A Slightly Different Take...

I came across this article by the Tax Prof Blog, edited by Professor Beyer. It relates to Nancy Silverton, who previously sold her restaruant in Los Angeles, La Brea Bakery, for $5 million. But she then lost all of it after she gave it to Bernard Madoff for investment. Madoff is alleged to have swindled investors to the tune to the total of $50 billion.

Of course, the primary lesson here is that she should have diversified her investments instead of simply giving it all to him. She didn't do this, and lost all of her retirement funds and also her childrens' college funds.

The secondary lesson here (for me) is her attitude. At the age of 54, she might be tempted to curl up into a ball and to give up. But here are her comments:

"I was silly and I learned a lot," said Silverton, 54, who is an owner of Pizzeria Mozza and its neighboring Osteria Mozza in Hollywood. "I will never not diversify."

Here is some more...an even more interesting reaction:

"I need to reinvent my life," said Silverton, who co-founded the landmark Campanile restaurant and La Brea Bakery with her ex-husband, Mark Peel, and another partner. "To think you have a chunk of money is very comforting. Now, I'm just like 99% of the world. If I had to retire tomorrow, I could not."

She also needs to "build something" again for her three children, ages 15, 23 and 26. "They don't have any of that savings."

I love (and could learn a lot from) her attitude. I'll bet that she does "build something" else.

Treasury to Seniors with IRAs: Drop Dead

In an earlier post, I noted that Congress has passed relief from the Required Minimum Distribution (RMD) requirement for Traditional IRAs for the 2009 tax year.

But I have a close relative who is howling, because he is now required to take RMDs for 2008 with his portfolio at firesale prices. His stock and fund holdings are (like almost everyone else) in the proverbial toilet -- so he's taking a bath. Unfortunately for him, and all other Traditional IRA owners over 70 1/2 years of age, the Treasury Department will not give relief for this tax year. Relief will only occur next year.

In a letter to the House Education and Labor Committee, the Treasury Department reasons:

The Treasury Department and the Internal Revenue Service have determined that any further change to the required minimum distribution rules should not be undertaken. The scope of Treasury's ability to make administrative changes has constraints. Thus, any steps Treasury could take would be substantially more limited than the relief enacted by Congress and could not be made available uniformly to all individuals subject to required minimum distributions. In addition, implementation of such changes would be complicated and confusing for individuals and plan sponsors. Thus, all individuals who are subject to required minimum distributions for 2008 should take their distribution under the existing rules and, as a result of relief provided by Congress, they will be entitled to a complete waiver of the requirement to take any distributions for 2009.

Ever Wonder What Can Happen When You Don't Update Your Estate Plan?

This is a somewhat odd story because it is extreme. Still, the consequences are not that unusual.

Martin Sowell is a 43 year old Ohio man who tried to kill his adoptive parents when he was 17. He tried to poison his father and then tried to shoot him as he fled (three shots, all missed). However, he successfully pumped three bullets into his mother's back. Somehow, both survived.

One aspect of the story is the fact he received only a year in juvenile hall for attempted murder, and that he was released at 18. But that is a different story, for a different day.

Another aspect is that even though his parents attempted to effectively disinherit him by giving him only $50 of their substantial estate, they also failed to update their wills. As a result of failing to name a contingent heir, Sowell now stands to inherit $500,000 after his last surviving parent, his father, passed away.

As stated in the Coshocton Tribune story:

According to the almost identical wills, both the Sowells named each other as their sole heir, with no mention of secondary heirs after they both died.

"It's a mess, a classic example of what happens when you don't update your will," said John Polito, chief magistrate and administrator in Probate Court. "The way it was written, it was as if they had no wills."

(Hat tip to the Ohio Trust and Estate Blog for this interesting but unfortunate story)

To Hell and Back...

Whoa.

I recall hearing in the media a few years ago of a "kinder, gentler" IRS. I guess even it were possible for perhaps the largest and most aggressive collection agency in the world to be "kinder" and "gentler". . . this probably isn't the best case to point that out.

A few days ago the U.S. Tax Court reported Nicholas v. Commissioner, T.C. Summ. Op. 2008-155 (Dec. 15, 2008), where the IRS chased a religious couple literally to hell and back for a delinquency of $712.

As they did every year, the couple donated almost half of their income to charity; in 2005, they donated $43,637 of total income of $89,092. However, in 2005 their accountant made a mistake, listing all contributions as "cash" contributions, even though $4,906 was noncash. Discovering the error, the couple filed an amended return, filing a Form 8283 for the $4,906 noncash contribution.

