In 1993, Suzanne executed a will that left 50% of her estate to her son – Dan – and 50% to her granddaughter, Nicole.  Suzanne began to suffer from hallucinations in 1995.  Approximately one year later, Suzanne executed a power of attorney authorizing Nicole to handle her real estate transactions.  At the time, Suzanne owned a home in New London.  Everyone knew that she was executing this power of attorney in favor of her granddaughter.

A couple of days after she executed it, Suzanne was admitted to the hospital with hallucinations.  While at the hospital, a doctor diagnosed her with mild senile dementia.  Several months later, Nicole sold Suzanne’s home for $150,000 and purchased a condominium in Waterford for $100,000.  Title to the condominium was in the name of Suzanne and Nicole’s mother (Darcy) as joint tenants with rights of survivorship.  Suzanne remained in the condominium until her death five years later.

After Suzanne’s death, Darcy became the sole owner of the condominium. Dan sued Darcy as well as Nicole.  In that lawsuit, he asked the court to impose a constructive trust on the condominium and any cash left over from the sale of Suzanne’s home in New London. Dan claimed that Darcy and Nicole intended to deprive Suzanne’s estate of its principal asset (the house in New London) and as a result, he lost out on his 50% interest in his mother’s estate.  At the heart of Dan’s claim was that Suzanne lacked the mental capacity to knowingly execute her power of attorney.

At trial, several witnesses testified to Suzanne’s mental capacity.  One of the witnesses was the doctor who treated her when she was admitted to the hospital.  That doctor testified that after Suzanne was admitted, he diagnosed her with mild dementia.  Also, after reviewing her medical records, the doctor testified that in his opinion, she suffered from moderate stage Alzheimer’s Disease.  Nevertheless, he also testified that Suzanne’s situation was fluid and that she could be lucid at times.  Finally, the court considered the records of the visiting health care providers who rendered care to Suzanne in the months leading up to her admission to the hospital.  Those records indicated that Suzanne experienced occasional hallucinations and moments of confusion.

In deciding Dan’s case, the court cited to another case for the proposition that there is a presumption of sanity in the performance of legal acts.  The court then stated that the medical evidence offered by Dan fell short of overcoming this presumption and concluded that he failed to prove his mother was incapable of executing her power of attorney.  Since the court found that Suzanne had the capacity to execute her power of attorney, that meant that Nicole was properly authorized to sell the home in New London and purchase the condominium in Waterford.

The issue of capacity is one that comes up in my practice over and over again.  The burden of proving a lack of capacity is onerous and difficult.  Every case stands on its own facts.  Ultimately, a court must determine whether someone has the capacity to execute a legal document and this determination is done with the understanding that there is a presumption in favor of capacity.  At Cipparone & Zaccaro, PC, we have a good deal of experience handling disputes over the use of a power of attorney.  If you have questions related to capacity, please don’t hesitate to give us a call.  We’d be happy to analyze the facts of your case and advise you according to the law.

Charlie married Olga in 1985 and one week before they got married, they signed a pre-nuptial agreement.  The agreement had a clause in it that stated neither party would be responsible for the debts of the other party which accrued before and during the marriage.  After they were married, Charlie then moved into Olga’s home.  This home was solely owned by Olga.

In 1995 - 10 years after they were married - Olga took out a home equity line of credit with a local bank.  The line of credit was in the amount of $50,000 and it was secured by a mortgage against Olga’s home.  Two years later, Olga went to her lawyer and made a will.  The will specifically devised Olga’s home to her son but it also reserved a life estate to her husband, Charlie.  The will also said that as long as Charlie occupied the home, he shall be responsible for and shall pay all expenses relating to the use and maintenance of the home which include but are not limited to the taxes, insurance, utilities and repairs.  Elsewhere in the will, there was a paragraph which specifically incorporated by reference, the pre-nuptial agreement that Charlie and Olga signed in 1985.  Then, Olga died two months later.  

After she died, Charlie paid the taxes, insurance, utilities and maintenance expenses associated with Olga’s property.  Nevertheless, he did not pay anything towards the line of credit nor did he pay any interest associated with it.  To put it mildly, Olga’s son was not happy with this decision, so he sued Charlie, claiming that it was his obligation to pay the line down, including any interest that accrued on it.

Does Charlie – as the life tenant – have any legal obligation to pay the line of credit or any interest associated therewith?  You may be surprised to learn that Connecticut law generally obligates a life tenant to pay a mortgage secured by the property that is the subject of the life estate but that a specific will provision can override or supersede the law, thereby excusing the life tenant from having to do that.

