REPORT FROM COUNSEL
WINTER 2003 ISSUE
Table of Contents
- CHARITABLE GIVING
- HIGHLIGHTS OF THE NEW FEDERAL TAX ACT
- TELECOMMUTING AND UNEMPLOYMENT
- ESTATE PLANNING WITH LONG-TERM CARE INSURANCE
- FEDERAL PRIVACY RULE PROTECTS HEALTH INFORMATION
CHARITABLE GIVING
By James A. Tews
All of us anticipate that our present labors will produce vast amounts of fruit. For many of us, our hopes will be realized. But what do we do with our harvest when either death is beckoning or we desire to give something back to society? For some, the answer is to pass on the family business and wealth to successor generations with the hope that our children will be well cared for. However, others will consider the benefits of charitable giving. Charitable giving does not require dispensing away with wealth completely, nor outright. Aside from the intrinsic feelings associated with making charitable gifts, there are also many practical benefits.
One means of charitable giving involves the use of what is called a charitable remainder trust (CRT). The person who creates the trust, to which subsequent charitable contributions are made, is called the donor. One of the main characteristics of a CRT is that the gift of property to the trust is actually composed of two interests. The first interest is the annuity, which is the annual payment made by the trust to a donor-designated recipient. The annuity amount is usually established in the trust agreement as a specified percentage of the trust property, i.e. 5% per year. Practically speaking, the donor usually retains the right to receive the annuity payments; however, the recipient could be almost anyone that the donor desires, including children, another trust or a business. The second interest is referred to as the charitable remainder. It is the present value of the assets that are anticipated to remain in the trust after it terminates. This interest passes to the donor-chosen charity. The duration of the trust can be either for a specified amount of time or for the remainder of the donor's life. After the trust terminates, the annuity payments cease and the charitable remainder passes to the chosen charity. Generally, the amount of the annuity must be at least 5% of the trust property value; the charitable remainder must also be at least 10% of the trust property value, determined when the trust is established. There are several other variations of charitable trust gifts, including the ability to reverse the interests described above, i.e. the charity receives the annuity payment and a donor-designated recipient receives the remainder. This arrangement is referred to as a charitable lead trust (CLT).
The use of a CRT provides several important benefits. First, the donor is entitled to an income tax deduction in the year that property is transferred to the trust. The deduction is limited to a specified percentage of the donor's adjusted gross income for the year. However, the amount of deduction depends on the type of property contributed to the trust and the type of charity that will receive the charitable remainder at trust termination. Fortunately, any unused income tax deduction for the year may be carried over for up to five years. For example, assume that a donor contributes highly appreciated stock to a CRT. If the charity designated to receive the charitable remainder is a "public charity," like the Red Cross, a church or a school, the donor will receive a 30% income tax deduction for the year in which the property is contributed, the amount of which is based on the fair market value of the stock contributed. Keep in mind the five-year carryover of any unused deduction. However, if the donor designates certain private foundations as the recipient of the charitable remainder, the deduction will be limited to 20% per year, the value of which is based on the basis in the stock. The difference in the amount of deductions can be large. As for the annuity payment, it constitutes taxable income to the recipient, which for tax purposes, retains the same characterization as it possessed in respect to the trust. In other words, if the trust generated income or capital gains, the annuity recipient will be taxed on the payment as income or capital gains, as the case may be. Aside from the income tax deduction, do not forget that the donor has just eliminated huge amounts of taxable capital gain. If the stock is sold after it has been transferred to the trust, the donor does not recognize any gain, nor does the trust because it is tax exempt. Further, any income accumulation occurring within the trust is also tax exempt.
In addition to the income tax deduction, the value of the charitable remainder is also eligible for an estate or gift tax deduction. However, unlike the income-tax deduction, estate and gift tax deductions are unlimited, regardless of the type of property contributed and usually, regardless of the type of charity designated as the charitable remainder recipient. As for the annuity, if the donor gifts it to someone other than him- or herself or his or her spouse, this will generate gift taxes, and potentially estate taxes, in each year that the annuity recipient receives a payment. On the upside, this further depletes the donor's estate, preventing the imposition of some death taxes.
Charitable giving is a great means to give back to the community that helped us achieve our goals. Fortunately, Uncle Sam feels the same and has decided to encourage charitable giving by granting generous income, estate and gift tax deductions. As such, a CRT is an excellent means to fulfill the desire to give back while enjoying taxable benefits. But, as with nearly all tax driven vehicles, do not try this one without competent counsel.
