BizLawBuz …. The Power of Know

A deadline is looming. Assuming you filed your 2010 income tax returns on time, you have until October 17, 2011, to recharacterize contributions to Roth IRAs as contributions to traditional IRAs. This deadline may be important to you if converted your traditional IRA to a Roth last year betting that the market would perform well and that you would, as a result, enjoy significant tax-free earnings in your retirement years, but are now having second thoughts.

Brief window to convert to Roth IRA
The October 17 deadline also applies to the recharacterization of contributions to traditional IRAs as contributions to Roth IRAs. If you are one of the fortunate few whose investments have done well and you are feeling confident about future market performance, you may want to take advantage of this brief window to convert your traditional IRA to a Roth.

Refund of taxes
If you do elect to switch from one type of IRA to the other, the IRS will treat both the recharacterized contributions and the income attributable to those contributions as though they were in other type of IRA all along. For example, if you previously paid income taxes upon converting to a Roth IRA, you would get a refund of those taxes upon reconversion to a traditional IRA.

Contributions that do not qualify
Most, but not all, types of contributions can be recharacterized. Regular contributions to both Roth IRAs and traditional IRAs qualify, as do Roth conversion contributions. An example of a contribution that does not qualify is a tax-free rollover from one traditional IRA to another.

If you think you want to recharacterize your Roth IRA as a traditional IRA or vice versa, be sure to talk with your tax or financial advisor right away as the process can take some time to complete.

Lee Flaherty

For several years now, Michigan Medicaid recipients have been waiting apprehensively for the state to implement a program whereby Medicaid benefits paid out during a person’s lifetime will be recovered from that person’s estate after death. Generally called “estate recovery,” this program is required by federal law. Michigan submitted its proposed program to the federal government four years ago, but cannot implement it until the feds approve it. That approval is expected at any time.

In anticipation of the federal approval, on July 1, 2011, the Michigan Department of Human Services will publish new policy detailing how it proposes implementing estate recovery. According to the new policy, estate recovery will only affect people who began receiving Medicaid after September 30, 2007, Medicaid recipients over age 55, and recipients who are permanently institutionalized regardless of age.

When estate recovery takes place
Estate recovery will not take place until after the Medicaid recipient dies. If the Medicaid recipient is survived by a spouse, by a child who is under age 21, or by a child who is blind or permanently disabled, then there will be no estate recovery until after those persons die.

The state may decide not to pursue recovery at all if recovery will create an “undue hardship.” Undue hardship exists when the assets of the Medicaid recipient are the sole source of income for surviving family members, such as a family farm or business. It also exists when the home is of “modest value” or when a survivor would become eligible for Medicaid if estate recovery were to occur.

Asset preservation strategies
Importantly, the state will only seek recovery from a decedent’s assets which pass through probate court. This means that a number of asset preservation strategies are still available, such as joint ownership, ownership subject to a life estate, and beneficiary designations on accounts and life insurance policies.

Assets exempt from estate recovery
Finally, there are certain assets that are exempt from estate recovery. For example, the state will not pursue recovery if the cost of recovery is expected to exceed the value of the asset.

The Department of Human Service’s new policy answers a number of questions, but it does not contain a lot of detail. We will still have to wait for the program to be put into practice to see just how it will affect Medicaid planning.

Lee Flaherty

While the changes are mainly technical in nature, some are substantive and worth noting. Changes to the Michigan Limited Liability Company Act (”LLCA”) took effect on December 16, 2010.