The first thing the court will do is construe the testator’s will and they will examine the entire will in order to determine the testator’s intent.  In this particular case, the court will try to discern what Olga’s intention was concerning the life estate that she created in Charlie in light of the language in the entire will.  In other words, since Olga’s will incorporated and referred to the pre-nuptial agreement, the court will consider that document as well, when determining what she intended.

Under the facts of this case, the will said that Charlie was responsible for - and had to pay - all expenses relating to the use and maintenance of the house.  Nevertheless, the pre-nuptial agreement – which Olga signed 12 years before her will - explicitly provided that Charlie and Olga would be responsible for his or her own individual debts acquired both before and during the marriage. The will made no reference to the home equity loan payments but the pre-nuptial agreement demonstrated Olga’s intention not to obligate Charlie to pay any debt that she alone contracted for after the date that the agreement was signed.  Thus, in this case, Olga’s will relieved Charlie of any obligation the law might have imposed on him otherwise, to pay down the principal or interest on the home equity line of credit.

This story demonstrates how someone would not be responsible to pay for a mortgage (or the interest associated with that mortgage) if they were named as a life tenant under a will.  Be advised, however, that this is not how Connecticut courts typically rule upon this issue.  Since the will discussed here, incorporated a pre-nuptial agreement, the life tenant was not legally obligated to pay this expense.  Scenarios like these are more common than you would think.  If you find yourself in a situation similar to the one that I’ve described here, you should contact the probate attorneys at Cipparone & Zaccaro, PC.  We would be happy to analyze your situation and guide you through this tricky and often - complicated - process.  

Income earned by limited liability companies (LLCs), partnerships and S Corporations traditionally passes through to members, partners and shareholders (collectively “partners”). That is why limited liability companies (LLCs), partnerships and S Corporations are commonly referred to as pass-through entities.  Partners pay tax on their distributive share of income from the business and typically make estimated payments for that liability. 

On May 31, 2018, Connecticut changed the way it taxes pass-through entities. Public Act 18-49 initiates a pass-through entity tax on LLCs taxed as a partnerships, general and limited partnerships, and S corporations (“PTEs”). The legislation does not impact publicly-traded partnerships, sole proprietorships or single-member LLCs that are disregarded entities. Connecticut taxes Connecticut source income of PTEs at the rate of 6.99%.

PTEs must make estimated tax payments to cover their pass-through entity tax. Because the law passed in the middle of the year, PTEs must make “catch-up” estimated tax payments.  The law requires estimated payments equal to 22.5% of the pass-through entity tax each quarter. Thus, a PTE is seriously behind on its estimated tax obligations if it has not started making payments to the state.  Because individual partners will get a credit for the pass-through entity tax paid by their PTE, many resident individuals will no longer need to make estimated income tax payments to cover Connecticut income from their PTE. If a nonresident individual does not have any other income from Connecticut sources and the PTE pays the pass-through entity tax, then the nonresident individual will no longer have to file a Connecticut income tax return or make estimated tax payments to Connecticut.  Most PTEs with corporate partners will elect the alternate method of calculating the new tax, which means the corporation will pay the pass-through entity tax on its distributive share of income from the PTE. 

The impetus behind this new entity level tax arises from the new federal income tax law (PL 115-97). The new federal income tax law caps the state and local tax deduction (“the SALT deduction”) for individuals at $10,000. No such limit applies to state and local taxes deducted by business entities.  Consequently, the PTE can take a deduction on its federal income tax return for the pass-through entity tax paid to Connecticut.  Public Act 18-49 allows partners in a PTE a deduction of 93.01% of the partner’s share of the pass-through entity tax paid by the PTE. In that way, it neutralizes the effect of the new pass-through entity tax and assures that the Connecticut income tax will be deductible on the business federal income tax returns.     

If you hold your business or vacation home in an LLC, partnership or S corporation and have not heard of this new law, you must calculate the projected income of your PTE for 2018 and pay 7% of it as estimated taxes.  Do not hesitate to contact the estate planning attorneys at Cipparone & Zaccaro, PC if you need any help understanding this new Connecticut tax.

Imagine that you are at a place in your life where your mom lives all alone and she is in cognitive decline.  Unfortunately, you can’t really help her much because she lives far away and you can’t visit her except on weekends here and there.  You’re an only child and your dad died many years ago.  Your mom has almost no one around to check up on her. 

Then the unthinkable happens.  You get a call from the police, telling you that they’ve picked up your mom and taken her to the psychiatric unit of the local hospital. A neighbor reported that she was wandering the neighborhood in her nightgown.  Unfortunately, her situation is grave.  The hospital discharged her to a nursing home where she is now institutionalized due to her condition.  The psychiatric unit has examined her and concluded that she suffers from severe dementia.  You take her to a geriatric psychiatrist who confirms that your mom is no longer capable of taking care of herself.  Your mother refuses to admit that she can no longer live at home alone. You also now know that her doctor prescribed psychiatric medications due to her confusion, agitation and anxiety.

