Moving an Elderly Relative Could Trigger a Tax Problem

It's a common scenario: An elderly relative is no longer able to live alone, so family members sell the relative's house and have the relative start living with them or in a nursing home or assisted living facility that's closer to the family. 

One thing you might not consider during this stressful process is that if the relative moves to a different state, you might have just changed the person's official state of residence for tax purposes. And that could have a significant effect on his or her estate plan.

For instance, if someone moves from a state with no state estate tax to a state with such a tax, and he or she passes away, an estate tax might be owed on the value of the person's assets - even if he or she lived in the new state for only a very short time.

This is a significant danger because, while the federal estate tax generally doesn't apply to estates unless they're worth over $5 million, many state estate taxes start at a much lower figure. In Massachusetts, for example, the state estate tax threshold is only $1 million. 

Such an outcome could even lead to friction between heirs. For instance, suppose the relative's will leaves one child certain specific assets and the other child "everything else." The relative may have set things up so the children would receive more or less equal bequests. But under the law, if a state estate tax is suddenly due, all of it will come from the share of the child who gets "everything else." This could upset a careful estate plan and create family disharmony.

If you're thinking of moving an elderly relative to an out-of-state home or facility, it's a good idea to speak with an estate planner about the change. There might be ways to avoid having the relative be treated as a resident of the new state.

Of course, you might also discover that there are tax advantages to having the relative be treated as a resident of the new state, and you'll want to plan for that as well.

Estate Planning May Be Harder for Couples Without Children

You might think that estate planning would be easy when couples don't have children. In fact, it can sometimes be more difficult - and also more important.

Couples with children generally agree about passing on their assets to their kids, and can rely on their kids to serve as caregivers and executors. It might not be so easy for other couples.

For instance, suppose Mike and Helen write a will leaving their assets to each other. If Mike dies first, Helen will inherit everything. When Helen dies, who will get Mike's assets? Helen could make a new will, but if she doesn't, all of Mike's assets will go to Helen's relatives. 

But what about Mike's relatives? They would be left with nothing. And the same is true for Helen's relatives if she happened to die first.

Of course, Mike and Helen could agree that the surviving spouse will sign a new will that's fair to both families. But what if the surviving spouse gets remarried, or has a falling-out with the in-laws, or dies shortly afterward, or is elderly and simply doesn't get around to it?

A better approach might be for Mike and Helen's wills to say that if one dies, his or her assets will go into a trust. The trust can benefit the surviving spouse during his or her lifetime, and then go to the other spouse's family. That solves the problem

Another issue is who will serve as power of attorney or health care proxy. If Mike and Helen name each other, and one dies, who will be listed as the alternate for the surviving spouse? If there are no children in the picture, this requires very careful consideration. 

Four Big Mistakes That Executors Frequently Make

Executors have a tough and often thankless job. They have to marshal all the estate's assets, file tax returns, and distribute property according to the Will. Sometimes, they make mistakes. Here's a look at the most common ones:

Paying bills too soon. Executors often see bills arrive in the mail and decide to pay them right away to avoid any problems. But this can actually create problems.

There is an order in which bills must be paid: Items such as taxes, funeral expenses and the costs of estate administration typically take priority over credit card statements, for instance. If an estate turns out to have a lot of debts (perhaps the person who passed away had an unexpected tax bill), and the executor has paid off low-priority debts first, there might not be enough money to pay the high-priority debts, and the executor might be personally liable for them.

It's best not to pay low-priority debts until the estate administration has been completed, or at least until you know exactly what the estate's tax and administration liability will be. 

Paying heirs too soon. Often, beneficiaries are impatient to receive their inheritance and pressure the executor to start making distributions. An executor can get into trouble if he or she makes distributions quickly and it later turns out there aren't enough remaining assets to pay off the estate's debts.

A related issue is that an executor has an obligation to secure and properly value estate assets. If beneficiaries are using "self-help" to make off with personal property - vehicles, artworks, furniture, a piano - before the executor can have them appraised, the executor could be personally liable for this as well.

(It can be an even bigger problem if a family member takes an asset that the Will says should go to someone else.) 

Handling real estate. If real estate is going to be sold, deciding how quickly to do so can create a minefield for executors. Sometimes an executor can be caught in the middle between one heir who's living in a house and another who wants it liquidated quickly. And sometimes it's hard to sell a property unless certain repairs or improvements are made first - but it's not always clear whether the executor has the authority to use estate funds to make the improvements.

Another issue arises if a property sits empty for a long time. If a house isn't occupied, it may be hard to obtain insurance for it, and it may become subject to maintenance problems, burglary and vandalism.