The LLCA now:

• Enables corporations to easily convert into limited liability companies (”LLCs”) and vice versa. This represents one of the most important changes to the LLCA. Prior to the amendment, it was necessary to go through a formal merger of a corporation and an LLC to make the conversion. There are several reasons, such as tax implications and corporate governance, that may make it desirable to change the form of an existing business entity, and this process will make such a change much simpler.
• Clarifies how a person is admitted to an LLC as a member. Previously, the LLCA indicated that a person could only become a member of an LLC at the time of formation if the person signed the initial operating agreement, but LLCs are not required to have operating agreements. Now, a person will be admitted as a member if he or she signs an operating agreement, or if the person’s status as a member is reflected in the LLC’s records. Additionally, a person can be admitted by the other members in any other writing.
• Provides processes and guidelines for the approval of transactions with interested managers or agents (i.e., the transaction was fair, material facts of transaction were disclosed, and disinterested managers/members approved the transaction);
• Explicitly authorizes LLCs to provide broad indemnification of members, managers, and others, subject to some exceptions. The former LLCA seemed to some to only permit indemnification of managers, not members and agents.
• Explicitly authorizes LLCs to purchase errors and omissions (D&O) insurance for members, managers, and others. Like indemnification matters discussed above, the former LLCA was interpreted to prohibit LLCs from purchasing errors and omissions insurance on behalf of any person other than a manager.
• Limits the rights of an LLC member’s creditor. As a result of the amendments, a creditor cannot take the member’s membership interest in the LLC and either sell it or become a member itself; creditors receive only a charging order and the right to distributions that would be payable to the member. Under the prior version of the LLCA, creditors were attempting to go beyond attaching the economic rights of their debtors and attempting to participate in management of the LLC or sell the membership interest.
• Clarifies that members and managers of LLCs may be entities rather than natural persons.

For additional information regarding changes to the LLCA and how they affect your business, please contact an attorney at Wright Penning & Beamer.

Julie Pfitzenmaier

Recently, a business client contacted our office because he received a request from someone claiming to have Power of Attorney over one of his customers (let’s call her Jane). This individual was looking for copies of Jane’s personal records and prior purchase information. Jane is an elderly woman, who had been a long-time customer of the Business. To the best of the Business Owner’s knowledge, Jane did not have any close family or friends in the area.

Requests for personal information
The individual, a male, who contacted the Business “on Jane’s behalf” was forceful, discourteous, and seemed to suggest that the Business had sold goods to Jane for an amount greater than the actual value. This raised red flags for the Business, so we were contacted for advice on whether the Business should comply with the request for Jane’s personal information.

Use caution
These requests are not unusual, and many of you may receive similar requests at some point. If you are contacted by someone seeking another individual’s personal information, use caution. Always request a copy of the Power of Attorney document and ensure that the person to whom you are talking is the person nominated as Power of Attorney in the document. The following steps would also be prudent:

• Request a copy of the person’s driver’s license or other identification. Don’t assume that the person requesting information is who they say they are.
• Ask an attorney to review the Power of Attorney to ensure that the person claiming to have power of attorney is authorized under the document to accomplish the task he or she is attempting.
• Ask an attorney to prepare a short affidavit for the individual to sign, certifying that:
  • The person is who they say they are;
  • The person has personal knowledge that the other individual is not deceased (powers of attorney are only valid if the individual is alive);
  • The Power of Attorney is effective;
  • The person has no knowledge that the Power of Attorney has been revoked or is otherwise invalid.

Protecting yourself
While you might not be in a position to contest the validity of the Power of Attorney, you can protect yourself in the event someone later questions your decision to provide confidential information to a third party. Taking the above actions, and keeping a record of those actions, will show that you acted prudently before disclosing the confidential information.

Julie Pfitzenmaier

Michigan permits husbands and wives to own real estate as “tenants by the entireties.” This special form of joint ownership, recognized only in about half of the states, protects real property from the claims of creditors unless the creditor is the joint creditors of both the husband and the wife. In other words, the creditor of one spouse has always been powerless to force the sale or refinance of entireties property in order to collect a debt.

This was true for all creditors until 2002, when the IRS prevailed in a court battle over whether a federal tax lien may attach to a delinquent taxpayer’s interest in real estate owned as tenants by the entireties. The 2002 ruling essentially gave the IRS “super creditor” status, but there was some comfort for taxpayers in that the IRS could not actually force the sale or refinance of entireties’ property. Instead, it could only wait in the wings until the property was either sold or refinanced, at which time the delinquent tax debt would be paid.