This all-too-familiar story repeats itself with greater frequency as our population ages.    What can you do to protect your mom?

The first thing you can do is obtain conservatorship of your mom by filing an application for involuntary conservatorship with the local probate court.  The probate court will appoint an attorney to represent your mom.  You must get a written evaluation from a physician who has examined your mom within 45 days of the court hearing stating that your mom is not capable of managing her finances or taking care of herself. It is then up to the Court to decide – based on a standard known as clear and convincing evidence – that your mom is incapable of managing her affairs or incapable of taking care of herself.  In making its decision the Court must find three things:
(1)     That your mom is incapable;
(2)     That her finances, health care and personal affairs cannot be adequately managed without the appointment of a Conservator; and
(3)     That the appointment of a Conservator is the least restrictive means of intervention.

If the court appoints you as conservator and you want your mother to remain in the nursing home, you would then file a petition for placement in an institution for long-term care and a second petition for authority to consent to the administration of your mom’s psychiatric medications.  Connecticut law provides that in order to grant the petition for administration of psychiatric medications, the head of the hospital at your mom’s institution must make a written determination that she is incapable of giving informed consent to the medication for the treatment of her psychiatric disability.  That person must also state that the medication is necessary for her treatment.  In addition, the law states that two qualified physicians must also make a similar written determination.  So in order to succeed in having the Court give you this authority, three people – the head of the hospital and two doctors – must each say in writing, that your mom is incapable of giving informed consent to her medication for the treatment of her dementia and that the medication is necessary for her treatment.

Once you’ve obtained these letters, you can submit them to the Probate Court along with your petition.  Thereafter, the Court will hold a hearing to determine whether to grant you the authority to consent to the administration of psychiatric medications.  If the Court is satisfied that your mom is in an institution for the purpose of treating her for a psychiatric disability and that the head of the hospital and two doctors have provided written determinations as required by law, it will grant your petition.  Once your petition is granted, you will now have the legal authority to consent to the administration of psychiatric medication for your mom.

This story is just one of many factual scenarios under which someone can seek to care for their mom with severe dementia who lives alone.  You should know that the bar is high and courts are especially careful about granting these kinds of petitions because they want to preserve people’s independence as much as possible and they won’t “rubber stamp” any petition.  If you find yourself in a situation similar to the one that I’ve described in this blog, you should contact the probate attorneys at Cipparone & Zaccaro, PC to help guide you through this legal process. 

I remember learning an old adage in law school that went something like, “the man who represents himself has a fool for a client.”  Consider this scenario.  Your mother just passed away and you are her only child.  She owned a home, a couple of bank accounts and some valuable works of art.  Ten years ago, she wanted to give her house to you because she thought she might have to apply for Medicaid and she was trying to divest herself of assets so she could prove that she didn’t own a home when she applied for those benefits.  So she hired a lawyer to prepare a deed conveying the property to you and then she recorded the deed.  So far, so good.

The problem is, you already own your own home an hour and a half away and the thought of paying property taxes, homeowner’s insurance and maintenance costs on a second home, did not appeal to you.  So rather than spend money on a lawyer to reverse this transaction, you decide to prepare your own deed with the help of Attorney Google.  The problem is, Attorney Google is not licensed to practice law in Connecticut and he has no malpractice insurance.  A couple of months later, you download a document from the internet and you draft a deed.  Then you go to your local bank to have a notary public take your acknowledgment on it, thinking that you’ve done things correctly.  Finally, you take the deed to the town clerk’s office and record it.  Were you successful reversing this transaction?

After your mom died, you wisely decided to hire a lawyer to do the work to administer her estate.  One of the first things the lawyer does is order a title search of your mother’s home.  The title search results come back with a note from the title searcher, indicating that there may be an issue with the title to the house.  There is a concern that your mom may not have owned the house at her death and that you may still own it.  So you ask yourself how can this be?  The problem is the title searcher noted that the deed you prepared (attempting to convey the home back to your mother) is not properly witnessed because it’s missing the signatures of two witnesses.  Hence, it may not be a valid deed after all.

Connecticut has a statute entitled “Validations re conveyancing defects of instruments recorded after January 1, 1997,” otherwise known as the Validating Act.  Among other things, the Validating Act states that any deed made for the purpose of conveying any interest in real property in the State of Connecticut, which was recorded after January 1, 1997, which was attested by either one witness – or by no witnesses at all – is as valid as if it had been executed with witnesses, unless an action challenging the validity of the deed was brought within two years after the deed was recorded.

