January 2006

MEMBERS’ CORNER
BY STANLEY TEPPER, CPA, MBA

Transfer on Death Accounts - The publication 50 Plus Senior News recently carried an article by Michael Hartzman, CFP (516) 349-5555. New York State now allows assets in investment accounts to pass to heirs using a Transfer On Death (TOD) designation. Banks have used these types of accounts for years as a means to transfer assets to heirs. (Commonly known as "pay on death" accounts.)

Now investors will be able to pass investment accounts to their heirs while avoiding the probate process. Prior to this new law, the only vehicles an account owner had available was to name beneficiaries on an IRA account, pension plan or life insurance policy or open a joint account with rights of survivorship (commonly referred to as JR WROS) which would transfer assets to the surviving person. Opening this type of joint account with a non-spouse created potential tax and estate problems and gave each person equal access and control over the activity in the account. They also left the assets susceptible to bankruptcy and divorce settlements.

Under the law investors in mutual funds, stocks and bonds can specify to whom the assets should go upon their death without giving that person control or access to the account while the owner is still alive. The TOD provision will also not cause the new owner of the asset to have to sell the investment based upon what the original owner paid. The new owner gets a step up in cost basis which is a potentially valuable tax savings when they inherit a security that has gone up in value. As far as the original owner is concerned, they know that a child or grandchild has inherited money that was intended for them without having to set up an expensive trust or will.

It is important to note that if you already have joint accounts established you cannot simply re-title these accounts with a Transfer On Death designation. If you want to change joint accounts you must get the approval of the current joint account holder and you might create a taxable event.

"The Second Sentence in Rule 203 Could Have Saved us all From Enron" - An Accounting Today Article written by Paul Miller & Paul Bahnson points out that tucked away near the heart of the American Institute of CPA's Code of Professional Conduct is Rule 203, titled Accounting Principles. It consists of no more than two sentences, albeit long ones.

What seems to happen in practice is that only the first one is observed. The second one is just as important but is totally ignored; if it were not so, we think that some of the Enron debacle could have been avoided.

The first sentence forbids AICPA members (or CPAs governed by similar rules in their licensing states) against opining or otherwise stating affirmatively that financial statements are presented in accordance with generally accepted accounting principles if they do not comply with standards issued by bodies designated by the institute's council as authoritative. In effect, this rule gives standing to rules issued by financial accounting standards board and others, and is obviously crucial for credible financial reporting.

But we're writing about the second sentence that says, with some convolution: "If, however, the statements or data contain such a departure (from GAAP) and the member can demonstrate that due to unusual circumstances the financial statements or data would otherwise have been misleading, the member can comply with the rule by describing the departure, its approximate effects, if practicable, and the reasons why compliance with the principle would result in a misleading statement."

That mouthful basically says that CPAs are obliged to depart from GAAP if complying with those principles will produce information that is misleading.

War Time Tax Relief - Accounting Today (Bob Rywick) reports that if a member of the United States armed forces dies while in active service and the death occurs:

• While serving in a combat zone;
• Outside a combat zone while performing duties in direct support of military operations in the combat zone, and while qualifying for hostile fire pay; and
• At any place as a result of wounds, disease or injury incurred while serving in the combat zone or in support of military operations in the zone, their federal income tax liability is canceled for the tax year in which they died and for any earlier tax year ending on or after the first day of service in a combat zone.

Estate Tax - The following appeared in the Certilman Balin Weekly Estate Newsletter edited by Stephen Silverberg and Lisa Hunter. (516) 296-7000.

Proceeds From Wrongful Death Settlement - The Internal Revenue Service (IRS) recently determined money (or potential money) from the settlement of a wrongful death suit would be considered "complete" at the time the money is assigned to an irrevocable trust.

The surviving wife of a man who was killed asked the IRS to rule on the federal gift tax consequences associated with her conveying funds to an irrevocable trust. The funds would be obtained as a result of awards from a wrongful death suit she had filed associated with her husband's death.

The court ruled, although the wife would still be involved in proceedings related to the wrongful death suit in an administrative capacity, she "will have no means to reacquire the economic benefit of the assigned proceeds or to change any of the interest created under the trust." As such, the IRS established the conveyance would be complete and subject to a gift tax.

Source: PLR-200534015

IRS Fails to Pierce Trust - Efforts by the Internal Revenue Service (IRS) to obtain a ruling requiring the assets of Turner Hunt Lewis pass to his niece, Carolyn Hunt, rather than to her children, were thwarted by the U.S. District Court for the Western District of Louisiana. The IRS was interested because Carolyn owed back taxes.

