Vermont Bar Journal
Winter 2007 - #6.
Tax and Medicaid Planning Aspects of the Standard Vermont Estate Plan - 2007 Update
THE VERMONT BAR JOURNAL WINTER 2007
Tax and Medicaid Planning Aspects of the Standard Vermont Estate Plan - 2007 Updateby John C. Newman, Esq. & Ron R. Morgan, Esq.
Need for a 2007 Update
Judging from the interest generated by our 2004 CLE offering and by telephone calls and e-mail messages we have received since then, our article on the tax and Medicaid planning aspects of what we tongue-in-cheek termed the "standard Vermont estate plan" has led attorneys to explore alternatives to the rather common recommendation of a joint tenancy with a family member to pass a Vermont elder's home to the next generation. Since the article was published in the Summer 2003 issue of the Vermont Bar Journal, the U.S. Congress passed legislation that radically changes the Medicaid planning aspects discussed in that article. In addition, the Vermont Supreme Court has issued three recent decisions that also must be considered in using the survivorship or remainder features in deeds to pass a home to surviving children. For this reason, we decide to republish our prior article with updated information on current Medicaid and Vermont Supreme Court implications impinging on the planning rules we explained in summer 2003. Background:
The Standard Vermont Estate Plan
In Vermont, it seems typical for an elderly single widow or widower to visit a local attorney's office and request that the attorney prepare a deed adding the individual's children as joint tenants with right of survivorship on the title to the family farm or ancestral residence. We have come upon this type of transaction so frequently that in our office we refer to it as the "standard Vermont estate plan." As with any proposed transfer of property, this transaction has inherent risks and advantages which should be weighed against other possible forms of transfer, such as the conveyance of a contingent remainder interest to the children while the elder retains a life interest with a power to sell the whole property (termed "an enhanced life estate" in Medicaid planning parlance).
The table below sets forth in summary fashion the various consequences of these family net wealth transfer strategies: FEDERAL GIFT TAX A lifetime transfer of the fair market value of the undivided interest in real property; value of entire property is included in decendent's estate (IRC 2040). No lifetime transfer; value of entire property is included in decendent's estate (IRC 2036(a)(1)). CAPITAL GAINS 100% basis step-up at death of parent/transferor; carryover basis if sold during tranferor's life. $250,000 gain exclusion available for sale of owner/ occupants' interest in resident only. 100% basis step-up at death of parent/transferor. $250,000 exclusion should be available for entire gain on sale of residence by lifetenant owner/occupant. MEDICAID Residence: a transfer for no value resulting in a disqualifying period; Nonresidential property: not a transfer, but value of entire property treated as countable resource. NOT a transfer of a liquid asset triggering a disqualifying period. LIABILITY Joint tenant is a title owner with liability. Remainderman has no liability while life tenant is alive. TOWN TAXES Equal share of town taxes due from each joint tenant; no income sensitivity unless tranferor is 62 years of age or older. Owned by life tenant; Act 60 prebate available to life tenant. EXIT STRATEGY Transfer of interest in property cannot be revoked. Property may be sold by life-tenant transferor, and proceeds applied for his/her sole benefit.
In this article, we would like to comment on the table and set forth a few considerations that should be discussed with clients who ask you to add their children to their deeds as joint tenants.
Federal Gift Tax
The creation of a joint tenancy by a parent adding a child's name to a deed as a joint tenant with right of survivorship is a taxable gift to the extent that the value of the transferred interest exceeds $12,000 per donee (an amount periodically indexed by the IRS in thousand dollar increments). This transfer to the new owner/child is a completed gift because, under Vermont law,(fn1) the child can make a unilateral decision to sever the joint tenancy and make it into a tenancy in common, allowing the child to then sell his/her interest in the property. Although the Vermont Supreme Court has resisted giving full effect to Vermont statutory law when the equities militate against it (see below, Section VII), these equitable remedies are unlikely to be given credence by the IRS in the gift tax context under the principle that the taxpayer cannot argue against the form he or she selects for the transaction.
