Do TOD and POD Designations Really Work?

“T.O.D.” (Transfer on Death), and “P.O.D.” (Pay on Death) designations have become common with most financial institutions.  These are essentially “beneficiary designations” like we usually see with life insurance, annuities, IRA and qualified plans.  At one time it was common for banks and brokers, not to offer these. When we used Revocable Living Trusts in planning, they would require that the account be re-registered in the name of the Trust.  By popular demand these designations are frequently offered today, and even when we have done Trusts, I usually regard these designations as the preferred way of titling accounts.

It is important to read these forms; ask the “what if” questions; and be certain that they do and say what we think they do

P.O.D. and T.O.D. forms are contractual in nature.  This means the institutions regard them as a contract and will follow them.  They will override the terms of a Trust or Will, and so must be carefully integrated with those documents.  The forms are almost always created and published by the institution itself, to fit their own particular goals.  The "devil is always in the detail."  Thus, as clients and as advisors, we need to read them carefully.  Every company will have a different agreement (indeed, the same company may well have different agreements for different products).

The forms are also often “generic,” “one-size-fits-all,” documents, for perhaps obvious reasons of economy.  In doing this, they often make an “educated guess” about what the “typical” client would want.  But that doesn’t always fit the desires of clients.  For example, they may provide for a beneficiary designation with “per stirpes” distribution in the event the beneficiary is not living (which has a very specific legal meaning).  The form may also call for a distribution of remaining assets to the other designated beneficiary(s).  Or, the form may not directly address this at all.  Even more problematic is the designation (directly, or as a result of the form’s default beneficiary designations) of minor or incapacitated individuals as beneficiary.  This may result in unintended and unexpected Probate proceedings.  I like to say that the forms do not always adequately answer the question: “what if?”  We have had some success negotiating with some of these companies to let us “custom draft” beneficiary designation forms to fit the desires of the client.  But what is critically important is to read these forms; ask the “what if” questions; and be certain that they do and say what we think they do (or should do).
 

“The Devil is always in the detail”

Generally, when designating a Trust as beneficiary, we can avoid these problems, by making the Trust the direct, primary beneficiary.  The Trust can be structured to address the “what if” questions, and have alternative disposition for unexpected situations.  For the majority of clients’ assets, my preferred method is to have them own the asset, with a T.O.D./P.O.D./beneficiary designation to their Trust.

IRA and “Qualified Retirement Plans,” “non-qualified annuities,” and some government savings bonds) do not “play well” with Revocable Trusts

There is a very important exception, however! There is one category of assets where naming the Trust as a beneficiary might be disastrous.  One of the unfortunate truths about Estate Planning is that our laws, rules and conventions are anything but consistent.  More consistent treatment of some of these things would make our jobs as planners easier, and the goals of our clients more certainly met.  But this would require the IRS, banks, brokers, insurance companies and state legislatures (among others) to all get on the proverbial “same page.”  Probably not gonna’ happen.  In this case, it is the IRS (really, Congress) that is the bad guy.  Surprise, surprise.  :-)

Certain tax-deferred accounts (namely, IRA and “Qualified Retirement Plans” [401(k), 403b, pensions, etc.], certain “non-qualified annuities,” and some government savings bonds) do not always, unfortunately, “play well” with Revocable Trusts.  I think this could be rather easily addressed by Congress and simplified.  Instead, they have chosen to go another way and have created perhaps the most complex “morass” of rules in the entire Internal Revenue Code.  This is another topic for another day, but suffice it to say that when these assets are involved, the proper beneficiary designation scheme should come under heightened scrutiny.

When the account owners are joint owners (typically Husband and Wife, but occasionally others), it is important that the form (or the institution’s policies) make clear what happens if one of the joint owners dies.  Presumably, the T.O.D. / P.O.D. would not be activated yet and the co-owner would continue to be the owner with the right to change or re-designate beneficiaries.  But the forms are not always crystal clear.  I recall an issue recently on an annuity contract where there were co-owners, but on the death of one of them, the contract required that the surviving co-owner re-designate beneficiaries.  No one ever raised that issue with her and she did not do so.  Instead, she assumed the original designation of one of her 4 sons was still valid.  On her death, that son made a claim.  The annuity company denied it and insisted that the proceeds be paid to her estate because since there was no re-designation, there was in effect, no designated beneficiary.  So it is very important the upon the death of a joint owner, the other joint owner(s) review and perhaps re-designate beneficiaries.

POD/TOD forms do not always adequately answer the question: “what if?”

The takeaway is that we must read the forms and not just rely on the fact that they are the “company standard form,” and therefore will always “work.”  It is also important to communicate with the institution if there are any questions or concerns.

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Designating IRA and other Qualified Plan Beneficiaries

Please note that this is a very complex area and what follows is generalizations.  This is an area that should be reviewed on a client-by-client, case-by-case basis with a qualified attorney or CPA.

The surge of Estate Planning “experts,” including websites and seminars over the past 20 years has created a surplus of “information” related to estate planning.  Much of this information, while useful in context, is misunderstood and consequently, misapplied.

My “rule of thumb” for the past few years has been to name adult, responsible beneficiaries as direct beneficiaries on IRA and qualified plan assets, unless there is a compelling reason otherwise.

Along with the growth in family Estate Planning Trusts, has come a misunderstanding by many clients and advisors, of the inter-reaction between Trusts and Qualified Retirement Plans.  We tend to think of Trusts as the best solution for all of our Estate Planning clients’ needs.  In a perfect world, this might be true.  From a planner’s perspective, I would like nothing better than to have the flexibility to funnel all of a client’s assets through their Revocable Living Trust.  It would give us ultimate control.  Unfortunately, it doesn't work that way, and while a frustration for planners, it is what we have to work with.

There is no area more fraught with potential economic disaster that so-called, “qualified retirement plans” and IRA’s.  Unfortunately, because our laws are sometimes at odds with each other, there is potentially major income tax peril in linking qualified plans with a Revocable Trust.  While there will be times when the clients’ objectives will require us to do so, such linking is not without pitfalls, and should be undertaken only very carefully.

My “rule of thumb” for the past few years has been to name adult, responsible beneficiaries as direct beneficiaries on IRA and qualified plan assets, unless there is a compelling reason otherwise.

In spite of this advice, we too often find that a client (or their financial advisor) has designated their Trust as beneficiary.

Qualified Plan and IRA Basics

The “idea” of qualified plans was to encourage people to do their own retirement savings.  The “carrot” was the ability to remove a portion of income from taxation when earned, and while it grew (in some cases, it worked “too well”).  Over my years as an Estate Planning Attorney, I have found it more common than not that a client has IRA and qualified plan assets that they are not drawing from, even when well into retirement.  However, the idea was never intended to be an Estate Planning mechanism for passing wealth down to the next generation.

the idea was never intended to be an Estate Planning mechanism for passing wealth down to the next generation

Because of this, the rules eventually require a “forced” withdrawal.  This normally ocurrs when the account holder (participant) reaches retirement age (“the year in which they reach age 70 1/2”).  A second instance is upon the death of the participant.  If the rules simply required a lump sum distribution at the death of the participant, it would be a simple mathematical equation and it would end there.  In that case there would be no issue with Revocable Trust beneficiary designation.  However, the law identifies some different methods of distribution and several of them are very tax-significant.

While an IRA is technically not a “qualified” retirement plan, it is by far the most common form of retirement savings, and shares essentially the attributes of a “qualified” plan.  Indeed once you are in “retirement mode,” the IRA is perhaps the better and more flexible retirement plan vehicle, particularly in terms of estate planning (and for this reason, we often counsel fully retired persons to roll their qualified plan assets into an IRA).  Most of the rules contained within IRS Regulations are specifically directed at IRA accounts.  IRAs are a more or less statutory retirement plan and as, such, are pretty typically similar, from sponsor to sponsor.  However, it is always advisable to read the plan document (be it an IRA or some other plan type), to ensure that it provides for what we think it does.  While we often apply IRA rules to other qualified plan accounts, it is important to understand that the plan documents may differ significantly.