The tax collection landscape changed dramatically this August when the U.S. Court of Appeals expanded the reach of the IRS by ruling that the government could foreclose a husband’s income tax debt by forcing the sale of the Michigan home he owned as tenants by the entireties with his wife. As a practical matter, this ruling means that any transfer of a marital home to one spouse or to that spouse’s living trust must be completed well before any tax dispute arises if the home is to be protected from the collection efforts of the IRS against the other spouse.

Lee Flaherty

A few years ago, terms like “short sale,” “upside down,” and “under water,” were not even part of our lexicon. Today, they are common place. Following some 15 years of steady appreciation, peaking in 2006, home values in Michigan have since declined 45% on average. In Oakland County, distressed sales now account for approximately 93% of all home sales. If a short sale becomes your only option, here are some basics to keep in mind.

1. A short sale results when the seller owes more money on the mortgage than the home is worth. As a result, the seller is forced to negotiate a discounted payoff of the underlying mortgage debt with the mortgage lender in order for the sale to take place. Sellers want to avoid having to pay money against the mortgage at closing and to obtain a waiver of any deficiency. Buyers want clear title and a quick closing.

2. It is absolutely essential that a short sale contingency be included in the listing agreement for the property and in the purchaser agreement. Such contingencies will provide that the sale is contingent upon the ability of the seller to negotiate a short sale with its mortgage lender upon terms and conditions that are acceptable to seller, in seller’s sole discretion. If the seller is unable to get such an approval, the purchase agreement can be terminated, buyer’s deposit refunded, and seller has no obligation to the realtor under the listing agreement.

3. Mortgage lenders have very specific, detailed and comprehensive procedures that must be followed, exactly, in order for a short sale to be considered. Substantial documentation must be provided, and there must be full and accurate disclosure on the part of the seller. Failure to accurately disclose such things as hardship, income and assets, may result in the short sale being later set aside on the basis of fraud. The process is detailed and time consuming (as long as 6 months or more), ultimately resulting in either the rejection of the request or a statement of the terms upon which the mortgage lender will agree to the short sale.

4. Mortgage lenders are not required to waive the balance owing on the mortgage. They may require that some, or all of it, be paid by the seller at closing, or that the balance owing will remain payable by the seller under the original mortgage note or a new promissory note.

5. A short sale will impact the seller’s credit rating and may adversely impact the ability to obtain certain types of mortgages in the future. And, any part of the loan deficiency that is forgiven must be reported by the mortgage lender to the IRS on Form 1099-C. Whether or not the forgiven debt is taxable depends upon a number of factors, including whether or not the home was the borrower’s principle residence, when the forgiveness took place, and so on.

Based upon historic trends, many believe that it will take another ten years or more for homes to regain the value that has been lost in the past 4 years. Distressed sales (short sales) are therefore a fact of life that will be with us for years to come.

Duane L. Reynolds

Revocation and Restoration of Tax-Exempt Status

Nonprofits subject to IRS annual reporting requirements
Until recently, most U.S. nonprofit organizations were not required to file an annual information return with the IRS. Beginning January 2007, all that changed when even the smallest of nonprofits became subject to IRS annual reporting requirements. The only exceptions were state organizations, churches and their affiliated organizations, and certain religious groups. Nearly all others were required to file some version of Form 990, and the failure to do so for three consecutive years would mean automatic loss of the organization’s tax-exempt status.

New nonprofit filing requirements
It has now been three years since the implementation of the new filing requirements, and the IRS estimates that perhaps 20% of all nonprofits may have lost their tax-exempt status on May 17, 2010 (the annual filing deadline for nonprofits with a December 31 fiscal year end), for failure to file an information return for three consecutive years.

When nonprofit tax-exempt status is revoked
Revocation of tax-exempt status is a serious matter for a nonprofit. It means that its income is now subject to tax, and that an income tax return must now be filed. It means that the organization can no longer accept tax-deductible contributions, which could potentially mean a loss of its entire base of support.