HIGHLIGHTS OF THE NEW FEDERAL TAX ACT
On May 28, 2003, the Jobs and Growth Tax Relief Reconciliation Act of 2003 became law. Much of this federal tax law applies only to the years 2003 and 2004, after which provisions in the 2001 Tax Act will again become effective. Nonetheless, the Act contains some significant changes for individuals as well as businesses.
Individuals
The child tax credit increases from $600 to $1,000, which is an acceleration of a scheduled phase-in that was to have occurred between 2005 and 2010. In 2005, the credit will fall to $700, but will then gradually rise to $1,000 again by 2010 by virtue of the 2001 Act.
The standard deduction for married couples will double to twice the amount of the standard deduction for single taxpayers. Married taxpayers filing a separate return will claim the same standard deduction as a single person. Similarly, for 2003 and 2004, the upper limit of the 15% income tax bracket for married couples will increase to a dollar amount that is twice that for a single taxpayer.
For 2003, income levels for the 10% tax bracket will increase to $7,000 for single taxpayers and $14,000 for joint filers. In 2004, these levels of income will be indexed for inflation. Retroactive to January 1, 2003, the new tax rates for individuals are 10%, 15%, 25%, 28%, 33%, and 35%. For transactions taking place from May 6, 2003 to December 31, 2007, the maximum capital gain tax rate has dropped from 20% to 15%, and from 10% to 5% for lower-income taxpayers.
To reduce the double taxation of corporate earnings, dividends received by an individual shareholder from a domestic or qualified foreign corporation will be taxed like capital gain income. This means a rate of 15% for most taxpayers and 5% for those at lower-income levels, assuming the stock is held for at least the holding period set by law. Dividends from certain corporations are not eligible for this new treatment, such as those from tax-exempt charities, farmers' cooperatives, and particular foreign companies.
Businesses
The Act increases the amount of investment that may be deducted immediately by small businesses from $25,000 to $100,000. The amount of this deduction is reduced by the amount that the cost of the business assets exceeds $400,000. Under prior law, this phase-out of the deduction began at $200,000.
The additional first-year bonus depreciation deduction is increased from 30% to 50% for investments acquired and put into service between May 5, 2003 and January 1, 2005. Qualifying property still must be brand new, with a class life of 20 years or less.
TELECOMMUTING AND UNEMPLOYMENT
Maxine worked in New York for a financial information services provider. When she moved to Florida, her employer agreed to allow her to telecommute. Maxine was responsible for the same tasks that she had handled in New York, only now from her laptop in Florida she logged onto her employer's mainframe computer each workday.
Two years into the telecommuting arrangement, Maxine's company decided to end it. When she turned down an offer to return to New York, Maxine was without a job. She was denied unemployment benefits in Florida following a ruling that she had voluntarily quit her job without good cause. However, the Florida agency advised Maxine that she might be eligible to receive unemployment benefits in New York.
In what may be the first court decision of its kind on interstate telecommuters, New York's highest court also ruled that Maxine was ineligible for benefits, but for a different reason. Under New York law, a threshold requirement for eligibility is that the employee's entire service for the employer, except for incidental work, must be "localized" in New York. Maxine argued unsuccessfully that her services were localized in New York, at her employer's mainframe computer, notwithstanding that she initiated this service on her laptop in Florida. The court ruled instead that the physical presence of the employee determines in which state a telecommuter is located. For work done while she was located in Florida, Maxine was not eligible for unemployment compensation in New York.
When the new economy met the old unemployment insurance system in Maxine's case, the court stayed with principles that predate the age of computers. The outcome was dictated by two rules that are uniformly recognized: All of an individual's employment should be allocated to one state, which should be solely responsible for paying benefits; and that state should be the one in which it is most likely that the individual will become unemployed and seek work.
Unemployment has the greatest economic impact on the community in which the unemployed individual resides, and benefits generally are linked to that area's cost of living. Legislators and judges from previous generations could not have foreseen today's world of interstate telecommuting, but the rules they created are still valid. For better or worse, Maxine was tied to Florida, where she was physically present, and she could not look to New York for unemployment benefits.
ESTATE PLANNING WITH LONG-TERM CARE INSURANCE
Longer life expectancies and the coming surge in the retirement-age population have increased the demand for long-term care, as well as for insurance as one means of paying for that care. Long-term care encompasses a broad range of services for those with a prolonged illness, disability, or mental disorder. Unlike the focus of traditional medical care exclusively on certain medical problems, the goal of long-term care is the maintenance of an individual's level of functioning.