When there is a Surviving Spouse

The Typical Family.

The most significant beneficiary designation involves the surviving spouse.  In the majority of planning situations, I deal with a married couple who have acquired assets together and raised their mutual children for a period of years.  Their typical wishes are to take care of each other in their retirement years and have any remaining assets go on to their children on a relatively equal basis upon their deaths.  In this case we almost never designate anyone but the spouse as the primary beneficiary of a participant’s retirement plan.  The spouse, in most circumstances, can elect to treat the decedent’s plan as their own.

In spite of this advice, we too often find that a client (or their financial advisor) has designated their Trust as beneficiary.  While this is often a cause for angst, there are IRS rulings (in the case of an IRA) that would allow a surviving spouse who was the sole income beneficiary of the trust to remove the IRA and make the favorable spousal election.  It does, however, increase complexity and reduce flexibility.

“Unique” Circumstances.

There may be circumstances where a direct beneficiary designation to a is not the desired result, such as where there is a second marriage, blended families, non-resident spouse, or perhaps just a concern that the surviving spouse may not appropriately manage the assets.  In this case, we may still want to designate a Trust as beneficiary.  For example, in a second marriage situation, the participant may wish to have the spouse have the annual income from the retirement plan, but ensure that any remaining plan assets go to their own children.  However, to use a common advertising disclaimer; "Do not try this at home."

While Congress has provided that it is permissible to designate a Trust as an IRA beneficiary (and, presumably, by analogy, other “qualified” plans); and the IRS has provided us with guidance on how to safely do so, that guidance is a proverbial minefield of danger.  Any misstep will likely not only result in a deemed lump-sum distribution (and therefore immediate income taxation) of the entire remaining balance, but will also very possibly result in taxation at the highest percentage brackets.

And, even if done properly, the appropriate administration of such accounts in a Trust guarantees long-term ongoing trust administration and lack of ultimate flexibility for the surviving spouse.

There may be circumstances where a direct beneficiary designation to a is not the desired result, such as where there is a second marriage, blended families, non-resident spouse, or perhaps just a concern that the surviving spouse may not appropriately manage the assets

Contingent Beneficiaries and When there is no Surviving Spouse

The concerns are even more compelling when there is no surviving spouse, or when, because of a prior death, the contingent beneficiary designation becomes effective.  Only the spouse is entitled the “treat-the-account-as-is-it-were-my-own” (referred to as a spousal rollover) election.  However, an individual beneficiary may still have some ability to reduce the effects of taxation on the account.

An individually designated beneficiary may elect “beneficiary IRA” treatment (sometimes called a “stretchout” IRA by financial advisors).  The rules here are pretty clear when the beneficiary is an identifiable individual.  The beneficiary may use his or her life expectancy (in accordance with published IRS tables), to calculate an annual required minimum distribution.  Distributions must commence shortly after the death of the participant, regardless of the age of the beneficiary.  But obviously, there is significant value in the continued tax deferral of the balance of the plan assets during the lifetime of the beneficiary.

“pass-through” language must comply with some very technical IRS Regulations requirements that attempt to match trust fiduciary accounting rules with IRA distribution rules.

Unpredictable Beneficiaries

What if our intended beneficiaries are minor children, or children with special needs or other “disabilities?”  These are instances in which we might wish to use a Trust, even in light of all the pitfalls.  These might be one of the “compelling” reasons my “rule of thumb” acknowledges.

The IRS rules, as noted earlier, do allow for a Trust to be the designated beneficiary of an IRA.  But as also noted, not without complexity and inflexibility.  The Trustee may “step into the shoes” of the trust beneficiaries in only a couple of instances.  First, if all of the trust beneficiaries are identifiable persons and the trust provides for immediate distribution of all of their shares to them; or second, if the trust contains specific “pass-through” (sometimes called “see-through”) language.  If there is a class of beneficiaries (like “children” or “grandchildren”), the distribution rules will be keyed to the oldest person in the class (with the effect of forcing the taxable income out in the fastest manner).

In each case, the IRA custodian will likely be somewhat inflexible.  Typically, this means that a trust “beneficiary” IRA is set up and the Trustee is charged with calculating the annual minimum distribution amount, requesting it from the custodian, and distributing it to the beneficiary, in accordance with the trust language.  This will likely continue on a yearly basis for the lifetime of the youngest beneficiary or until assets have been exhausted.  While this gives the “stretchout” benefit, it must be balanced with the economic and emotional costs of maintaining the trust.

And, the “pass-through” language must comply with some very technical IRS Regulations requirements that attempt to match trust fiduciary accounting rules with IRA distribution rules.

What about Charitable Beneficiaries?

The IRS regulations are also clear about who may be a designated beneficiary for purposes of the “stretchout” election.  They must be identifiable individual beneficiaries.  So what if the trust (or the IRA by direct designation) provides for a charitable beneficiary?  The purpose behind the individual requirement appears to be so the life expectancy calculations may be accurately made.  Obviously, an entity cannot have a life expectancy.

But the IRS has acknowledged that charitable beneficiaries are common, and has given us a planning “out.”  As long as the charity’s portion can be determined and is paid out within a year after the death of the participant, the IRS will essentially ignore it.

What this does tell us is how important the details in planning are.  I often find it fits client’s objectives more closely to designate a specific portion of the IRA to charity, or event to split off a separate account and designate it entirely to charity.

As with all Estate Planning, we need to remember that it is a “moving target.”  Regular period review of designations and of your goals are important to making sure this all works.

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Should You Have a "Ladybird Deed" ?

With all the competition for customers (from lawyers and non-lawyers alike) in the estate planning field, it is easy to see why the consuming public has the perception that an estate plan merely consists of a pre-printed form, or a set of forms, and that there is a “standard” method of planning.  And it seems like there is always some hot, new technique for estate planning being advocated, often by marketers.  It is nearly impossible these days to find an article, or attend a presentation on Estate Planning these days without hearing about the virtues of  the “Ladybird Deed,” and why everybody should have one.  It is common to have a client call or come in for an appointment, already convinced that they “need” a ladybird deed.

  it seems like there is always some hot, new technique for estate planning being advocated, often by marketers.

The reality is that these are actually somewhat complicated real property conveyancing tools.  And like all tools, I have often said over the course of my career that estate planning is not a “one-size-fits-all,” proposition.  And there is perhaps no better example of this than the “Ladybird Deed.”  The truth is that some people may benefit from the technique and many may find it a detriment.  In order to appreciate this, we need to discuss what a “Ladybird Deed” is and what it does.

Ladybird: What’s In a Name?

"Ladybird" is a name that caught on from use by a Florida attorney and lecturer whose favorite fictional spouse reference was “Ladybird,” in his examples.  The technically correct name is “Enhanced Life Estate Deed."

The reality is that these are actually somewhat complicated real property conveyancing tools.  And they are not a “one-size-fits-all,” proposition

Attorneys learn early in law school that property rights in the most of the U.S. can be divided up into different interests, and that the interests can be defined in different ways.  The sum total of all the rights held together, is known as the fee title.  It is not uncommon to see specific rights be divided (such as mineral, water and wind rights) and conveyed or reserved when the underlying land is conveyed.  It is also possible to convey rights that can be measured by the duration of ownership.  One such division and conveyance is the traditional “life estate.”  Like it sounds, a life estate is measure by the lifetime of the owner of the life estate.  Usually.