IRS list of nonprofits whose tax-exempt status has been revoked mailing
So what does this mean for individual donors and grantmakers? The IRS is apparently waiting until 2011 to send out letters of revocation and to publish a list of nonprofits whose tax-exempt status has been revoked. Until that time, individuals can still deduct charitable contributions and grantmakers can still make qualifying distributions to those charities. Beginning in 2011, however, foundations will need to amend their pre-grant due diligence process to include confirmation that a charity has not lost its tax-exempt status.

Welcome relief for small nonprofits only
In the meantime, a press release issued by the IRS on July 26, 2010 offers welcome relief for small nonprofits only. Small exempt organizations have a one-time opportunity to either (1) file their missing returns by October 15, 2010, or (2) engage in a voluntary compliance program. The first option is for very small organizations that are eligible to file Form 990-N (known as the “e-Postcard”). The second option is for somewhat larger organizations that are eligible to file Form 990-EZ.

Organizations that file Form 990-N can simply go online and complete their filings electronically. Organizations that file Form 990-EZ must both bring their delinquent returns up to date and pay a compliance fee.

Regaining nonprofit tax-exempt status
For charities that receive an IRS revocation letter next year, all is not lost. A nonprofit can regain its tax-exempt status by filing a lengthy application (Form 1023 or Form 1024) with the IRS and paying the applicable user fee. (Unfortunately, this application process applies even to organizations that did not have to apply in order to gain their initial tax-exempt status.) Reinstatement will usually be effective as of the date the application is filed. However, if a nonprofit can demonstrate that it had reasonable cause for failing to file returns for three years, reinstatement will be effective as of the date of revocation.

Donor and Grantmaker Questions
Whether you are a donor with questions about an organization, a grantmaker that needs assistance in revamping its due diligence processes or a charity that fears it may have lost its tax-exempt status, the attorneys at Wright Penning & Beamer stand ready to assist you.

Lee Flaherty

These days it’s hard to listen to the radio, watch television or go on-line without being inundated by ads pitching the latest and greatest do-it-yourself, on-line, estate plan documents: who needs those money grubbing lawyers anyway? One thing all of these pitches have in common is the assurance that the forms are legally valid and binding. Truth be told, “legally valid” is not a tough threshold to meet. If the person signing the Will (or trust, or, you name it) has the requisite mental capacity under the laws of the state where the document is being signed, and the document is signed, witnessed, or notarized in accordance with the laws of the state, it is legally valid. Legal validity, however, is only part of the story. Imagine the shock years down the road when it is discovered that an estate plan put in place by well meaning parents, intending to provide for each other and their children upon their disability and eventual deaths, does nothing of the sort.

I recently had the opportunity to help a young couple with very small children, where one spouse was facing a life threatening illness. They were referred to me to review their revocable living trust. I was under the impression that it had been drafted by another lawyer, and, therefore, my initial review was not clouded or prejudiced in any way. As I went through the document I was appalled at what I perceived to be the utter incompetence of a fellow practitioner, and, quite frankly, dumfounded as to why and how any attorney could pass something like this off on unsuspecting clients. The document was grossly deficient in a number of particulars, and, more importantly, would not have accomplished the desired result of providing for the surviving spouse and children upon the disability or death of one of the parents. It was then that I learned that in their haste to insure that the surviving spouse and children would be provided for, the couple turned not to a lawyer, but to one of the popular on-line sites for their estate planning needs, which included a revocable living trust (for which they paid a fairly sizeable sum I might add).

To enumerate and explain the deficiencies in the document would exceed the space allowed here, so I’ll only touch upon three, specifically:

1. form
2. concept, and
3. substance.

First, from the standpoint of form, although touted by the website to be a Michigan specific document, the terminology used was not consistent with, or reflective of, Michigan law. This past April 1, 2010, the Michigan Trust Code went into effect, changing many aspects of Michigan trust law. Those changes had not found their way into the document.