The IRS apparently flagged the return, and disallowed the $4,906, claiming a delinquency of $712.

Fortunately, the Tax Court was less than impressed with the IRS, and allowed the full deduction. Here is a portion of the decision:

For the 2005 tax year Mrs. Nicholas maintained notes on envelopes and on other documents recording the types of asset,names of charitable recipients, costs, and estimated values of petitioners’ noncash contributions. In substantially all instances petitioners had a receipt and/or letter from the charitable recipient. As is typical with contributions of assets valued under $500, the charitable organization left it to the donor to fill out the items and values, which Mrs. Nicholas did. Although Mrs. Nicholas did not have receipts to substantiate the original cost of each item, she had been the purchaser and had recollection of the amounts. More critically, Mrs. Nicholas frequented garage sales and flea markets and had a keen sense of the value of her contributed items. The items contributed included books, CDs, used furniture and lamps, and similar types of items. Petitioners were avid readers and accumulated large volumes of books which they stored in their home. Many of the books concerned religious topics, and some were children’s books that petitioners regularly purchased for their children. On regular occasions, as books and other items accumulated, Mrs. Nicholas would make a trip to the Salvation Army or some other charitable organization and make a donation.

(Hat tip to Professor Caron's Tax Prof Blog for pointing this case out)

Discount Wars, Part II

I must admit: I have been hesitating to write this second installment to Discount Wars. The first part is here. In my last post on this subject I detailed how the IRS is using a certain provision in the Internal Revenue Code, specifically Section 2036, as a weapon to attack the discounting of Family Limited Partnership ("FLP") interests. Transferring property to an FLP is a technique sometimes used to reduce estate taxes in large estates.

The reason I have hesitated in writing this second installment, quite honestly, is that after posting Part 1 I realized that I would have to actually explain IRC §2036, this IRS weapon of choice. Section 2036 is hardly light reading. In effect, I "blogged" myself into a corner (assuming that the word "blog" is a verb.) But, here goes…

First, as a preliminary explanation: There are certain sections of the Internal Revenue Code providing that certain "gift" transfers to others remain in the giver's estate for estate tax purposes. The reason is simple: Givers don't always transfer all of their interest, but often want to keep something back. Many of us get confused with this, in that we think of a "gift" as just that -- something we completely give up our right to. Not many of us give a Christmas gift, and say to the recipient, "don't get too attached to that new Rolex watch. I might call you next week and demand it back." But making a "gift" that is completely revocable (as in this most extreme example) would place this "gift" squarely back into the estate of this giver, most specifically under a different section of the Code, IRC §2038.

Considering this example, certain people, me included, would question whether a "gift" which is revocable is truly a "gift" in the first place. But that's really the point of keeping the property in the estate of the "giver," isn't it? The point is that some transfers appear to be "gifts" on the surface, but really aren't.

Section 2036 is directed to a more subtle situation. The issue isn't so much "give that back!" Rather, the point of Section 2036 might be paraphrased: "You can have this when I am done with it." The pertinent part of Section 2036 provides that the estate of the giver shall include a transfer of property, where he or she retains "possession or enjoyment of, or the right to the income from, the property" for his or her life, or "a period not ascertainable without reference to his death, or for any period which does not in fact end before his death…"

Therefore, retaining a life estate or an income interest to the property that you "give" away will generally place the property right back into the estate of the "giver." The reason for this is our simple mortality. After all, all of us only have a life interest in all the property we own, anyway (i.e., "you can't take it with you.") Thus, by retaining a life interest in property but "giving" away the rest, we are not giving up much. Are we?

So, where's the gift? Of course, that's Congress' point when enacting Section 2036, and the point of the IRS when enforcing that section.

In my next installment I will discuss how the IRS uses Section 2036 to attack FLP interests and discounting.

Update: Before I get e-mails or comments on this issue, I want to point out that I recognize retaining only a lifetime interest usually precludes the "giver" from selling or consuming the property -- something that an outright owner can do. Giving away an apartment complex but retaining the lifetime interest (i.e., the rent) does not mean that the giver can sell the property. However, the fair market value of the building, itself, would probably end up back in the "giver's" estate as of the date of his or her death under Section 2036.

This qualifies my statement that "retaining a life interest in property but "giving" away the rest, we are not giving up much."