Under the facts of this case, the Validating Act saved the day.  First, the deed at issue in this example, was prepared ten years ago … well after January 1, 1997.  Second, although your signature was properly acknowledged by a notary public, it was not properly witnessed by two disinterested witnesses.  Nevertheless, no action was brought challenging the validity of this deed within two years of its recording.  So in the end, the statute validated the deed and your mother’s home is properly included in her estate.

Imagine if the facts were different though.  For example, what if one of your creditors brought a timely lawsuit, claiming that the deed was an invalid conveyance from you back to your mother.  If that creditor was successful, the property would not be a part of your mother’s estate and instead, it would be considered your property.  That means it would be subject to attachment by that very same creditor for a debt that you owe them.    

This is just one of an unlimited number of examples of the bad things that can happen to people when they choose to represent themselves.  Thankfully, disaster was averted here but if things were different, you could have been the fool.  Don’t be a fool.  When you’re faced with something as serious as the example I’ve written about here, do the right thing.  Contact a competent lawyer who can help you do things the right way.  Chances are, the fix is not as expensive as you think it is.  

If you have questions related to the Validating Act or about estates that have unusual real estate issues, please don’t hesitate to call the estate planning and probate attorneys at Cipparone & Zaccaro, PC.  

Grandparents want to be grandparents but sometimes they need to step in and try to get guardianship of a grandchild. In this blog post I explain the process you might go through to obtain guardianship of a grandchild. 

You are 60 years old and you’re thinking that it’s time to focus on yourself, now that your kids are grown and on their own.  You’ve reached a point where you can start socking away as much money as possible and plan for the day when you retire.  The problem is your daughter has an addiction. 

Since her early teens, she has been in and out of substance abuse rehab centers.  She didn’t finish high school and is unable to work. She can’t seem to find a long-term relationship.  At various points in her life, she’s been sober, only to relapse once again.    She became pregnant and had a son four years ago. She has been unable to establish paternity.

Your daughter struggles with raising her son. To provide stability for the child, you agree to let them move in with you.  Unfortunately, your daughter cannot overcome her drug addiction.  Consequently, you are raising your grandson.  Now he is four years old and you would like to get him into a daycare setting. When he reaches five, he will enter kindergarten.  His pediatrician tells you that you need to have legal authority to consent to his medical care because the school will want to know that he has his vaccinations before he starts.  What can you do to help your grandson?  You must meet with an experienced probate attorney.  (Keep in mind that custody is a family court matter involving the parents of the child.  Guardianship is a probate court matter involving anyone else who is not a parent of the child. )

The attorney advises you that a probate court can only appoint you as guardian if the court removes your daughter from that position.  Before you meet with your attorney again, you have several conversations with your daughter about the need to make you guardian.  Your daughter agrees and consents to her removal. Your attorney prepares a Petition for Removal of Parent as Guardian that indicates your daughter consents to the removal.   The attorney also prepares an Affidavit which alleges that your grandson has been living with you for the past few years and that you’re not aware of any other pending legal proceedings that relate to this Petition. Your lawyer also prepares a second Petition to have you appointed as guardian.  This Petition alleges that it is in your grandson’s best interests to have you appointed and because your daughter has consented, she must sign this document as well. In addition, your lawyer attaches a certified copy of your grandson’s birth certificate as required by the court. 

The attorney files the paperwork with the probate court and you ask for a hearing date.  What happens next?  The court contacts the Department of Children and Families and they assign a social worker to your case.  The social worker interviews you, your daughter and your grandson.  She also inspects your home to determine whether appropriate accommodations have been made for him.  She does a criminal background check on everyone.  She checks the sex offender registry and other relevant databases and ultimately concludes that your daughter should be removed as guardian and that you should be appointed as permanent guardian in her place.  This report is then filed with the probate court and the judge reviews it.  

Finally, you appear at the hearing, present your testimony and the judge confirms that your daughter has consented to her removal as guardian. The court then finds that it is in the best interests of your grandson to appoint you in that role. The court issues a written decree that you can use to provide care for your grandson and now he can finally start school with you as the decision maker.

The facts described above present just one possible scenario under which a grandparent can obtain guardianship of her grandson.  The fact patterns are endless and depending on those facts, a lawyer might advise his client differently than what he advised in this particular case.  The thing to keep in mind is that these situations are real and they exist in everyday life and most people don’t know how to proceed.  If you have questions related to guardianships, please don’t hesitate to call the probate attorneys at Cipparone & Zaccaro, PC.  We’d be happy to help you with your unique situation.

Mick Jagger once famously sang “what a drag it is getting old.”  Let’s face it, aging in America is fraught with all kinds of perils.  One of those perils includes living alone.  