If the joint tenancy is not severed, upon the elderly transferor's death the entire value of the property is includable in the transferor's taxable estate under section 2040 of the Internal Revenue Code, even though a completed gift had previously been made. However, because of the way the estate tax and gift tax work together, there will not be a double level of taxation imposed on the transaction. Moreover, the inclusion for estate tax purposes is advantageous because it allows a basis step-up at death for capital gains tax purposes, as discussed below.
Although many Vermont attorneys seem to ignore or minimize this tax compliance formality, as tax lawyers we must recommend that when you document the creation of a joint tenancy between a parent and their child, you should inform your clients that they are required to file a federal gift tax return recording this gift at the same time they file their annual IRS Form 1040. This filing is made on IRS Form
709. In general, no gift tax will be due unless the transferor is a nonresident alien. Beware, however, when a nonresident, non-citizen is involved; such a non-resident does not have a gift tax exclusion amount exceeding the annual $12,000 exclusion. United States citizens and tax residents usually do not have this problem because a U.S. citizen or resident's gift very likely is covered by the U.S. donor's lifetime gift exclusion of $1 million. This $1 million gift tax exclusion has not increased since the 2001 estate tax reforms (in the parlance of tax wonks: EGTRRA 2001).
Under these EGTRRA 2001 reforms, the applicable federal estate tax exclusion amount is $2,000,000 in 2007 and 2008, increasing to $3.5 million in 2009. Under current tax legislation, the estate tax is supposed to sunset in 2010 only to be reinstituted under the rules in effect in 2001. In our office, we had assumed that the U.S. Congress and the president would have reached an agreement to rationalize the effect of the estate tax sunset provision in advance of the X-generation's incentive to euthanize its wealthy elders in 2010 when the estate tax will sunset for one year, but that has not happened.
This is all to say that while a gift tax formality is imposed on the creation of joint tenancies neither a gift tax nor an estate tax is likely to be payable for the clients who we find typically engage in this type of estate planning
Life Estate Interest (Power to Sell)
The transfer of a remainder interest in a property to a child or children, with the transferor reserving a life estate and the ability to sell the property during his/her life and to retain the sale proceeds, is essentially equivalent to a testamentary transfer. Not surprisingly, the federal estate tax rules consider the life estate retained by an individual to be a testamentary interest in the entire property that will be fully includable in the donor's federal taxable estate at death.(fn2)
Although the authors are unaware of any case or IRS ruling on the subject of such transfers, the retained power to sell and keep the proceeds of sale during the transferor's life would appear to prevent the transaction from being a completed gift; therefore, no federal gift tax return should be required. For this reason (no completed gift), this will be the preferred transaction when a non-citizen, non-resident wishes to pass property down a generation through the automatic survivorship feature using a retained life estate.
Capital Gains Taxation
When a parent transfers a joint tenancy interest to a child, the tax basis of the property that is given away is "carried over" to the recipient. In other words, the joint-tenant child will have a "carryover" tax basis in one-half of the real property, assuming a 50/50 joint tenancy. Depending upon the parent's tax basis in her residence, the carryover basis could result in an unanticipated income tax cost if the property is subsequently sold during the parent's life.
For example, if the parent had a tax basis of $20,000 in the property, and the property is subsequently sold for $200,000, the one-half interest that the child received by gift (worth $100,000) will have a $10,000 tax basis. When the $100,000 in proceeds is received by the child for his/her gift interest, the child will owe federal and state income tax on a capital gain of $90,000 ($100,000 sales price minus $10,000 tax basis). In Vermont, the combined federal and state tax on such a capital gain is likely to be 20 percent (combined state and federal rate), for a tax liability of $18,000. Here again, we had assumed that EGTRRA 2001 income tax reforms (which temporarily pushed the longterm capital gains tax rate down to 15...