"The Common Law Origins of the Infield Fly Rule" Author Passes

This has nothing specific to do with estate planning or financial planning; however, it is worth noting. The author of the 1975 law review article, a semi-parody, The Common Law Origins of the Infield Fly Rule, William Stevens, passed away. His passing prompted an article in the New York Times on December 11, 2008:

“The dynamics of the common law and the development of one of the most important technical rules of baseball, although on the surface almost completely different in outlook and philosophy, share significant elements,” he wrote.

Published as a semi-parodic “aside” in June 1975, “The Common Law Origins of the Infield Fly Rule” quickly achieved legal fame, in part because nothing like it had ever appeared in a major law review, in part because of its concise, elegant reasoning. It continues to be cited by courts and legal commentators. It is taught in law schools. It is credited with giving birth to the law and baseball movement, a thriving branch of legal studies devoted to the law and its social context. It made lawyers think about the law in a different way.

R.I.P.

(Hat tip: Prof. Beyer of the Wills, Trusts & Estates Prof. Blog)

Congress Revises Required Minimum Distribution (RMD) Rules for 2009

Because of the economic crisis, Congress has passed what it evidently thinks is temporary retirement plan relief in through H.R. 7327, the "Worker, Retiree, and Employer Recovery Act of 2008."

This new law allows an account holder not to take what would otherwise be a Required Minimum Distribution (called "RMDs") in 2009. The technical explanation of the Act can be found here. Generally, account holders must take RMDs from a traditional IRA commencing at the age of 70 1/2.

The logic, I imagine, is to prevent the forced liquidation of assets at low stock market prices to meet the RMD requirements. But on the other hand, only Congress would consider the option of taking in less money "relief."

Setting aside my cynical self, the "technical explanation" does offer a good explanation of the RMD requirements and the regulations. Here is some of the explanation of the Act:

Under the provision, no minimum distribution is required for calendar year 2009 from individual retirement plans and employer-provided qualified retirement plans that are defined contribution plans (within the meaning of section 414(i)). Thus any annual minimum distribution for 2009 from these plans required under current law, otherwise determined by dividing the account balance by a distribution period, is not required to be made. The next required minimum distribution would be for calendar year 2010. This relief applies to life-time distributions to employees and IRA owners and after-death distributions to beneficiaries.

In the case of an individual whose required beginning date is April 1, 2010 (e.g., the individual attained age 70 1/2 in 2009), the first year for which a minimum distribution is required under current law is 2009. Under the provision, no distribution is required for 2009 and, thus, no distribution will be required to be made by April 1, 2010. However, the provision does not change the individual’s required beginning date for purposes of determining the required minimum distribution for calendar years after 2009. Thus, for an individual whose required beginning date is April 1, 2010, the required minimum distribution for 2010 will be required to be made no later than the last day of calendar year 2010. If the individual dies on or after April 1, 2010, the required minimum distribution for the individual’s beneficiary will be determined using the rule for death on or after the individual’s required beginning date.

A new blog of note...

I must admit that I am a little taken by a new blog I just discovered, Taxgirl. Kelli Erb isn't new to the blogging world...it's obvious that she has been around for awhile. Still, I have added her to my bloglist...happily.

Oh, so you own "securities"?

Stocks are undoubtedly an investment. You go to a market, and place an order. At that point, money leaves your bank account to pay for the stock, and also to pay for the broker’s fee. In return, you get “something.” You receive either (1) a piece of paper called a “stock certificate,” or (2) a notation on your monthly statement saying that you bought this “something.” In other words, you get some ink and paper. This is called a security – and most people accept this. Nearly everyone would agree that they just purchased “something,” which is in reality no more than a piece of paper, or notations on a broker statement.

A few months ago, I opened a bank account with an online “bank.” There is no physical bank, and I receive no paper statements. I exchanged my hard earned money for an Internet web page – electronic blips and code on my screen. I’m told that I may withdraw these funds (I haven’t as yet), where I may deposit the funds in my neighborhood bank, and withdraw the funds and purchase something – like a hamburger lunch. I’m told that this “account” with this “bank” is insured by the FDIC. And I accept this, too.

I argue that estate planning is no less an investment. In fact, it is more of an investment. With an estate plan, you are modifying the legal relationship which you have with your assets, including your physical assets such as your real estate, diamonds, and tangibles. You are also modifying your legal relationship to intangibles – such as these online accounts and “securities.” After the stock market decline of the last few months, “securities” seem much less secure than they did previously, don’t they?