There is a very real temptation (often by persons unqualified to give estate planning advice) to indiscriminately use Ladybird Deeds

An Enhanced Life Estate reserves or conveys the traditional duration (life of the owner), but also adds an element (usually reserved by the transferor) to in effect, “change their mind,” and convey the fee title of the property away to someone else (or back to themselves).

Ladybird deeds can be very powerful, versatile, estate planning tools.  But like any tool, they can be misapplied.  Estate Planning is a process involving the careful application and combination of available tools.  There is a very real temptation (often by persons unqualified to give estate planning advice) to indiscriminately use Ladybird Deeds.  But the deed is just a tool, not a process!

Why Shouldn’t You Use a Ladybird Deed?

The danger in casual use of these deeds lies in viewing real estate conveyances as on-dimensional.  There are numerous related risks.

“Uncapping."

Michigan’s ad valorem real property tax scheme is based on complex valuation rules.  In the late 1990’s Michigan’s Constitution was amended to impose a “cap” on how much real property tax assessments could be increased.  This capped value is known as “Taxable Value,” and is subject to a cost of living – based formula, limiting increases.  Like so many laws, over time a series of exceptions and exemptions have emerged. Taxable Value, for example, may be “uncapped” when the property is conveyed (remember that there is a conveyance – or perhaps multiple conveyances – involved when a “Ladybird Deed” is created).  While there are certain exemptions to this “uncapping” rule when Estate Planning and Family transfers of residential real estate are involved, current Michigan law does not appear to apply such exemptions to the end conveyance accomplished by the Ladybird Deed.  So beware!

In order to track the changes of ownership (and therefore “uncapping” opportunities), Michigan has an affidavit filing process (MI Department of Treasury Form L4620 – Property Transfer Affidavit) with local assessors.  There is a relatively nominal fine for failure to file the affidavit and perhaps a temptation to ignore filing it.  One significant concern is that if the time period between the recording of the conveyance and the automatic conveyance by termination of the life estate is substantial, will this cause issues.  The affidavit should be filed, and one of the exemptions invoked, in my view.

Indiscriminate use of a Ladybird Deed may have unintended and undesirable results

Probate Avoidance.

Our modern society has evolved with the ability to structure “pay on death” direct beneficiary designations with nearly every type of asset people own today.  Michigan is one state where such transfer techniques are plentiful and easy to accomplish.  The Ladybird Deed, is such a technique.  It is relatively easy to create, and may well result in a probate--avoided transfer.  Again, indiscriminate application however, may create undesirable results.  This is particularly true where the intended recipients are multiple children.  “Joint” ownership of real property may create a whole set of unintended problems of its own.

Medicaid Planning.    

The so-called Elderlaw planning industry really thrust the use of the Ladybird Deeds into the forefront.  They have been a very powerful tool for Elderlaw planning.  But a lack of understanding of the tool and the process may well create unintended consequences.  The filing of a Medicaid Application is very timing specific.  Whether to convey property by Ladybird Deed, directly to a trust, by JTWROS designation, or not to convey at all, should be carefully considered by the planner, in light of all of the client’s circumstances.

What State are You In?

Not all States recognize Ladybird Deeds.  Since the real estate laws and rules vary by State to State it is wise to consult a knowledgeable specialist in the State where the property is.  Some States recognize a "pay on death," or "transfer on death" conveyance.

Ladybird Deeds are a powerful and often desirable planning tool.  My objection to them is when they are used in an unconsidered, “knee-jerk” one-size-fits all approach to the planning process as a whole.

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Should your Children have an Estate Plan

Occasionally, during an Estate Planning conference with clients, this question comes up.  As an Estate Planning lawyer, I should probably be more pro-active about suggesting this topic.  As a professional, however, I always feel some discomfort about coming across as just “selling” services or forms.  So, I tend to soft-peddle the selling aspect of my job, and try to focus on the needs of the client.

It is a question that should be addressed in every client relationship

But it is a good question, and one that at some point should be addressed in every client relationship.  Most of my clients have children.  Many of them are yet living at home, or are in school somewhere.  These are the children my question addresses.  Once emancipated, I think the question is an unequivocal yes.  But for children still “living at home,” whether an estate plan is appropriate is dependent on the circumstances.

As long as children are minors, the parent is generally still their legal guardian, and can make most legal and health decisions for them.  However, it often comes as a surprise to parents who are still “footing the bill” for everything for their children, that they no longer have legal rights to many important areas once their child has reached the age of majority (18 in Michigan and in most states).  And more surprisingly to some parents, in some states, their legal rights may be somewhat limited at an earlier age.

The concern here is not usually any kind of adversary relationship with parent and child.  The concern is that third parties will (and in most cases are legally required) to honor the privacy rights of children.  This means that it can be very difficult in some instances to get information, speak to people on behalf of your children, and generally remain “in the loop.”

it often comes as a surprise to parents who are still “footing the bill” for everything for their children, that they no longer have legal rights to many important areas

Particularly when they were away at college, we had our children execute Durable Powers of Attorney and Health Care Designations of Patient Advocate.  There were a number of instances during those times when those documents came in very handy – both for us and for our children.

In some instances, we have also created Trust Agreements for children who have accumulated some financial wealth.  In most cases, this wealth would be either turned back to the parent, or distributed among siblings.

As a general matter, I believe the answer to the question will often be yes, and that the question should almost always be asked as part of the Estate Planning Process.

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Welcome Clarification on Family Transfers of Residential Real Property and “Uncapping”

The new law now provides that transfers of property into and out of a trust, and via an estate, to these family members, are exempt, in addition to direct transfers.

Beginning December 31, there is yet another beneficial new exception to “uncapping” of transfers of residential real property between certain family members.

In the early 1990’s the Michigan Legislature passed legislation that “capped” the ability of local taxing bodies to increase the “taxable value” of real property to a the lesser of (currently 1.05%) and the rate of inflation for the year.  The statute attempted to define “transfer,” and also set out a series of exceptions to “transfers.”  Over the ensuing years, other exceptions (notably the Agriculture Exception) were added.  But also during this period, some disagreements arose over the meaning and intent of this legislation.  The was a particularly important issue for family cottages and recreational properties that were passed down from generation to generation.

In 2011, the Michigan Supreme Court interpreted one of these disagreements, in Klooster v. City of Charlevoix, holding among other things, that if at the time all owners at one generation died, but there was also a surviving joint tenant in the next generation (most commonly one or more children), that the survivorship conveyance of title by operation of law was not a “transfer” as the Legislature intended that term.  While I have never been persuaded by the Klooster analysis, who am I to rock the boat – particularly when the decision is basically favorable to the taxpayer?  See my blog, “Michigan Supreme Court Buys Us Another Generation on Real Property Taxes,” from March, 2011.  The Klooster case gave us some new, limited planning opportunities to preserve the “cap” on family transfer of property.  But it wasn’t enough.

It wasn’t enough

In December of 2012, Governor Snyder signed new Legislation aimed at this problem.  See, New Michigan Law Avoids “Uncapping” in Family Transfers.”  But as we will see, the aim was not as accurate as it might have been.  The new legislation (effective December 31, 2013, and on), provided that a direct transfer or conveyance of residential real property to a person related to the transferor “by blood or affinity to the first degree,” where the residential use continued, was not deemed a transfer for “uncapping” purposes.  This rather archaic definition seemed reasonably clear to those of us who took the basic Wills and Estates course in law school, but it left way to much uncertainty on the table.

It remained unclear whether these transfers among family members only applied to direct transfers (which would exclude transfers using Trusts, Wills, Estates and Limited Liability Companies).  If they did, it was – though a welcome forward step – still not enough.