Turner Hunt Lewis accumulated a fair amount of wealth over his lifetime. He never married, had no children, and all his siblings pre-deceased him. However, Mr. Lewis had developed a close relationship with two of his nephews, Richard and William Lewis, with whom he had worked in a family business.

Mr. Lewis unfortunately developed a medical condition that eventually led to his incapacitation. At this point his nephews, William and Richard, filed for and received a temporary interdiction (restraining order) and offered a proposed trust, holding all Mr. Lewis' assets, to the Louisiana court which the court accepted.

Mr. Lewis died intestate prior to the expiration of the temporary interdiction. In the court-approved trust, the nephews, acting as curators (trustees), had included language directing assets that would have been passed to Carolyn Hunt instead pass to her children. Neither Carolyn nor any other family members took issue with this directive, but, the IRS did. Their issue with the directive arose from Carolyn's filing bankruptcy in the 1980's which kept her form paying owed taxes. At the time of the bankruptcy Carolyn made an agreement with the IRS, "whereby she would turn over 100% of the amount of any devise, bequest, or inheritance she receives."

Conscious the IRS would probably contest the validity of the trust as it related to the provision concerning Carolyn's inheritance, the curators made application to the federal court for instruction or to determine who was entitled to Carolyn's share of the assets.

In making their decision; the court took into consideration Mr. Lewis had no will and had in no way made any wishes known as to how to disburse his assets. Additionally they considered that no one in the family protested any terms of the trust nor was there any evidence of bad faith or self-dealing. The main factor evaluated was interpretation of Louisiana law as it relates to interdiction and the fact that the Louisiana court had approved the trust, which gave the curators authority to add the provision regarding distribution of Carolyn's share of the assets.

Ultimately the court ruled in favor of Carolyn's children and against the United States, effectively denying the IRS any claim to Carolyn's inheritance.

Source:In re Turner Hunt Lewis Trust v. Hunt,

(W.Dist. VCT. LA, No. 03-2118-M, 6-30-05)

Past Law - Not Current - Governs in Will Revocation. The Court of Appeals of the state of Kentucky recently ruled the law in effect at the time of execution of a will takes precedence over current law.

On October 30, 1990 James Riggins, a widower, drafted a hand-written will including instructions for the distribution of his assets to his children at the time- Dennis, Jane, and John. On October 31, 1990, James married Tita Alega, a woman from the Philippines who James married via a contractual arrangement. No provisions were made in the will for Tita nor for any children they might have.

In 1990 when James drafted his will, there was a law on the Kentucky books stating wills will be revoked by a marriage. There were three exceptions noted in the law, however, the court ruled the exceptions were not relevant to this case. This law was subsequently revised in 1998 to state, "a will shall not be revoked by the marriage" of the testator.

James died in 2002. Upon his death, his son John presented the will for probate, but the husband of James' daughter, Jane filed to declare the will invalid. The court ruled the will had been revoked under the original law, i.e., the law in effect at the time the will was signed, would take precedence over the law in effect at the time of death of the testator. Because the will had been ruled revoked the day James married Tita, the day after it was signed, it was ruled James died intestate and his assets were to be distributed accordingly.

The decision was appealed, and the Kentucky Appeals Court affirmed the lower Court's decision.

Source: Riggins v. Floyd (KY App. Ct.,

No. 2004-CA-001486-MR, 9-0-9-05)

Scrivener's Error Grounds For Modifying irrevocable Trust - The IRS ruled in PLR- 200535007 an irrevocble

trust could be changed abinitio (from the beginning) due to an error on the part of the scrivener.

Two parties established a trust intending it qualify as a net income charitable remainder unitrust (NIMCRUT). The NIMCRUIT was supposed to contain a provision directing realized post contribution capital gains be paid to the income of the trust.

The trustee of the trust administered it as though such a provision was included, but upon inspection the trust's law firm discovered no such provision existed. Due to this inadvertent omission and because the trust was irrevocable, the trustee sought authorization from the court to modify the trust ab initio.

After reviewing sections related to split-interest trusts, self-dealing, and the actual requirements of a NIMCRUT, the IRS ruled, under §4947(a)(2)(A) and §53.4947-1(c)(2)(ii), Example (1), "a charitable remainder unitrust's payments to its income beneficiary do not result in any tax on self-dealing under §4941. Under the circumstances described, a retroactive amendment in favor of the charitable remainder beneficiary does not constitute self-dealing under §4941."

Based on the above determination combined with the fact the trust had, without fail, allocated realized post contribution capital gains to the income of the trust (thus supporting the position the NIMCRUT was intended to have such a provision upon creation,) the IRS ruled the trust would be recognized as a valid CRUT ab initio, and it could be revised to include a provision allocating realized post-contribution capital gains to trust income.

Source: PLR-200535007