However, as a legal device, my living trust did not decline in its effectiveness. The assets my trust controls may have gone down in value (or, maybe later they will increase in value), but that does not affect the value my estate plan has to me, and my purposes: I may have added protection from creditors. My plan is as flexible as before. It is as effective in avoiding probate and in taking advantage of the marital deduction. Therefore, my plan still increases the value of my overall estate because it passes more to my heirs and provides me with lifetime flexibility in management. In that respect it is unaffected by the ups and downs of "securities."

So, if you do not understand estate planning and therefore question the value of looking into it, ask yourself: How many “securities” do I own now?

"A Day Which Will Live in World History"?

There is a post on the Legal Profession Blog, which shows a fascinating copy of the first draft of FDR's address to Congress following the Japanese attack on Pearl Harbor, delivered 67 years ago. The document is either stored at or on loan to the National World War II Museum, located in New Orleans. FDR, in his own hand, changed the first sentence, from December 7, 1941 that will be "a day which will live in world history" to "a day which will live in infamy" -- a powerful change of wording. According to the National Archives website:

Early in the afternoon of December 7, 1941, President Franklin D. Roosevelt and his chief foreign policy aide, Harry Hopkins, were interrupted by a telephone call from Secretary of War Henry Stimson and told that the Japanese had attacked Pearl Harbor. At about 5:00 p.m., following meetings with his military advisers, the President calmly and decisively dictated to his secretary, Grace Tully, a request to Congress for a declaration of war. He had composed the speech in his head after deciding on a brief, uncomplicated appeal to the people of the United States rather than a thorough recitation of Japanese perfidies, as Secretary of State Cordell Hull had urged.

President Roosevelt then revised the typed draft—marking it up, updating military information, and selecting alternative wordings that strengthened the tone of the speech. He made the most significant change in the critical first line, which originally read, "a date which will live in world history." Grace Tully then prepared the final reading copy, which Roosevelt subsequently altered in three more places.

Again, thanks to the Legal Profession Blog for this wonderful piece of history.

Should You Use a Legal Software System for Estate Planning?

There are a plethora of options available for those wanting to prepare an estate plan with legal software, or an online legal software system. In fact, there are a number of well known personalities who sell their legal software "products" at your local bookstore. Other online services "interview" you, and then provide you with a trust or a will or trust -- often at a fraction of the cost of an attorney.

Of course, there are advantages and disadvantages to using any such system in preparing a will or a trust. Consider the benefits and costs of purchasing that legal software CD from your local bookstore rather than hiring an attorney to complete your estate plan. Here are some advantages:

• Your start up cost is relatively low. To use a legal software system you only need a computer, a printer, and some time. The average start up cost of an online legal service or software purchased from the bookstore is substantially less than the cost charged by an attorney.

• You often save time. Obviously, the advantage of time savings will vary from person to person. If you are slow working a computer the time savings will be less, or non-existent. If you are faster, there will be more of a chance of time savings.

• You don't always deal with the consequences. This is a strange "advantage," but it's true. So many people simply don't care about the consequences: It's their heirs' problem. In life, if you screw up a do-it-yourself plumbing job and end up hiring a plumber to fix the mess, you are forced to deal with the consequence. If you try to fix the head gasket on your car and end up having your car towed to the garage to complete the repair (often at multiples of what would have been the original cost had you drove to the shop in the beginning), you must deal with the consequence. This is not always the case with estate planning. Your heirs are often forced to deal with the problems.

• You have more privacy (and you don't have to deal with your shyness). Yes, this is true! To hire an attorney requires opening up to a complete stranger. Many people detest revealing private, personal information to someone they do not know. This reason is perfectly understandable.

• You seem to be in control. Some people like to be in control and feel empowered using an online legal software system rather than hiring an attorney.

Here are some of the disadvantages of buying that legal software CD instead of hiring counsel:

• The relatively low start up cost and time "savings" can also be a disadvantage. This may seem odd, but it is true. The old saying that "you get what you pay for" is so very true, both in life as well as in planning your estate.

• Using these products may cost you more time and more money. Now, I just indicated that you save money and might save time using a legal software system, didn't I? Yes I did. However, "doing it yourself" naturally increases the chance of an error, meaning that you may ultimately spend yet more time and more money to fix it.

• In estate planning the cost of an error usually isn't cheap. If an estate plan gets messed up, it can be quite costly to fix -- assuming that it can be fixed. Some errors simply cannot be fixed because courts are very hesitant to modify the terms of a will or a trust once death occurs or after a trust becomes irrevocable. Many people do not realize this: Even if 1,000 witnesses contradict what is written in the trust or will, after death (or when the trust becomes irrevocable) it can be quite difficult and expensive to change a provision. Also, it is very, very uncertain -- you may spend the fees and still not fix the problem.