Consider this scenario: your mom lives alone and you fear that she may be suffering from dementia or worse, Alzheimer’s Disease.  She won’t accept any help from visiting nurses and she has several medical issues at her advanced age.  You’ve arranged for her to receive Meals on Wheels but she doesn’t answer the door for them.  You’ve noticed that she has become combative and aggressive.  You’re worried about whether she’s putting herself in danger when you’re not there to look after her.  Worse still, other people report some scary things about your mom like how she has a tendency to leave the stove on from time to time and how she wanders in the neighborhood.  To make matters worse, you live an hour away, you have full-time job and you have responsibilities to your spouse and children.  Your mom’s only other child – your brother – lives across the country in California, so he’s not around to help. Your mom will not even listen to suggestions of leaving the home she has lived in for decades. Sound familiar?

Unfortunately, you have no legal authority to help your mom.  She does not have a power of attorney to manage her finances or an Appointment of Health Care Representative to manage her health care decisions.  Even if you became her agent under those documents, you do not think she would make sound decisions for her care.

Having exhausted all options, you hire an attorney to file a conservatorship application with the probate court. The attorney files a petition seeking the court’s permission to appoint you to act as your mom’s conservator.  The court issues a decree appointing you as the conservator of both her person and her estate.  Now what?  You’re convinced that your mom can no longer live alone in her own home.  Your next move may be to place her in an assisted living facility or nursing home.

Connecticut law does not allow you to place a conserved person in an institution for long-term care – a nursing home or an assisted living facility – without permission from the court.  You must file a petition with the probate court that approved the conservatorship.  You must send a copy of the petition to your mom, her attorney and any other interested parties (like your brother in California).  The law states that you must file this petition before any placement occurs. If your loved one is placed in a nursing home as a result of a hospital discharge, then you can file the petition after they’ve been placed.  In that instance, however, you must file your petition with the court no later than five days after the placement.

In either case, the probate court will hold a hearing to determine whether to grant your petition.  At the hearing, the court will accept evidence and hear testimony to determine what efforts you have made to tap into community resources in order to avoid placing your mom outside her home.  The judge will also ask why you - as conservator - cannot meet your mom’s physical, mental and psychosocial needs in a less restrictive setting than a nursing home.  If the judge is convinced that you’ve made efforts at trying to arrange for resources in the home and that your mother’s needs cannot be sufficiently met in any other way except by placing her in a nursing home, then it will issue a decree giving you the authority to place your mother in nursing home.

No one wants to face the possibility of forcing their loved one to move to a nursing home. The process for doing so is neither simple or easy.  Probate courts take the moving of a conserved person out of their home very seriously.  If you have questions related to moving a loved one to an institution for long-term care or about conservatorship matters generally, please don’t hesitate to call the estate planning and probate attorneys at Cipparone & Zaccaro, PC.  

Beginning January 1, 2018, Public Act 17-136 allows the guardian of a person with intellectual disability to manage that person’s assets if the assets do not exceed $10,000 in value.  The guardian files a petition with the probate court where the protected person resides to obtain such authority.  Under prior law, guardians of intellectually disabled individuals were not allowed to assist protected persons with their finances.

Upon receiving the guardian’s petition, the court will give notice of the petition to interested parties. The court will send the notice of the petition to the protected person and the protected person’s spouse, if any. The court will also send notice to the protected person’s parents or children. If the protected person’s parents are deceased, the court must send notice to the protected person’s siblings.  If the protected person lives in a facility, the court will notify the person in charge of the facility.

The probate court will also order the Department of Developmental Services (hereinafter “DDS”) to conduct an assessment to determine whether the protected person is able to manage his or her finances.  After DDS conducts its assessment, it drafts a report which is then furnished to the Court and all interested parties.  Once DDS files its report, the probate court will schedule a hearing on the guardian’s petition.

At the hearing, the court must receive evidence with respect to whether the protected person can manage his or her finances.  As with any other proceeding before the probate court, the protected person has the right to be represented by counsel and he or she also has the right to attend the hearing. Nevertheless, the court can exclude the protected person from the hearing if it finds that the testimony or evidence presented would be detrimental to the emotional or mental well-being of the protected person.

For the court to order that the guardian has authority to manage the protected person’s assets, the court must find by clear and convincing evidence that the protected person has no more than $10,000 in assets and that they are unable to manage their finances.  The term “unable to manage their finances” means the inability of a person with intellectual disability, to receive and evaluate information or make or communicate decisions to such an extent that the person is unable – even with assistance – to manage his finances. Thus, if the court finds that the intellectually disabled person can manage the assets with the assistance of others, the court will not grant authority to the guardian to manage the assets.

What if the protected person’s assets exceed $10,000? The Court cannot appoint the guardian to manage the funds. Instead, the guardian or another interested party must file a petition for appointment of a conservator of the protected person’s estate.  A conservatorship proceeding involves a physician’s evaluation and other requirements making it a more formal proceeding. 