It was still not enough

My own view was that given the history of interpretation of similar issues by local governments and by the Michigan Department of Treasury, combined with the near-bankrupt condition of our state government, they were going to take a very literal interpretation of the statutory language.  In Michigan State Tax Commission Bulletin number 23 dated December 16, 2013, my supposition was confirmed.  They would view this as only applying to direct transfers:  “Due to the blood relationship clause, the Commission has defined the transferee and transferor as a ‘person.’  Therefore, this exception to uncapping does not apply to a trust, a limited liability company, or a distribution from probate.”  Transfers to and from estate planning devices like trusts would not come within the exception.  Nor would transfers from an estate, whether by Will or intestate succession.  Again, while there were some additional planning opportunities (the “Ladybird” Deed, for example would work), they were still too limited.  One of the benefits of estate planning – and particularly the trust as a planning tool – is the ability to maintain some management and control where the beneficiaries are either not sufficiently mature to manage, or where there are multiple beneficiaries.  The trust allows ownership and management of assets for the benefit of children, including family legacy real estate (like the family cottage).

Now there is good news

The title of the blog promised good news.  And there is.  On October 10, the Legislature passed still more legislation, clarifying the “uncapping” rules.  Effective December 31, the law now defines those family members within the no uncapping exception more specifically as transfers to “a mother, father, brother, sister, child, adopted child, or grandchild.  And even better, the new law now provides that transfers of property into and out of a trust, and via an estate, to these family members, are exempt, in addition to direct transfers.

We now can breathe easier as estate planners and clients, knowing that we can continue to plan for estates using tried and true techniques.  Like any new law, there will be a period study and analysis and inevitably, questions about clarity of certain provisions and interpretation.

All in all:  I think this is a great development.

Thanks to my Law Partner and fellow Estate Planner, Elian Fichtner for her research and help on this article and topic.  See more about both of us on our website link at the top of the Blog 

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Should You have a “Ladybird” Deed?

Twenty-five years ago, I was covering for an astute, senior partner at my first law firm employment. I got a call from the title company questioning a deed he had drafted. His proposed form of conveyance purported to convey all but a "life estate," to her son, while retaining the right of the grantor to essentially change her mind and convey the property to someone else at any time during her lifetime. This seemed to go against everything I had learned in law school about vested life estates, fee interests, remainder interests and all sorts of "future" interests in real property. Knowing the drafter was an experienced real estate lawyer, I gave him the benefit of the doubt and did a little research.

Maybe; Maybe not

Michigan Land Title Standards (Std. 9.3), allows for precisely that type of conveyance. I have used it occasionally during my 30 year career, but up until recently, sparingly. While the deed has been around for many years in Michigan, it has only recently gained popular recognition, particularly as a Medicaid planning tool. However, it really is a more diverse and useful tool, and is becoming increasing popular with estate planners. So much so, that currently, one of several most often asked questions when clients call or come in for estate planning conferences is: "should I have one of those lady bird deeds?" My answer: "Maybe. Maybe not." J

The "ladybird" deed is not a one-size-fits-all" panacea for all of our real property estate planning challenges

The Estate Planning process often lends itself to automation, and generalities. In many cases this is unfortunate, as we really should be looking at each individual circumstance as unique and carefully tailoring our planning solutions to that unique situation. So while I am using "ladybird" deeds more often these days, it is actually making me think more carefully about this particular aspect of planning.

Urban legend is that the "ladybird" deed gained its name because Lyndon Johnson conveyed property to his wife using one. This writer finds it hard to believe that Lyndon was the first to use the technique. The technique involves a property concept known as a "power of appointment," and the concept was surely around before Lyndon was even a gleam in the elder Mr. Johnson's eye. But I am content to let legend be legend. One prominent Michigan Probate Judge has opined that it should really be more properly titled a "Deed subject to Life Estate," which is how it is characterized in the Title Standard. The "ladybird" deed is as close as we can get to a "beneficiary designation," on real property here (a number of states actually have statutorily recognized transfer on death deeds, but Michigan is not one of them). It can be used to effect a transfer-on-death conveyance of real property, either to other individuals, or to a trust. I can see some real utility there.

The Estate Planning process often lends itself to automation and generalities

But, whatever we ultimately call it, the "ladybird" deed is not a one-size-fits-all" panacea for all of our real property estate planning challenges. We still need to examine the goals of the client carefully. And not every consequence of the use of this deed is clear.

I recently wrote about the changes to Michigan's real property tax statute, regarding the "uncapping" of taxable value on the transfer of property. One of the advantages of the "ladybird" deed is that it is really not a transfer. The "transfer" occurs on the death of the grantor. And under the new law, a transfer of residential real property to a party related in the first degree, will not be "uncapped" as long as the transferee continues its residential use. But there are traps here, for the unwary. What if I want multiple children to benefit from the family cottage? Remember, the new law addresses a transfer to a person related in the first degree. It does not say to a trust, or other entity established by the transferor for the benefit of her children.  Indeed, the State Tax Commission has recently confirmed my suspicion that they view this exemption as not applicable to Trusts, LLC's, or to a distribution from Probate! (Bulletin 23, December 16, 2013).

Conveyance of property in Michigan requires that the parties file a "Property Transfer Affidavit" with the County Register of Deeds and the Tax Assessor when a "transfer" occurs. Is a "ladybird" deed a "transfer" requiring the filing of this form (L-4260)? Arguably not. But prudence suggests that filing—with an explanation—might be a good practice. More importantly, is there a Form L-4260 filing requirement upon the death of the grantor? I think there is room in the statutory language to conclude that the answer is yes. So, in our planning, we need to think about who will be responsible to ensure such a filing on a timely basis. Form L-4260 has a box to check for "transfer of that portion of a property subject to a life estate." But a conventional "life estate" is different in that both it, and the remainder interest are vested in their respective owners. There is in fact a transfer or conveyance of an interest in property. It is just an "exempt" transfer under the statute (until the Life Estate expires). Technically, there is not such a conveyance with the "ladybird" deed. Until there is judicial or administrative clarification, the proper approach to this will remain uncertain. My thinking is to be "redundant." Perhaps the best (albeit confusing and to me somewhat inconsistent) approach is to check both the "life estate" checkbox and the "other" checkbox, and insert language indicating that the deed was executed pursuant to Title Standard 9.3.

As use of the "ladybird" deed increases, there are bound to be questions by third parties about whether mortgage provisions (e.g., "due on sale clause") are triggered, as well as other restrictive deed items (P.A. 116 liens, conservation easements, etc.) will be affected. Use of this deed, like any other legal tool, requires thought about its application to the circumstances—both current and future. And the answer to the question is, as always: "Don't try this at home."

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New Michigan Law Avoids “Uncapping” in Family Transfers

Two years ago in March, I reported here on the Klooster v City of Charlevoix case, which addressed the issue of "uncapping" in a real estate transaction between family members. 1994 amendments to the Michigan Real Property Tax, placed a "cap" on the amount a taxing authority could increase the value of real property under consistent ownership. Under the 1994 rules, a taxing authority may raise the taxable value of real property no more than the lesser of 5% and a CPI calculation.

The principal change is new sub-paragraph (s) which provides a new exception for residential real property transferred to a relative who is related by blood or affinity to the first degree (i.e., children)

However, when there is a "transfer" of ownership in real property, the taxing authority may "uncap" the valuation for the "tax day" immediately following the transfer, raising the taxable value as high as the state determined State Equalized Value (SEV) of the property. This can be a considerable increase in taxes for the new owner.

The Klooster Court interpreted the transfer provisions of the statute, holding that where a father added his son as a "Joint Tenant with rights of Survivorship" while the father was alive and while the father remained a joint owner, there was no transfer. That seems to track with the plain language of the exceptions to "transfer" in the statute. In what was a surprise to many of us (most certainly to the City of Charlevoix and municipal entities around the state), the further held the death of the original joint owner (the father) was not a transfer. This lead to a new (for some of us at least) avenue of planning and caused us to re-think our planning strategies see, Some Family Cottage Strategies in Light of the Klooster Case; my follow up to the Klooster article.