• The heirs often bear the consequences. The $1,000 or $2,000 cost to hire an attorney to put an estate plan in place may seem costly now, but it may seem quite cheap later if things go awry. I am aware of one at least one attorney who absolutely loves do-it-yourself legal software and online services: He is often hired to fix errors and he ends up charging much more than what it would have cost to prepare the plan initially.

There are probably other advantages and disadvantages not listed here. However, consider this question before buying any software product or online service: Are you serious about planning your estate, or do you simply want to feel better? If you are serious then it should be done correctly, the first time, with competent counsel.

Is the STOLI a Faustian Bargain?

All our times have come
Here but now they're gone

Seasons don't fear the reaper

Nor do the wind, the sun or the rain..we can be like they are

Come on baby...don't fear the reaper

Baby take my hand...don't fear the reaper

We'll be able to fly...don't fear the reaper

Baby I'm your man...

"Don't Fear the Reaper"

Blue Oyster Cult

A new "fad" of auctioning off your "life insurance capacity" is something you may wish to think about before doing it. You should think long and hard.

Promoters and investors are selling the idea of Stranger Owned Life Insurance (STOLI) to healthy seniors with the promise of earning extra cash. The strategy has other names: Spectator Initiated Life Insurance (or, SPINLIFE) and Investor Owned Life Insurance (IOLI).

Whatever the acronym, here is how it works: Investors (or, promoters) locate a senior who is willing to have his or her life insured by strangers, usually with the lure of "free" insurance coverage, or a lump sum cash payment. The investors then take out a non-recourse loan from a lender to purchase a high premium life policy. Naturally, given the advanced age of the insured, the premium is high. However, the senior must be healthy to pass insurer underwriting requirements, minimizing the cost of the policy to the investors.

Because the loans used to purchase these policies are non recourse, they are also purchased from the lenders at a premium. Usually, the interest on these loans are around 10% to 15%.

The investors (as the policy owners) have several options as the notes expire. First, of course, if the insured passes away beforehand, it's bad for the elderly insured, but great for the investors: The investors pay off the note and pocket the balance of the policy death benefit. If death does not occur, however, the investors may also sell the policy in the institutionally funded life settlement market. If the insureds health begins to fail, the investors may opt to simply keep the policy, and hope for the best (or hope for the worst -- depending upon who you are speaking of).

If this sounds like a pyramid scheme -- it is. Obviously, the investors are betting against the life of an insured. However, for those considering entering into this bargain, think for a moment about all who have a hand in this "pie":

1. The Lender. The lender is usually a bank or hedge fund which charges a usurious insurance rate to hedge against the high cost of the non recourse loan sold to the investors.

2. The insurance agent/broker. The broker earns a substantial commission on the sale of the policy. Such policies need to have a significant death value to offset the investors' risks -- and to make it worthwhile for all concerned.

3. The life insurance company. At least one party is cheering on the insured: The insurer. The insurer is betting on the insured having a long life, with either continued payment of premium and/or continued use of the single premium payment before the death benefit is paid.

4. The promoter. There is also a promoter who puts together the "package" who must also be paid. The services provided by the promoter include integrating the transaction, and obtaining financing.

And of course there is also the insured -- who takes the investment and income tax risk. One story of a STOLI gone awry was told by Harry Jenkins, a healthy 80 year old who spent his life in the exercise business, and has done four such deals. His wife, Anna (who was Jack Lalanne's exercise partner in the 60s) was skeptical from the onset. As reported by KTKA:

"Somebody out there is waiting for me to die," Jenkins said.

"I really had a lot of skeptical feelings about what was going on," his wife, Anna, said.

Harry did four of these deals, making about $600,000, but things got complicated. He had to pay income tax on the money he made, but also an additional $50,000 tax on mysterious amounts of interest that were not actually paid to him. And when he tried to buy out the fourth policy himself, he was told he would have to pay another $1.2 million in interest. Now, he's in a lawsuit over that fourth policy.

Thousands of older Americans have entered similar deals, and inevitably some believe they were misled.

"There's a lot of people that got hurt on this, big time, and I think it's wrong," Jenkins said.

Even though they did make some money, Harry and Anna have regrets.

"Forty-nine years I've been telling him to listen to me. And to trust my intuition," Anna said.

"I'll be the first guy to say it probably was a mistake," Jenkins said.

As is usually the case, if something seems too good to be true: it probably is. An excellent summary of this practice is addressed in an article by David Wexler in the Wealth Strategies Journal.