What if the guardian is granted authority to manage the protected person’s assets but through inheritance or other means the value of the assets increase beyond $10,000?  The guardian has 30 days to inform the Court in writing that the value of the assets exceed the $10,000 limit.  The Court will then decide whether the guardian’s authority should be terminated or extended and whether it then becomes necessary to appoint a conservator in place of the guardian.

The new law incorporates certain safeguards to insure that the guardian is acting as a reasonably prudent person.  For example, the court can order the guardian to post a bond to secure his faithful performance.  In addition, the guardian must file an Inventory of the protected person’s assets within 60 days of his appointment.  Finally, the guardian must file periodic accounts with the Court at least once every three years (or more frequently, if required by the Court).

If you have questions related to the new law giving guardians the power to manage assets or about probate matters generally, please don’t hesitate to call the estate planning and probate attorneys at Cipparone & Zaccaro, PC.  

Trusts enable you to grow assets and provide income for your family. Some trusts provide income to one person for life, with the principal ultimately passing to the next generation. The principal of a trust can consist of stocks, bonds, real estate and other investments which are hopefully generating income. How the trust defines income will determine the amount the beneficiary of the trust receives each month. Trusts which provide for distributions based on accounting income (i.e. – just interest and dividends) can cause tensions among beneficiaries and can seriously prevent the person managing the trust, the trustee, from obtaining the best investment results.

Let’s take an example. Teresa is married to Paul. Paul has two children from his first marriage, Lori and Annelle. Paul wants to provide for Teresa and, at the same time, make sure that his assets ultimately benefit Lori and Annelle. Paul’s lawyer drafts a trust that provides: “The trustee shall distribute all of the income of the trust to Teresa. When Teresa dies, the trustee shall distribute the principal of the trust to Lori and Annelle.” Paul names his business associate, Michael, as trustee. Teresa is the “income beneficiary” of the trust and Lori and Annelle are the “remainder beneficiaries” because they receive the remainder of the assets after Teresa’s lifetime.

Competing Goals Creates Conflicts Between Trust Beneficiaries

Under the language quoted above, Teresa will only receive dividends, interest, rents and similar items. Even though capital gains are taxed as income, all appreciation in the value of the investments will be allocated to principal. If the trust owns stocks, bonds and mutual funds, Teresa will want the trustee to invest to maximize interest and dividends. Lori and Annelle will press for growth-oriented investments. Michael, the trustee, will be caught in the middle.

Traditional Trusts Encourage Sub-par Investment Performance

Unless the trust document directs otherwise (and the vast majority do not), a trustee must balance the interests of the current beneficiary with those of the remainder beneficiaries. Many trustees invest half in bonds for income and half in stocks for growth to satisfy the competing interests. Yet, this “fair” approach results in sub-par investment performance. Only half of the portfolio is generating income and half of the portfolio is positioned for growth. All of the beneficiaries complain and the trustee is criticized for something that the trustee didn’t cause.

Traditional Trusts lead to Unpredictable Distributions

Many trusts are created to give the beneficiary, often a spouse or a child, a reasonably steady and predictable source of support. What can the “income beneficiary” count on? In the 1980s, she might have received 12%. Today her income may be less than 3%. She will have years of feast and years of famine. These fluctuating distributions bear no rational relationship to the beneficiary’s needs.

A Limited Solution: the Principal and Income Act

A statute called the “Principal and Income Act” allows a trustee to make an “adjustment” and augment income returns with an allocation of principal, as long as the trustee acts in a fair and impartial manner. The power to adjust is an excellent way to increase distributions from older trusts. It is not an elegant solution for trusts that we’re creating because control is totally in the trustee’s hands. The trustee could possibly still be criticized and the beneficiary does not have a reliable stream of distributions.

A Better Solution: Total Return Trusts

Total Return Investing

The income-principal distinction found in many trust documents has no relationship to the way people invest their own assets. Most investors look for total return which means they are looking for income AND asset growth. At the same time, the art of investing lies in balancing reward against risk. The most efficient portfolios seek the greatest potential for reward at the least risk. As we have seen, a trustee will have difficulty using this efficient investment paradigm for a traditional trust. We need to look to a trust architecture that is compatible with current investment wisdom.

How Total Return Trusts Can Meet Competing Goals

Studies of investment returns, such as the ones conducted by Vanguard, conclude that, from 1926 to 2016, a portfolio of 60% stocks and 40% bonds can produce an average annual return of approximately 8.7% per year. Because of the inherent conflicts in the administration of traditional trusts, trustees have been prevented from achieving this result.