Perhaps in response to Klooster and the uncertainty that surrounded its reasoning, and certainly to protect family interests in family-owned residential real estate, the Michigan Legislature passed, and Governor Snyder signed into law in December of 2012, a newer, clearer exception to the "transfer" for family-owned real property. House Enrolled Bill No. 4753, signed into law on December 27, 2012, amends Section 27a(7) of the Michigan General Property Tax Act (MCL 211.27a) to provide several new exceptions. Most are clarifications of existing exceptions.

The principal change is new sub-paragraph (s) which provides a new exception for residential real property transferred to a relative who is related by blood or affinity to the first degree (i.e., children). Notably, the exception does not limit itself to "cottage" or "vacation" property. Nor are the number of instances or parcels limited. Indeed, the Senate Fiscal Agency's "Bill Analysis" acknowledges that the exception is not limited to "homesteads," nor is there any limit to the number of times a single parcel could be transferred to first-degree relatives.

Caution!

It is important to note that this new transfer exception does not become effective until December 31, 2013! Thus, for owners dying before December 31, it may still be wise to consider the strategies discussed at the link above, at least temporarily. Still, this is a welcome change for owners of family real property, particularly in those instances of homesteads and family cottages that may have remained in the family for multiple generations. Like all legal changes, this development will require planners to consider whether old strategies remain viable and what, if any, new strategies may come into play.

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Congress Finally Gives us Answers on Estate and Gift Tax

To quote former President Gerald Ford, with respect to the Federal Estate and Gift Tax: "our long, national nightmare is over." Late on January 1, Congress enacted "The American Taxpayer Relief Act of 2012." I won't go into great detail about the act (there is a lot about it we still don't actually know and will have to wait for the analysis of people more capable than I am), but will point out the highlights of the Estate and Gift Tax provisions which are of considerable importance to Estate Planning.

The Act preserves the $5 million per person ($10 million per married couple) "unified" estate and gift tax exemption and indexes it for inflation.

The Act preserves the 2012 levels of a $5 million per person exemption, maintains the "unified"estate and gift structure (meaning the $5 million threshold applied to total transfers, whether by gift during lifetime or inheritance on death), and indexes them for inflation. The Act also makes the concept of "portability," which was added in the 2010 extension for the first time, a permanent part of the tax structure. What "portability" means is that for married couples, the $5 million credit can be allocated or "shared" between them at any time, including after death. This effectively eliminates–in most cases–the need for those "clunky," inconvenient, "AB Trusts" ("his and hers"), and all the allocations and adjustments we were constantly making in those plans. This should have the effect of greatly simplifying the planning process in all but a few instances. The only real, substantive change in the law is a (modest?) increase in the rate (which will only apply after the $5/10 million credit has been used up).

What does "permanent" mean?

Most importantly, the Act makes the current Estate and Gift tax laws permanent. One of my colleagues asked me, what does "permanent" mean? I think that is a fair question. In 2000, the so-called "Bush Tax Cuts" were implemented and because of internal machinations in Congress, were built around a 10-year "sunset." This meant that unless Congress acted during the 10-year period, the laws would automatically expire on December 31, 2010. In a demonstration of the "brinksmanship" for which our modern Congress has become so famous for, in late December of 2010, they "extended" the law for 2 more years.

For the first time in the past 12 years, planners will be able to tell clients what to expect in this area. As we move forward in 2013, I expect that many of our clients will be looking at much simpler estate planning devices.  I think that is a plus

But when they extended the general tax laws, they made unanticipated major changes to the Federal Estate and Gift tax. This was in every way a good change. But it was "temporary," because it was part of an extension, again due to expire recently on December 31, 2012. The new law does not have a "sunset" provision. This means that until Congress acts by legislation to change it, it is permanent. That is as "permanent" as any law gets these days.

My personal view, and what I have been able to glean from reading other sources, suggests that Congress has no appetite to make future major changes to this area, for a number of reasons. So, what we now have is some consistency and something on which we should be able to rely for the foreseeable future.

For the first time in the past 12 years, planners will be able to tell clients what to expect in this area. As we move forward in 2013, I expect that many of our clients will be looking at much simpler estate planning devices. I think that is a plus.

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SHOULD YOU BE DOING LARGE YEAR-END GIFTS IN 2012?

Unfortunately, before we can intelligently answer this question, some history is necessary. With the pending expiration of the so-called "Bush Era Tax Cuts," there is a significant amount of buzz about making large year end gifts to take advantage of the current high gift threshold. Historically, the current Federal Estate and Gift Law scheme dates back to the early 1980's when the "unified estate and gift tax exemption" and the "unlimited marital deduction" were created. A 1986 threshold of $600,000 was set as the amount exempt from federal estate and gift tax transferred by each person. This effectively meant with some careful planning, a married couple could pass $1.2 million to their heirs by lifetime gift or at death before a federal transfer tax was imposed. The amount was capped in 1986 at the $600,000 level. Many of us watched as inflation and growth took our parents' modest estates (often substantially below $600,000) and turned them millions. As we watched, many of us also felt strongly that the $600,000 threshold was no longer a reasonable measure of "modest" wealth and that Congress' failure to address an inflation factor in this threshold was a serious policy flaw.
In 2000, a "conservative" Congress enacted the "Bush Era" tax laws. In the context of the Federal Estate and Gift Tax, those laws made some major changes, but had some perplexing provisions. Inexplicably, they de-unified (if that is a word) the exemptions. They increased the $600,000 Estate Tax Exemption, incrementally over a series of years, to $3.5 million in 2009, and entirely eliminated the Federal Estate Tax (sometimes called the "death tax") in 2010. At the same time they increased the Federal Gift Exemption to $1 million and froze it there. Their plan was that in 2010 and later, there would be no transfer tax on death, the untaxed lifetime gifts would continue to be limited (to $1 million per person). I have never heard a sensible explanation for this "policy." There were some other "nightmarish" provisions in the new law, including a change to "carryover basis" for inherited capital assets.
The problem with their plan was that due to some internal rules, the conservative majority in Congress did not have the numbers to make the changes permanent. So this tax law had a 10-year lifetime, which was due to expire on December 31, 2010. Rather than deal with it, Congress (mostly) "punted" and extended this expiration deadline to December 31, 2012 – right around the proverbial corner!
However, they did some surprising and unexpected things regarding the Estate and Gift tax laws. It gave me some hope that perhaps there would be an end to the seemingly endless uncertainty involve in Estate and Gift Tax planning over the past decade. In late December, 2010, Congress re-instated the Federal Estate Tax (remember, it expired under the short-lived law in 2010), but increased the threshold to $5 million! They also re-unified the credit, increasing the Gift Tax Exemption, also, to $5 million. Then they indexed both of these exemptions for inflation (in 2012, they are slightly over $5 million). But wait – there's more. They also created a new (and long awaited) allocation rule called "portability" (portability means that we no longer had to have separate trusts in most instances for Husband and Wife).
But Alas, all of this is scheduled to end at midnight on December 31. And the aftermath will be all the way back to a $1 million per person unified exemption.
Now, to the question proposed in the title: Should you make large gifts? I like to think of what we have now as a window. At the moment, it is open wide and at its widest opening, there is room to fit $5 million of assets through it ($10 million for married couples). If nothing changes, Congress will close the window most of the way, leaving it open just enough to fit $1 million of assets through it. So, as I view it, there is little to be gained by making gifts of $1 million or less. We will always be able to get that much through the window. Where the gain comes is if we can put more than $1 million through the window, because once it's closed down, we will have forever gotten the excess amount through the window.
When planning year end strategies, we cannot make this analysis in a vacuum. There is always an argument for making gifts of appreciating assets, up to and even above the $1 million discussed above. We move not only the asset itself, but the future growth out of the estate. But we also have to be cognizant of the nature of the asset being moved and whether we can truly afford not to own it anymore. And, perhaps equally importantly, we need to ask whether we want to continue to own it. It has always seemed bad planning policy to me to let tax considerations override the desires of the client.

