, stock, investments, collectibles, etc.) with purchase price, history of acquisition, improvements and tax basis (which will be extremely important if the tax laws continue unchanged)
25. Driver’s license number and expiration date, vehicle registration information, inventory of any items in storage and storage company phone number
26. Any post office rental box, contact information for neighbors and friends, a list of names and phone numbers of those who should be notified during a serious illness or death
27. Web site or e-mail accounts and passwords
28. It is not too early to write an obituary while the person can contribute to it

am a nurse working in head injury research.  Someone mentioned that they didn’t know the statistics for

equestrian related head injuries.  Well, have a few sources here and will provide some of them for you.

Sports Medicine 9(1):36-47, 1009

Synopsis:  The most common location of horse-related injuries is:

         upper extremity 24-61% (reported in different studies)

         lower extremity 36-40%

         head and face 20%

The most common type of injury is:

         soft tissue injury 92%

         fractures 57%

         concussion 15%

The most frequent consequence of injury is:

         hospitalization 5%

         residual impairment 2% (i.e. seizures, paralysis, cognitive impairments, etc)

         death 1%

JAMA, April 10, 1996, vol 275, no 14, p. 1072

Synopsis:   During 1992-93 in Oklahoma, horseback riding was the leading cause of sports-related head injury, (109 of 9409 injuries or 1.2% associated with riding and 23 additional injuries attributable to horses)  Of the 109, there were 3 deaths (3%).  The injury statistics were:

         males 55, female 54

         age range 3 yr to 71 yrs, median 30 yrs

         most commonly seen in spring and summer

         48% occurred on Saturday or Sunday

         95% involved riders who struck their heads on the ground or a nearby object after falling from the horse

         4% were kicked or rolled on after falling from the horse

         1% hit head on a pole while riding and fell to the ground

         90% were associated with recreational activities

         10% were work-related

         107 were hospitalized with a median LOS of 2 days

         79% had one or more indicators of a severe brain injury, including

1.        loss of consciousness 63%

2.        posttraumatic amnesia 46%

3.        persistent neurologicsequelae 13% (seizures, cognitive/vision/speech deficits, motor impairment)

Among the 23 injuries not riding related, 21 (91%) resulted from a direct kick to the head by the horse, where died immediately and 2 required CPR.  13 of these injuries occurred in children less that 13 yrs old.

Journal of Trauma 1997 July; 43(1):97-99

Synopsis:   Thirty million Americans ride horses and 50,000 are treated in Emergency Departments annually. Neurologic injuries constitute the majority of severe injuries and fatalities.  A prospective study of all patients admitted to the University of Kentucky Medical Center with equine-related trauma

from July 1992 – January 1996 showed the following:

         18 of 30 (60%) patients were male

         11 (37%) were professional riders

         24 (80%) were head injuries and 9 (30%) were spinal injuries (4 with both)

         age ranged from 3 to 64 yrs

         patients died (17%)

         2 suffered permanent paralysis (7)

         60% were caused by “ejection or fall from horse”

         40% were kicked by the horse, with 4 of these sustaining crush injuries

         6 patients (20%) required craniotomy (i.e. brain surgery)

         24 patients (80%) were not wearing helmets, including all fatalities and craniotomy patients

“Experience is not protective; helmets are.”

This last line is a direct quote from this article.  hope you find these statistics helpful.

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