With a Total Return Trust, the current beneficiary receives a distribution of a specified percentage of the trust’s value each year. The amount of the distribution is based on the value of the trust, not on its income. If the value of the assets increases, the distribution also increases. If the value declines, the distribution decreases. A properly designed Total Return Trust will have a “smoothing provision.” The distributions will be based on a moving average of the trust’s asset value, perhaps based on the preceding three or five years. The percentage to be distributed can be based on the beneficiaries’ needs and the expected investment returns. It need not be one fixed rate throughout the term of the trust.

Examples of a Total Return Trust in action

How a Total Return Trust Provides Income and Growth

Let’s revisit Teresa, Paul, Lori and Annelle. Suppose that Paul creates a Total Return Trust that provides Teresa with a 4% annual distribution. Teresa is young enough that one can reasonably assume a 9% annual total return on investments during her lifetime. Of that 9%, we allocate 2% to pay income taxes, leave 3% in the trust for future growth and distribute 4%. Studies have shown that, in a long-term trust, distributions in the 3.5-4.1% range can be made almost indefinitely while retaining the purchasing power of the trust principal. Now everyone is happy. Teresa will receive distributions that will increase as the fund appreciates. Lori and Annelle see their remainder growing. Michael, the trustee, is free to pursue the most efficient investment policy.

How a Total Return Trust Can Allow for Different Distributions

Tom is a widower with three children, Rachel, Andy and Nathan. He is comfortable leaving Rachel and Nathan their shares outright, but has some concerns about Andy, who is a bit of a spendthrift. Tom wants to provide generously for Andy, but doesn’t think that he could handle an outright distribution of his entire share. He wants Andy to be the primary beneficiary of a trust. Andy is single and has no children. He creates a Total Return Trust that gives Andy a 5% annual distribution. In addition, an independent trustee may make distributions for Andy’s medical care not covered by health insurance. With a 5% annual distribution, it is likely that the fund will eventually be exhausted. However, according to Tom’s financial advisor, the trust for Andy will last a long time.
 

Some Tax Considerations for Total Return Trusts

Marital Trusts

Most marital trusts require that the surviving spouse receive all of the trust income at least annually. A Total Return Trust can qualify for the marital deduction as long as it contains a specific provision. The surviving spouse must receive the greater of the trust’s income or the distribution percentage.

Turning 37% Income into (for now) 23.8% Capital Gains

In our “income only” trust, the trustee is compelled to realize reasonable income from dividends and interest. Interest income is taxed at rates as high as 37% in 2019. Long term capital gains are currently taxed at 23.8%, including the 3.8% Net Investment Income Tax. In a Total Return Trust, there is no distinction between income and principal. The trustee is able to raise cash for the annual distribution by paring some of the growth. This effectively creates an “income” that is taxed at capital gains rates.

CONCLUSION: Total Return Trusts solve a great many of the problems created by traditional trust designs. They allow the trustee to maximize returns and reduce conflicts among beneficiaries and between beneficiaries and trustees. However, they are not a cure all for every situation. Some clients will be better served by a fully discretionary trust that allows the Trustee to use principal as well as income. Total Return Trusts provide a valuable solution, however, especially in planning for second marriages and for children or vulnerable elderly parents who cannot manage an outright distribution.

Come see the estate planning attorneys at Cipparone Zaccaro, PC, if you would like to discuss how a Total Return Trust might improve your estate plan.

The Tax Cuts and Jobs Act passed by Congress and signed by President Trump on December 22, 2017 (“the Act”) contains many new federal tax provisions.   In this article, I explain how the new tax laws affect seniors and individuals with special needs.

How Does the New Tax Law Affect ABLE Accounts?

An ABLE account allows family members to save funds for the care of a disabled individual without jeopardizing the individual’s eligibility for government programs.  ABLE accounts operate in much the same manner as 529 College Savings Plans. Any person may contribute to an ABLE account on behalf of the eligible individual. They become completed gifts once made.  Earnings on contributions to ABLE accounts are not taxable income for either the person who made the contribution or the eligible beneficiary.

The Connecticut State Treasurer announced in October, 2017, that Connecticut will partner with the State of Oregon to create its ABLE account. Until Connecticut has its own ABLE accounts, Connecticut residents can open ABLE accounts sponsored by any other state. You can compare the requirements and characteristics of each state’s ABLE account at www.ablenrc.org .

To be eligible to receive funds from an ABLE account, the beneficiary must have a disability that occurred before age 26 and be either 1) entitled to Supplemental Security Income (SSI) benefits or Social Security disability benefits or 2) provide a qualified disability certification.

Distributions from ABLE accounts do not count toward Medicaid eligibility. Note that contributions to and distributions from an ABLE account are also not counted toward other federal assistance programs such as Temporary Family Assistance, Low-Income Home Energy Assistance Program, and need-based institutional aid grants offered by state colleges and universities.