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The Michigan Property Tax Personal Residence Exemption

The Michigan General Property Tax Act authorizes municipal entities, including cities, townships, villages, schools, and municipal "authorities" to levy taxes real and personal property in Michigan. There are two principal exemptions from part of the taxes that routinely impact our clients. The most commonly invoked exemption is the "personal residence exemption" (a/k/a "homestead exemption). The second important exemption is the "qualified agricultural property" exemption (see, Navigating The Michigan General Property Tax Qualified Agricultural Property Exemption). Both exempt the subject property from the school tax. The mechanics of their application differs somewhat.

There is a lot of misinformation out there, much of it by word of mouth. This is an important exemption, as the school tax tends to be one of the highest taxes levied. So, understanding its applicability is worth a few moments' reading.

The personal residence exemption applies to property which is classified by the tax assessor as "residential property." Classification as "residential," does not by itself qualify the property for the exemption. The owner must demonstrate, to the satisfaction of the taxing authority (or – ultimately – the Michigan Department of Treasury), that the property for which they are seeking the exemption is their one, true personal residence.

Obtaining the Exemption

In order to qualify for the principal residence exemption, a homeowner must file an Affidavit of Personal Residence, (Form 2368), which may be obtained on line at the Michigan Government Website (www.michigan.gov/treasury). The affidavit must be filed – in most cases – not later than May 1 of the year the exemption is sought. The Affidavit is filed with the Local Assessor, not with the Treasury Department.

There are instances when a "late" filing can be sought by appearing before the tax board of review (which convenes in most municipalities in July and again in December). It probably makes sense to seek some professional assistance at that point, as there are rules and deadlines that must be carefully observed.

The greatest area of concern is when a residence is purchased after the May 1 deadline. In most instances, the prior homeowner has already filed the affidavit and qualified and the exemption will remain in effect until December 31, after which you may file to meet the May 1 deadline for the following year. The Affidavit need only be filed once and the exemption remains in effect as long as the residence continues to qualify for that owner.

Qualifying For the Exemption

This is the area where the most confusion (and frankly, a fair amount of "license" with the rules) usually arises. This exemption is intended to apply to one personal residence where a resident of Michigan intends to permanently use as their primary home. There are certain indicia that the Department of Treasury (or the local assessor) uses as "proof" of residency. The statutory provision makes clear that it is a matter of intent on the part of the owner. But proof of such intent is sometimes difficult. The authorities will look at things like voter registration address, address on Michigan Driver's License or other Michigan I.D., where the applicant has his or her mail sent, where bills are mailed and the address they use on official tax filing. None of these items alone will be determinative, but they will be used as evidence of intent.

The Michigan Department of Treasury publishes a pdf pamphlet called "Guidelines for Michigan Principal Residence Exemption Program." It is worth noting that in the guidelines, they specifically address the vacation home or cottage issue. Up until just recently, most lakefront vacation property in Michigan was appreciating much more rapidly than suburban or urban residential property. The tax pressure on owners of these properties was enough that many such owners have attempted to make them their personal residence in order to have the exemption apply to their higher value property. Some even attempted to claim both residences as their principal residence. About 10 years back, there was a strong push by taxing authorities to seek out these "transgressors."

The Guidelines make it clear that the state will view this as a matter of reality. In other words, you cannot simply change your driver's license, voter registration and other "indicators," and automatically have the property qualify. You have to demonstrate in a meaningful way that you indeed intend to reside in the property as your principal residence. While there are obviously grey areas (e.g., the "snowbirds," who may spend 6 or more months in a warmer climate), this means that you "live" there – you spend the bulk of your time there.

Multiple Exemptions

It is clear that a homeowner is only entitled to one principal residence exemption. You must be a resident of the State of Michigan and you may not have claimed a similar personal residence exemption in another state, country or territory. You cannot have dual residency, for purposes of the exemption.

What if you are husband and wife? State and Federal laws are nothing if not unclear about this distinction. The general approach is that we treat married couples as a single unit. However there are exceptions. For purposes of the principal residence exemption, if a husband and wife file a joint income tax return, they are entitle to one exemption for their "marital unit." However, if they file separately, they may each claim an exemption. Beware, however, that they will still have to demonstrate the "intent" reality discussed above. In most cases, unless the parties are separated, that will be pretty difficult to do.

Much will depend upon the diligence of the local taxing authorities on all of the above issues.

The Ownership Requirement

This requirement may be among the most elusive – and confusing. Like much legislation, the language is not necessarily consistent, nor clear. For example, the General Property Tax Act refers to the term "person." Yet they don't necessarily consistently apply their interpretation. For purposes of the principal residence exemption, "person" is interpreted as its plain meaning, a "human." A residence that has been transferred into a Limited Liability Company, a Partnership, or some other legal entity will cease to be qualified for the principal residence exemption. While this may seem harsh, it is the law in Michigan. Where we see this application cause the most problems is in the family farm arena, where we are often structuring land-holding entities and family limited liability companies and partnerships. Because there are other complex rules and programs affecting farmland, and because the farmstead and family home are often part of a larger tract of land, family estate and succession planning can become problematic and complex, and attention to detail is important in that context.

You do not, however, need to be a 100% owner of the property. The law says a partial owner may claim the exemption (again, subject to demonstrating that it is their one true personal residence). This means joint owners, and holders of life estates may still claim the exemption.

The law does not specify the amount of ownership. This opens the door to some creative tax and estate planning. For example, a child, parent or sibling could legally own a fractional interest (as little as a 1% joint tenancy interest), but reside in the home and claim the exemption. This, combined with the "uncapping" protections we learned about in the Klooster case (see, "Some Family Cottage Strategies In Light of The Klooster Case") may present some very enticing family property succession strategies.


A residence that has been transferred to a grantor-revocable trust also qualifies for the exemption.  In that case, the grantor (in most cases) is deemed the "person" who is the owner and entitled to the exemption.

Finally, note that you may claim the exemption if you are a Land Contract purchaser. This makes sense because Michigan Law sees such a purchaser as the "equitable" owner of the property, subject to the security interest of the Land Contract Vendor (the so-called "legal owner").

What Property is Covered?

This is another area which is sometimes susceptible to confusion. Adjacent land parcels are often arbitrarily separated by legal description (e.g., by the way they are acquired by deed) or by tax parcel identification code. They may be separated by roads, ditches, waterways, or other natural or man-made obstructions.

The exemption covers all contiguous property to the occupied residence, as long as it is: (1) classified residential, (2) is vacant, and (3) is not used for non-residential purposes. The Guidelines provide several examples of what qualifies as contiguous. Essentially, it is property which is "touching" the property the primary residence is on. A road, ditch, stream, etc., does not destroy contiguity. Another parcel owned by another that is in between does (there is some thought that the state views a corner-to –corner touching as not contiguous, though I fail to see the logic in that view) .

Separately described or deeded parcels or parcels with separate tax code parcel identification numbers, will all still qualify, as long as they satisfy the contiguity requirement. You need not combine parcels in order to have the exemption. You do, however, need to file separate exemption Affidavits for each separate tax code parcel.

The state is dead-serious about the 3 limitations above. If a contiguous parcel has a separate structure on it, it is not "vacant" and does not qualify for the exemption. If any business use is occurring on the contiguous parcel, at least a portion of it will not qualify. The most common example of this latter occurrence is vacant farmland, which is being farmed for rent. In most cases, it will or can be classified as qualified farmland, which will solve the problem. In other cases, it will be important to seek qualified professional assistance.