Investing estate assets. If an estate will take a long time to settle, executors may be tempted to invest some of the estate assets. That might be okay if the investments are extremely safe, but an executor could be on the hook if an investment loses money and an heir inherits less as a result. 

It's important to remember that while executors have an obligation to conserve estate assets, they have no legal duty to try to grow them.

Of course, the opposite problem can come up if the estate assets are already invested in risky things. In that case, an executor must decide whether to leave them there or move them into safer investment vehicles.

Back-to-school and HIPAA

If you have a child who is away at college, you should be aware that the federal medical privacy rules apply to him or her. Once your child turns 18, the federal HIPAA law says that you can no longer have access to your child's medical information without his or her consent.

That's a problem, because if there's an emergency and your child isn't able to provide consent, you might not be able to access the information you need to make important medical decisions. In fact, if might not even be clear that you have the legal right to make such decisions.

This problem has a simple solution. A health care proxy signed by your child and naming you as healthcare agent and HIPAA agent, will give you the authority to access the medical information needed to make healthcare decisions for your child in an emergency situation, and the authority to make those decisions. 

New Problem for Some Executors and Heirs

Executors who have to file a federal estate tax return, and some heirs who receive assets from an estate that is subject to the federal estate tax, may be facing a significant new problem as a result of rules just issues by the IRS.

The problem only affects larger estates - generally those where the deceased person's assets, large lifetime gifts, and life insurance proceeds total more than $5.45 million. But for those estates, it's a serious issue.

The problem stems from a law passed by Congress last year. The law says that an executor who files an estate tax return must now also fill out a form - called a Form 8971 - identifying all heirs to the IRS as well as the value of the assets to be distributed to them. Each heir must also be given a related form (called Schedule A) identifying the assets they will receive and their value.

If the estate is subject to the federal estate tax, then the heirs must use the value of the assets as stated on Form 8971 as their capital gains tax basis if they eventually sell them. There's a 20% penalty for claiming a different value.

(The idea was to prevent a perceived tax abuse where an executor claims a low value to save on estate taxes, and an heir later claims a higher value for the same asset to save on capital gains taxes.)

The IRS has just released proposed regulations explaining how all this will work in practice. And while the IRS's proposed rules clarify some things, they also highlight some serious issues.

For instance, Form 8971 must be filed fairly quickly after the deceased person's death, and an executor might not yet know exactly which estate assets will be given to which heirs, or which assets will be sold to fund a particular bequest. If that happens, then the executor must send the heirs a Schedule A that includes the value of all assets that could even conceivably be used or sold to fund their bequest.

So imagine that an estate is worth $7 million, and a distant relative or friend is going to receive an inheritance equal to 1% of the estate. That beneficiary might have to be given highly detailed and personal information about the entirety of the deceased person's financial affairs - something the deceased person almost certainly never expected to happen.

What's more, a relative or friend might look at the lengthy list of assets and assume that he or she is going to get a lot more than the actual bequest. This could leave an executor with a number of very angry and frustrated beneficiaries. 

The Schedule A form itself doesn't help much. Here's what it tells the heirs:

"you have received this schedule to inform you of the value of property you received from the estate of the decedent named above."

A beneficiary could read this and easily assume that he or she is receiving all the property listed.

Nor does Schedule A clearly explain (in language a non-expert could understand) the fact that heirs face a big penalty if they sell an asset and claim a different basis.

For this reason, many executors are going to have to go to some lengths to tell beneficiaries what they need to know and keep them from getting false hopes.

Another big problem is that, under the IRS's proposed rules, if an heir later transfers an inherited asset to a family member (or even just a portion of an asset), the heir must then file a second Form 8971, and must send a Schedule A to the family member. Many heirs will be totally unaware of this requirement, and as a result many family members might have no clue what the required basis is and end up inadvertently owing a 20% tax penalty.  

Here are some other important points in the IRS's proposed rules:

• An executor who files an estate tax return has to file a Form 8971 even if no estate tax is owed, and therefor the heirs aren't legally required to use the value on the form as their basis. (This could happen, for instance, if there's a large marital or charitable deduction.)
• If an executor is filing a return solely to claim "portability" of the estate tax exemption (so a surviving spouse can later use his or her own exemption plus the spouse's exemption), a Form 8971 doesn't have to be filed.
• An executor who files a Form 8971 doesn't have to declare cash, assets in certain retirement accounts, or items of tangible personal property worth less than $3,000.
• If additional assets are discovered after an estate tax return in filed, their capital gains tax basis will be zero unless the estate files a supplemental return.
• If no estate tax return is filed, but one should have been filed, then all estate property will have a zero basis until a return is filed.

You should note that the IRS has only issued proposed regulations. Taxpayers can comment before they become final, and the IRS might tweak them later. But for now, we should assume the IRS means what it says.