Under the Supplemental Security Income (SSI) program run by the Social Security Administration, needy individuals can receive $750/month in cash assistance. An ABLE Account and its earnings are not counted as income or assets for purposes of SSI.  The same is true for Special Needs Trusts which is another way to set money aside for a disabled individual. The major advantage of ABLE accounts over Special Needs Trusts is that they cover housing expenses such as mortgage payments, property taxes, rent, heating fuel, electricity, water and sewer.

ABLE Accounts suffer from a serious limitation.  Only one ABLE account is allowed per individual and only an amount up to the annual gift exclusion ($15,000 in 2018) can be contributed each year. Congress recognized this limitation and sought to expand the utility of ABLE Accounts in the new tax law.  Beginning in 2018, in addition to the $15,000 contribution, employed beneficiaries can contribute up to the federal poverty level for income ($12,060 in 2018) to their ABLE account. The beneficiary must earn compensation up to the amount contributed and the beneficiary cannot be covered by a retirement plan through work. This provision expires in 2026 like all of the other individual tax cuts.

The new tax law also allows a beneficiary of a college savings plan (i.e. – a 529 plan) to roll over a 529 plan balance to an ABLE account for the beneficiary or a member of his or her family (e.g. - spouse, child, brother, sister, niece, nephew and first cousins). The rollover cannot exceed the $15,000 annual limit from all contributions. Thus, before rolling over a 529 plan balance to an ABLE account, the 529 plan beneficiary must know how much has already been contributed to the ABLE Account for the intended beneficiary. Staggering the rollover to cover 2 separate tax years may make sense.

The Personal Exemption Retained for Qualified Disability Trusts

In 2017, each person who filed or was claimed on a tax return received a personal exemption of $4,050. Under the new tax law, that personal exemption was changed to zero. Congress, however, did not change the personal exemption for a trust ($100 for complex trusts; $300 for simple trusts paying out all income) in the new tax law.   Qualified Disability Trusts also remain intact.  Third-Party Supplemental Needs Trusts also qualify under the new tax code.  However, self-settled Special Needs Trust usually do not qualify for such an exemption because they are grantor trusts for income tax purposes. Third-Party Supplemental Needs Trusts will receive a $4,150 exemption in 2018. 

Changes to the “Kiddie Tax” Under the New Tax Law

If a child under the age of 19 or a child under the age of 24 attending school full-time receives unearned income (e.g. – income from dividends, interest or capital gains, or income from a trust or Uniform Transfers to Minors Act (UTMA) account), they must pay tax on that income. In 2017, that income is shown on the parent’s return so the income was taxed at the parents’ highest rate.

Starting in 2018, the tax rate of the child’s parent no longer matters. Under the new tax law, unearned income of a child will be taxed at the rate paid by trusts and estates. Parents didn’t pay the top rate of 37% unless their taxable income exceeded $600,000. Trusts and estates, on the other hand, pay the top tax rate of 37% if their taxable income exceeds only $12,500. Thus, a child receiving investment income will pay much higher taxes on that money than their parents would pay.  This change in tax rates could have a major affect on Special Needs Trusts with large principal balances.

It will be interesting to see if the IRS comes out with a separate tax return for children with unearned income that is subject to the kiddie tax. The change in tax rates only applies from 2018 to 2025.  Unless Congress changes the tax code before then, the tax on a child’s income will once again appear on the parents’ return starting in 2026.

How the 2017 Tax Law Affects the Election to Take the Standard Deduction vs. Itemizing Deductions

Seniors will need to consider the value of simplifying their returns by claiming a standard deduction instead of itemized deductions. For single filers, the standard deduction has increased from $6,350 in 2017 to $12,000 for tax years 2018 to 2025. For married couples filing jointly, the standard deduction increased from $12,700 in 2017 to $24,000 for tax years 2018 to 2025.

A large standard deduction could simplify income tax returns for many seniors. The deduction for state and local taxes on real estate, motor vehicles, and income cannot exceed $10,000. For senior couples in Connecticut, the “SALT limitation” as its called could make the standard deduction especially attractive. Mortgage interest and charitable deductions remain deductible but miscellaneous expense deductions for tax preparation, legal fees and investment management fees no longer exist.

Yet, for some seniors, itemized deductions could still exceed the standard deduction.   The new tax law lowers the threshold for medical expense deductions to 7.5% of adjusted gross income for tax years 2017 and 2018.  In 2019 and beyond, medical expenses can only be deducted if they exceed 10% of adjusted gross income.

These provisions only touch the surface of the numerous changes to the federal tax law.  For more on the Act, see Ten Things to Know About the New Tax Law.