 

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Some Family Cottage Strategies in Light of the Klooster Case

Nothing triggers emotions more than the family cottage. You may have raised children who spent all their vacations there. You may have grown up there yourself. All the best memories are often there. Yet this family "heirloom" often becomes the most difficult asset to pass to the next generation; and sometimes the most contentious.

As an owner-family, one of the first questions I have clients consider is whether they should even go down that proverbial road? There is simply no legal "GPS" for finding the right mix of ownership and management of multiply-owned family recreational property. Much has been written about this subject over the years, including "Saving the Family Cottage," by Stuart Hollander, a Northern Michigan Attorney who lived and practiced in Leelanau County; and "The Cottage Rules" by Nikki Koski. These books purport to help "solve" the problems arising in trying to pass a cottage from one generation to the next. Yet they admit that it is more of an art than a science. In the end, I usually counsel my clients that their own family "chemistry" will make or break the succession, no matter how good or clever our written documents and plans may be. And, a continuing problem is how, even after passing to the second generation, successive generations will be treated. This article is not really a piece addressing whether the family cottage should be passed. Nor is it really a road map illustrating how it should be done. Rather, it addresses some of the pros and cons of different ownership methods and when they might be considered, in light of the real property taxation.

In 2010, the Michigan Supreme Court decided Klooster v City of Charlevoix, defining under what circumstances a "transfer" resulting in "uncapping" for purposes of the Michigan ad valorem real property tax. "Capping" refers to a limitation placed on the ability of the taxing municipality to raise the "taxable value" of real property as its fair market value increases. The intent of the act was to keep current owners from being unfairly taxed in relation to increase and development of surrounding properties, during their tenure of ownership. It imposes a formulaic limit on tax increases. However, when the ownership is transferred, this "cap" comes off and the taxing authority is free to make a one-time (for each transfer) adjustment to reflect fair market value in the hands of the new owner. The Klooster decision put an interesting (and for some of us, unexpected) twist on the meaning of "transfer" of ownership for purposes of the act. See, Michigan Buys Supreme Court Buys Us Another Generation on Real Property Taxes.

Before addressing the pros and cons, it is appropriate to review ownership options for family cottage properties. Over the years, some different methods of ownership by the next generation have been prevalent.

Joint Ownership

Perhaps the most common (and the most fraught with problems) is joint ownership of property. Michigan law observes several different types of joint ownership. Among non-married owners, the most common and often presumed type is as tenants-in-common. In tenancy-in-common, each owner owns an "undivided" fractional interest in the property. The interest can be sold, or transferred freely. In the event a problem arises in co-ownership, a tenant-in-common may ultimately petition the Circuit Court for an action to partition. The court may, alternatively, order a sale or physical division of the property. A second type of concurrent ownership is as joint-tenants. This type of ownership presumes that on your death, your interest passes, automatically, to the surviving owner. But during lifetime, between non-married owners, the interests may be sold or transferred freely. Such a transfer converts the joint tenancy to tenancy-in-common. A third type of joint ownership is known as joint tenancy with full rights of survivorship (JTWROS). Here, the decedent's interest also automatically passes to the survivor(s). However, these interests may not be transferred or sold without the concurrence of all joint owners. The JTWROS tenancy may not be severed, even by a court.

You may note that I have prefaced each of these with "among non-married owners." In Michigan, when a husband and wife take title to real property, it is presumed that they do so as tenants-by-the-entireties (a special type of JTWROS ownership reserved for married couples). It should be easy to see that, depending upon the makeup of owners and their ability to (and perhaps live) together, each of these owner methods may have potential significant disadvantages.

It is permissible, and in my view, strongly recommended, that the parties have a separate, recordable and enforceable written agreement providing for use, management and succession issues.

A separate, written agreement providing for use, management and succession issues is strongly recommended

Trusts

Another ownership method is a Trust. Most often, a parent-owner will create a Trust for ownership during their lifetime which provides for "rules" and management of the property following their death. Trusts can create complexities and difficulties that may have been completely anticipated by the client and/or drafter. Someone or some entity must act as the Trustee, with the significant responsibilities impose by both the Trust Agreement and the Michigan Trust Code. Tax reporting at both the federal and state level is required. The allocation of the taxable (and deductible) attributes is not always simple. There are annual reporting and accounting requirements, sometimes to more "remote" individuals who may have no current involvement, but have a possible future interest. Trusts are generally a cumbersome method for continuing ownership and often will direct another form of ownership upon the death of the original owners/trustors and transfer to the next generation. The "uncapping" circumstances for trusts are quite complex.

Entity Ownership - Limited Liability Company / Partnership

For numerous reasons, the Limited Liability Company (LLC) has become the real estate owning entity of choice in Michigan. It is an outgrowth of the Partnership, which was perhaps the preferred method before the LLC. The partnership's "achilles heel" was the unlimited liability every partner had on all partner activities. The LLC effectively created a Partnership with the same limited liability that a corporation traditionally had. And, over time, the Michigan LLC Statute has evolved as the most flexible and creative business entity tool available for planning.

The LLC has become the Real Estate Owning Entity of Choice in Michigan – but it has "uncapping" Issues.

With an entity format, the owners can have an agreement for management and succession of ownership for multiple generations. A manager(s) can be designated and "branches" among the family can be defined, for purposes of voting. A "buy and sell" agreement can be put in place, providing for valuation methods and payment methods, as well as limitations on sales and transfers. Accounts can be established for payment of expenses. And, because the entity is the owner of the real property, as "members" come and go, the ownership stays within the company. Because of this structure, the LLC is, in my view, a better practical and legal planning alternative to the Joint Property Agreement.

There are negatives. There is a cost to set up the LLC, and a (generally nominal) cost of annual maintenance. Like the Trust, federal and state tax reporting is required. The LLC is a "public" entity, in that it is on file in Lansing, with a register address and agent. Perhaps the most significant negative is the "uncapping" issue mentioned above.

How Klooster Applies

The Michigan Tax Tribunal has ruled that transfers of real property interests to a LLC will automatically cause uncapping. While a reading of the statute does not, in my view, intuitively suggest that result, the rulings of the Tribunal have the force of law in Michigan until a court having proper jurisdiction says otherwise. To the best of my knowledge, at the time of this writing, no court has done so. Nor is the Klooster result, in my opinion, the intuitive result of a reading of the statute. But the Michigan Supreme Court is the highest legal authority in the state and they have spoken.

If "uncapping is an issue, consider Joint Ownership with a written agreement; If it is not, go the route of the LLC

In summary, if "uncapping" is not a significant issue, you should strongly consider the formation of a LLC. Conversely, if "uncapping" is a significant issue, you should consider joint-ownership with a Property Agreement. However, before spending too much time on the "uncapping" issue, it is probably worth looking at whether the "uncapping" issue is as significant at one might think. Currently, most vacation property values are at a long-time low here in Michigan. Thus, the "jump" from current taxable value and fair market value (loosely, SEV in Michigan) may not be as significant as it first appears. Even though the "value" looks like a substantial number, it is worth doing the math to see what the actual increase in taxes might be. It may be that "uncapping" in the current environment is a "window" that should be taken advantage of. Remember that once the "uncapping" occurs, the "cap" starts over again for the succeeding owners.

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Why and When Is a Trust Accounting Report Required?

Clients often ask why we need to report or account to beneficiaries. This is a particularly perplexing concept when the beneficiaries are remote (i.e., they are not currently due to receive anything from the trust and may never receive, unless they outlive the current beneficiary(s)). A related question is to whom we must report and when?

