President Obama's 2014 Budget Includes Troubling Changes Affecting Estate Planning

The celebration following the federal government's increase in the estate tax exemption to $5.25 million is, perhaps, destined to be short lived.  President Obama’s proposed budget plan for 2014 came out on April 10, and proposes substantial changes to the estate and income tax code.  These changes would mean real changes in estate planning. 

According to the budget plan, the federal estate tax rate will increase from 40 to 45 percent. The individual exemption equivalent will be reduced from $5.25 million to $3.5 million, and it will not adjust upward over time to keep pace with inflation. This means that as time goes on and inflation increases, people will surpass the exemption mark due to appreciation in the value of their estate, and be subject to federal estate taxes. Further, these changes are proposed  as "permanent changes" meaning that they will not sunset or lapse in time.  

The lifetime gifting exemption equivalent is also affected, since the gift and estate taxes use a unified exemption.  The maximum amount that a person can leave his or her family in combined taxable lifetime gifts and inheritance is thus reduced from $5.25 million, which increases with inflation, to a non-adjusting maximum of $3.5 million.

Limiting Grantor Retained Annuity Trusts

More surprising and substantive changes are proposed for sophisticated estate plans. A GRAT (grantor retained annuity trust) is a tax-reducing trust popular for giving assets to family members while retaining an income benefit for some defined period of time.  The grantor puts his or her assets into the trust and receives  an annuity which pays a fixed amount each year. Gift tax is paid when the GRAT is created and the tax is based upon the present value of the remainder of the trust, meaning that the value of the gift, for gift tax purposes is substantially less than the actual fair market value of the assets.  One of the real challenges in such planning is that if the grantor dies before the trust ends, the assets become part of the grantor's taxable estate,and the purpose for the trust, reducing estate taxes, is frustrated.. If the grantor survives the term of the trust, any assets left to the beneficiary — usually the grantor’s children — are tax free. GRATs have typically been short-term trusts to make it more likely that the grantor survives beyond the term of the trust.

The proposed budget will require a minimum trust term of ten (10)  years for all GRATS. This defined longer term makes it more likely that the grantor may die during the trust’s existence, and increases the chances that the trust does nothing to reduce the value of the taxable estate. If death of the grantor occurs within the ten year term, the trust is taxed as part of estate, effectively losing nearly half its value to federal estate taxes.  The proposed budget, therefore, limits greatly the attractiveness of  GRATS as an estate planning option.

Eliminating Intentionally Defective Grantor Trusts

The proposed budget also effectively eliminates intentionally defective grantor trusts (IDGT).  An IDGT  is used to freeze the value of appreciating assets for tax purposes. This strategy allows the grantor to be the owner of the assets for income tax purposes but it removes the value of the assets from the grantor’s taxable estate. As the value of the trust increases, the transferor receives the income earned by the assets (and pays tax on the income) but the assets grow outside of the transferor’s estate.

Under proposed budget:, there would be no separation in the tax codes for this trust. Estate or gift tax would have to be paid on the trust at the time of the owner’s death. This would make the IDGT obsolete.

Signalling a Change?

Perhaps the most significant change reflected in the proposed budget is that the federal government has, once again, returned to a  lack of appreciation for the benefits of certainty and stability in estate and business planning.  Among the reasons that many celebrated the recent changes to the estate tax code (recent being changes adopted at the last minute, less than six months ago), is that the inflation adjustment and portability provisions signaled, to some,  an appreciation for long-term stability and certainty.  It appeared to some that having resolved the estate tax exemption amount, and having adjusted it automatically for inflation over time,  the federal government was, in effect, acknowledging the need for stability and certainty, eschewing uncertainty, and detrimental periodic and last minute legislative changes.  

Of course, perhaps the proposed budget is really the "same as it ever was."  

This article is based in large part on an article by Phoebe Venable, entitled "Obama's Budget Plan would Hit Estate Plans Hard," published May 11, 2013, in the Tennessean, and available online here.   

Adult Children Could Be Responsible for Parents' Nursing Home Bills

The adult children of elderly parents in many states could be held liable for their parents' nursing home bills as a result of the new Medicaid long-term care provisions contained in a law enacted in February 2006. The children could even be subject to criminal penalties.

The Deficit Reduction Act of 2005 includes punitive new restrictions on the ability of the elderly to transfer assets before qualifying for Medicaid coverage of nursing home care. Essentially, the law attempts to save the Medicaid program money by shifting more of the cost of long-term care to families and nursing homes.

One of the major ways it does this is by changing the start of the penalty period for transferred assets from the date of transfer, to the date when the individual would qualify for Medicaid coverage of nursing home care if not for the transfer. In other words, the penalty period does not begin until the nursing home resident is out of funds, meaning there is no money to pay the nursing home for however long the penalty period lasts. (For the details, click here.)

With enactment of the law, advocates for the elderly predict that nursing homes will likely be flooded with residents who need care but have no way to pay for it. In states that have so-called "filial responsibility laws," the nursing homes may seek reimbursement from the residents' children. These rarely-enforced laws, which are on the books in 29 states (the figure was 30 but Connecticut's statute has since been repealed), hold adult children responsible for financial support of indigent parents and, in some cases, medical and nursing home costs.

For example ,Pennsylvania recently re-enacted its law making children liable for the financial support of their indigent parents. 

According to the National Center for Policy Analysis, 21 states allow a civil court action to obtain financial support or cost recovery, 12 states impose criminal penalties for filial nonsupport, and three states allow both civil and criminal actions.

Medicare Proposes Rules On Hospital Observation Care

Medicare officials have proposed changes in hospital admission rules in an effort to reduce  the rising number of beneficiaries who are placed in "observation care" but not admitted to the hospital.  When a patient is placed in observation care, but not formally admitted to the hospital, the patient is often rendered ineligible for nursing home coverage. Patients must spend three consecutive inpatient days in the hospital before Medicare will cover nursing home care ordered by a doctor.  

Observation patients don't qualify, even if they have been in the hospital for three days because they are outpatients and have not been admitted.  If the patient was in the hospital for three days, but under observation as an out-patient, and then is referred to a nursing home, the patient is solely responsible for the cost of care in the nursing home. 

Adding insult to injury, these patients also often realize higher out-of-pocket costs than admitted patients while in the hospital, including higher copayments and charges for non-covered medications. Observation is generally cheaper than inpatient care for insurers and hospitals, but the opposite can hold true formany  patients. Many patients have supplemental coverage that picks up the portion of her hospital bill Medicare does not pay, but observation patients without other coverage typically pay 20 percent of hospital outpatient services, which isn't required for inpatient care. 

One might think that patients would object to the practice, but sadly, patients are usually wholly unaware that they are being treated as out-patients, since they are, after all, in a hospital.  This lack of notice and knowledge renders the patient impotent to protect his or her own interests, and to control his or her costs. Hospitals are simply not required to tell patients they are under observation care.  Most do not.