Second, the document was premised upon property law concepts that are not followed in Michigan. Admittedly, this is where the explanation can get technical and complicated, so I’ll convey only the basics. Insofar as property ownership between a husband and wife is concerned, 40 states follow concepts derived from, and based upon, English common law. There are 10 states, however, that characterize property owned by a husband and wife pursuant to concepts that can be traced to French and Spanish civil law. Those states are said to be “community property” states. And, even within these groupings of common law and community property law jurisdictions, there are many variations. The salient fact remains, however, that property owned by a husband and wife is treated differently in community property and common law jurisdictions. Michigan is not a community property state. Yet, this document, although touted to be a Michigan specific document, employed community property terminology and concepts.

Lastly, there are many reasons why people need estate plans, and trusts in particular, ranging from tax savings to probate avoidance. For people with children, the primary need for a trust is to provide for the children upon the death or incapacity of one or both parents. Without a trust, minor children will receive their inheritance when they turn 18; all of it. Because that is rarely a good idea, trusts are the means of providing a method for holding property and administering it for the benefit of the children according to a detailed plan of distribution determined by the parents, in advance. The trust document I was asked to review contained none of these provisions. Although this couple had a number of children, upon the death of the second spouse to die, the trust assets would simply be held for distribution to each child as he or she turned 18. The document contained no provisions for the administration and distribution of the trust property for the care of the children while they were young.

Was this a legally valid and binding trust? It was. Would this trust have fulfilled the intentions and desires of this young couple and the needs of their family? Not even close. The problem is that they had no way of knowing that. For users of these on-line documents, it will be years or decades before the ultimate beneficiaries will learn just how bad the documents are. Merely filling in the blanks on a form is no substitute for the expertise of an experienced estate planning attorney. There is a reason why we dedicate our working lives and energy doing what we do.

Duane L. Reynolds

The Michigan General Property Tax Act (the Act) requires real property in Michigan be assessed yearly and taxed at one-half (1/2) of its true cash value (true cash value is the same as market value). However, with the passage of the Headlee Amendment to the Michigan Constitution in 1994, limitations were placed on how much assessments and taxes could go up each year. Since 1994-1995, annual property tax increases have been “capped” at levels specified in the Act and remain capped until a “transfer of ownership” occurs. Once a transfer of ownership occurs, the property is reassessed at one-half (1/2) of the “true cash value” as of that date and the taxes, in most cases, go up substantially. The property tax is capped at the new, higher amount until the next transfer of ownership takes place (Michigan property tax bills show a “Taxable Value” and a “State Equalized Value.” The Taxable Value is the capped value upon which the property tax is assessed. The State Equalized Value approximates one-half (1/2) of the true cash value/market value of the property. Once the property tax is uncapped, the State Equalized Value and the Taxable Value become the same for the year in which the uncapping occurred and the cap goes back into effect at that amount).

The key term in all of this is “transfer of ownership,” which basically means a conveyance of title to, or a present interest in, real property. However, not all conveyances constitute a transfer of ownership. One such exclusion is for a transfer of ownership between two or more persons that creates or terminates a joint tenancy if

1. at least one of the persons was an original owner of the property before the joint tenancy was initially created, and,
2. if the property is held as a joint tenancy at the time of the conveyance, at least one of the persons was a joint tenant when the joint tenancy was initially created and that person has remained a joint tenant since that time.

In 1959, James and Dona Klooster, as husband and wife, acquired title to property in Charlevoix. They held the property as “tenants by the entirety” which is a form of joint ownership in Michigan applicable only to married couples. Dona then conveyed her interest to her husband James, who in turn as sole owner, conveyed the property to himself and his son Nathan as joint tenants with rights of survivorship. James died in January, 2005 which automatically made Nathan the sole owner. On September 10, 2005, Nathan conveyed the property to himself and his brother as joint tenants with rights of survivorship (”joint tenants with rights of survivorship” simply means that upon the death of one of the joint owners, the remaining joint owner(s) are automatically deemed to own the property as a matter of law; there is no new deed or new conveyance).

In 2006, the assessor for the City of Charlevoix determined that the death of James in 2005 constituted a conveyance to Nathan and uncapped the property taxes, resulting in a new taxable value that was almost double the previous taxable value. Nathan appealed the assessor’s determination to the local board of review which upheld the decision of the assessor. Nathan appealed that decision to the Michigan Tax Tribunal which upheld the decision of the board of review. Nathan appealed that decision to the Michigan Court of Appeals.