When the grantor is still alive and is serving as his or her own trustee, there is no duty to report. This makes sense, as it would be a duty for the owner who retains total and complete control over the assets in the trust to report to him or herself. These very common estate planning trusts are known under the Internal Revenue Code as "Grantor-Revocable Trusts." The get this name from the section in the Internal Revenue Code which exempts them from filing or reporting separately on an income tax return. Instead, the grantor simply continues to report these items on their personal tax return. However, on the death of the grantor (and in some circumstances, when the grantor no longer is acting as trustee, if though they may be still living), the duty to report and file income tax returns arises.

Perhaps the most direct answer to why we must do this is that the law requires it. But what, exactly does that mean? Estates, whether Probate Estates or Trust Administration, are mainly governed by the law of the state where the grantor is/was a resident, or where they stipulated in the Trust Agreement which state law would govern. So we must look to the Statutes of the State. At the same time, in an effort to achieve some uniformity from state to state, there are "unofficial," but very influential and persuasive guidelines to Trust and Estate administration. State statutes often follow the guidance of these "national" guidelines.The Restatement of Trusts (now in its 3^rd iteration) is one such uniform nationally recognized guideline. The Restatement (Third) of Trusts states that A trustee has a duty to maintain clear, complete, and accurate books and records regarding the trust property and the administration of the trust, and, at reasonable intervals on request, to provide beneficiaries with reports or accountings. Following on this, Michigan's new Michigan Trust Code contains provisions requiring a Trustee to report to beneficiaries.

The Trustee of a Trust is a fiduciary. That means that they have a special duty to all of the trust beneficiaries, of fair and honest dealing, and of sensible management and investment of the trust's assets. This fiduciary duty also includes the duty to keep beneficiaries apprised of the status of the trust's assets and investments.

Who are the beneficiaries entitled to an account or report? That is a bit less clear. It is clear that the current beneficiaries are entitled. But what about more remote (or contingent) beneficiaries? The commentary to the new Michigan Trust Code says the language of the code "clarifies" this formerly unclear area. I am not so sure. The Code uses the new term (new to us in Michigan, anyway), "qualified beneficiaries." It defines "qualified beneficiary" in what I think is a rather confusing way. What is clear is that current beneficiaries are entitled to an accounting and that more remote beneficiaries may be entitled. The code requires a reporting to the current beneficiaries (current generally meaning that they have some current rights to trust assets, either in the form of income distributions or the right to distributions of some or all of the principal in the trust). It then goes on to say that other "qualified" beneficiaries are entitled to an accounting on request.


The Michigan Trust Code authorizes the maker (grantor) of the Trust to limit the duty of the Trustee to report to certain beneficiaries. However, a Probate Court can override this and order reporting anyway.

In my view, what this tells us is that a Trustee should keep detailed records, and prepare a report at least annually, to keep in its records. While that does not necessarily mean provide each beneficiary with an account, it puts the Trustee (or successors) in a position to provide that information upon an order of the Court. It may serve a secondary purpose of highlighting for the grantor and/or Trustee any problems that might be lurking out there in terms of trust accounting and record – keeping.

Finally, on all but "grantor revocable trusts," the Trustee will be required to file an annual income tax return with the IRS and with any state or states in which it earns reportable income. So it doesn't seem like a huge inconvenience for the tax preparer and/or Trustee to simply put together some kind of accounting report each year as and when the tax return is prepared.

The Michigan Trust Code does not specify a format for the report. It does give guidelines, suggesting that the report should be thorough and detailed enough to fully apprise the recipient of the nature and status of trust assets. This means it should probably have a method for recording items of income as well as how they affect the capital or income side of the trust accounts, as well as items of loss and expenditure, for the same reasons.

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Michigan Supreme Court Buys Us Another Generation on Real Property Taxes

Thursday, March 10, 2011, the Michigan Supreme Court, in Klooster v. City of Charlevoix, seems to have granted us another "generation" on Michigan Real Property Taxes. In 1994, so-called "Proposal A" placed a cap on the amount of increase in Michigan Real Property taxes a municipality could apply, regardless of how much the actual market value increased, as long as there was not a "transfer of ownership." The devil is always in the detail, and the Klooster case centered on the definition of "transfer of ownership," and the meaning of one of the exceptions laid out in the act.

The Act, which allows the municipality to remove the "cap" in the tax year following a change in ownership, has a rather involved definition of transfer of ownership. It also has a long list of exceptions to the rule allowing the cap to be removed. The Klooster decision focuses on the so-called "joint-tenancy" exception. That exception provides that the creation or termination of a joint tenancy by one who is an original owner does not result in an uncapping event, even though it is a change of ownership. The court defines "original owner" as one who has ownership immediately following the last "uncapping" transfer. The court further explains that death of a joint owner (joint with rights of survivorship) results in a "transfer" by operation of law. So an original owner who has created a joint tenancy with another and then dies, effects a transfer of ownership, but it is within the exception and therefore not an "uncapping" transfer.

There has been some question about this since the exception of the act. Some of us (particularly municipalities) felt that the intent of the act was to prevent an unfair increase in taxation while the same original owners and spouses were alive and owned the property, but the when the last original owner in a generation died or transferred out of ownership, an uncapping transfer occurred. The Klooster opinion makes clear that, as a matter of Michigan law (now anyway J ), we were incorrect. The court carefully dissects the language of the statute and concludes that the uncapping will occur on the next transfer. In other words, my dad and mom could add me as a joint with right of survivorship owner to real property and after both of their deaths (which would be a "transfer of ownership" by operation of law), an "uncapping event" would still not occur until the next transfer (either by deed or by my death) happens. This means the cap can stay on for my lifetime, if no transfer of ownership occurs.

Great care must be taken in planning. Once my parents die, for example, I may want to plan for my own succession. If I add a joint tenant who does not come within one of the "not a transfer" exceptions in the statute (e.g., adding children or siblings), an uncapping transfer occurs (adding a spouse or conveying to a grantor revocable trust would probably not be viewed as a subsequent uncapping event). Also, presumably, on my death, an uncapping transfer occurs. This opens much proverbial "food for thought" in real estate succession planning transactions.

It will also be interesting to see if the Legislature takes any action to change the statutory language the Court interpreted.

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Trusts After 2010 Estate Tax Reform

Since the extension of the so-called "Bush Tax Cuts" by Congress on December 17, 2010, and the very favorable changes to the Federal Estate Tax, I have received numerous calls and e-mails, all asking essentially the same question: "Can I scrap my Trust?" My answer is, "of course not!" Indeed this question underscores the continued misunderstanding by clients and advisors alike about the part Trusts play in the Estate Planning Process. We too frequently view the process as only a tax-driven process. In one of my earliest Blogs here, I pointed out that Estate Planning is an overall process involving a number of tools, only one of which is a Trust, which covers only some portion of a well-thought out Estate Plan. So, with changes which eliminate estate taxes as a concern for the vast majority of our clients, I get very concerned that clients and their advisors will unwittingly abandon one of the more important and useful planning tools.

The function of a Revocable Trust Agreement in the estate plan is primarily as an administrative tool to manage and distribute assets, during lifetime, during incapacity, and after death. It most often acts as a Will substitute, and properly structured and maintained, can avoid the need of Probate Court proceedings. With proper drafting, a Trust can also restrict the scope of "outsiders" entitled to information on administration, and can manage assets for minors, and others who are not ready or capable of handling assets yet.

What the new Tax Law does do is, in my view, allow us to vastly simplify the Trust planning we have customarily done to avoid taxation, making it an even more palatable and powerful tool. As I read the new law provisions, even for the relatively rare clients who may have assets exceeding $5 million, we no longer need to set up separate Trusts for spouses and divide up assets before a death occurs. Thus, Trust planning has just become more flexible and inviting in my view.

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