In an opinion rendered on December 15, 2009, the Michigan Court of Appeals reversed the decision of the Michigan Tax Tribunal, finding that the transfer that occurred as a result of the death of James (making Nathan the sole owner) did not constitute a transfer of ownership under the Act. As a result, the taxes should not have been uncapped. The court came to this conclusion based upon the wording of the Act which requires a “conveyance.” Because the Act does not define “conveyance,” the court, considering both legal and dictionary definitions, determined that a “conveyance” is an instrument in writing affecting title to real property. The court ruled that the death of James, which automatically vested sole ownership in Nathan as the surviving joint tenant, was not a conveyance. The assessor has appealed that decision to the Michigan Supreme Court which, just a few weeks ago, agreed to take the case.

So, why is this case important? Plummeting property values equate to lower property taxes and lower tax revenues. If taxable values can be uncapped, revenues will increase. This case, which focused solely on whether or not the death of a joint owner constitutes a transfer of ownership such as to allow for the uncapping of property taxes, is therefore of substantial importance to property owners and assessors alike. A decision is expected later this year.

Duane L. Reynolds

As you probably have heard, the federal estate tax rules changed radically in 2010 and will change radically again in 2011 unless Congress passes new legislation. This article will discuss what some of the changes can mean for you.

First, a little background:
The 2001 Tax Act. In 2001, Congress passed legislation which significantly increased the federal estate tax exemption and lowered tax rates. Among other things, the 2001 Act provided:

• In 2009, the estate tax exemption increased to $3.5 million per decedent, with a reduced 45% tax rate on any excess assets.
• In 2010, the estate tax is repealed for one year. In addition, the step-up in basis (which gave a “fresh-start” fair market basis for most assets of a decedent) is replaced with a more complex adjusted carry-over basis system.
• In 2011, the estate tax will be reinstated. However, the tax exemption will drop down to $1 million and the tax rate will jump up to 55%. In addition, carry-over basis will disappear and the step-up in basis will once again be the law of the land.

What Happened in 2009? Estate planners universally expected Congress to extend the favorable 2009 estate tax rules through 2010. However, unexpectedly in December, the House failed to enact a one-year extension and instead sent the Senate a bill to make the 2009 rules permanent. Because the Senate was focused on health care and there was broad disagreement in the Senate on what to do with estate taxes, it did nothing. Thus, effective January 1, 2010, there is no federal estate tax and the adjusted carry-over basis rules apply.

Estate Planning Is Now in Chaos. Congress’s failure to act in 2009 and the possibility that it will not act this year make for an unpredictable planning environment in which any number of radically different changes may occur.

Here are some of the possibilities:
Congress may do nothing this year. While you probably will not die in 2010, you still need to consider planning for that possibility because not doing so could be disastrous. For example:

• Trust language that allocates your estate tax exemption to a “family trust” could disinherit or place undesirable restrictions on a surviving spouse or other heirs.
• Conflicts could arise on asset basis issues.
• Passing assets directly to your spouse may result in higher estate taxes after 2010.
• Congress may retroactively adopt legislation to carry the 2009 rules over 2010. If a retroactive law is adopted, it will most likely be challenged as unconstitutional and it could take years for the Supreme Court to rule on the issue. Until such a ruling, uncertainty will prevail. In any event, your estate plan should contemplate your dying both before or after a potential retroactive enactment.

Congress may act to address the tax issues, in which case it may:

• Adopt a permanent estate tax exemption. If so, most commentators anticipate the tax exemption will fall between $2-5 million and tax rates will range from 35% to 45%.
• Adopt a temporary estate tax exemption.

What Should You Do? Uncertainty makes it difficult to plan, but waiting to see what happens next is not a good idea. The earlier you can implement flexible tax and estate planning to respond to these changes the better. Please call us to schedule a time to go over your current estate plan and determine what changes need to be made to minimize taxes and to reduce the possibility of future family conflicts in these chaotic times.

Lee Flaherty