Types of Care
The two main types of care are skilled care, provided by medical personnel for medical conditions according to a treatment plan, and personal care. Personal care, sometimes called custodial care, is assistance with the activities of daily living that can be provided in many settings, including nursing homes, adult day-care centers, or the individual's own home.
Whether the purchase of long-term care insurance makes sense for a particular individual depends on age, health status, overall retirement objectives, and income. As with any type of insurance, it is critical to understand what is and is not covered among the types of long-term care services that are available. Exclusions and limitations are common. Equally important is knowing where services are covered. Some policies cover care in any state-licensed facility, but others may specifically include or exclude particular types of facilities.
Key Features
Since the amount of coverage is dictated by the type of service, coverage amounts will vary depending on the service. Most policies have a "total lifetime benefit" for the duration of a policy. In addition, benefits are often payable up to maximum amounts per day, week, month, or year.
A provision on when benefits are payable, sometimes called a "benefit trigger," is another key feature that can vary significantly among policies. Some states have legislated benefit-trigger requirements, making it a good idea to check with state insurance departments. Typically, benefits become payable because of the insured's inability to perform a certain number of the activities of daily living. Policy language on mental incapacity also allows for benefits when the insured fails mental functioning tests. Such a benefit trigger is especially important for those afflicted with Alzheimer's, even though most states prohibit the outright exclusion of coverage for that disease.
Although they can add to the cost of a policy, there are optional policy provisions that can help to tailor a policy to individual circumstances. Third-party notification authorizes the insurer to notify a designated third party, such as a relative or friend, if the policy is about to lapse for nonpayment of the premium. A waiver of premium clause allows the insured to stop paying premiums once he or she is in a nursing home and the insurer has begun to pay benefits. Nonforfeiture benefits return some of the investment in the policy if coverage is dropped. If an insured has paid premiums for a certain number of years, some policies allow a death benefit to the estate consisting of a refund of premiums, minus any benefits the company has paid.
Tax Implications
Premiums paid for long-term care insurance are deductible as a medical expense, as long as all medical expenses exceed 7.5% of adjusted gross income. Since premiums on average increase more than tenfold between the ages of 40 and 70, this deduction increases substantially with age. The maximum long-term care premium you can add to your other deductible medical expenses is based on your age at the end of each tax year.
Employer contributions to long-term care insurance for their employees are tax deductible for the employer, and premium payments are not taxable income to the employees. Benefits from a long-term care plan are excluded from income up to the lesser of the actual costs incurred or $63,875 per year. The annual limitation will increase with inflation in future years.
FEDERAL PRIVACY RULE PROTECTS HEALTH INFORMATION
Recently, the first-ever federal privacy standards to protect individuals' health-care information went into effect. The mandate for these standards, collectively known as the Privacy Rule, was in the Health Insurance Portability and Accountability Act of 1996 (HIPAA).
The Privacy Rule gives individuals access to their medical records and greater control over the use and disclosure of their personal health information. States are still free to keep or adopt their own policies or practices that are at least as protective as the new federal requirements.
Who Is Covered
Entities subject to the Privacy Rule include health-care providers, health plans (including insurance companies and HMOs), and health-care clearinghouses, such as physicians' billing services. The regulations also apply to "business associates," meaning any organization or person (other than a worker for a covered entity) that receives or accesses private medical information on behalf of a covered entity. When a covered entity uses a business associate, the two must enter into a written agreement containing specific protections for the health information used or disclosed by the business associate.
On its face, the Privacy Rule does not directly apply to employers, but that is not to say that employers need not become familiar with its requirements. Employers frequently interact with covered entities and their business associates. In addition, employers administering their own group health plans are effectively brought within the reach of the Privacy Rule.
Safeguards for Individuals
The Privacy Rule applies to "protected health information" (PHI), defined as all individually identifiable health information held or transmitted in any form or media, whether electronic, paper, or oral. Individuals generally should be able to see and obtain copies of their PHI within 30 days of a request. Covered entities must provide a notice to individuals describing how their PHI may be used and informing them of their rights under the Privacy Rule.
In the interest of promoting quality health care, providers are not restricted in their ability to share information needed to treat patients. Generally, PHI may not be used for purposes unrelated to health care. However, in the rare cases where it is allowed, only a minimum amount of protected information may be used or shared. Covered entities may release medical information to outside businesses such as insurers, banks, or marketing firms only with specific written authorization from the individual.
The Privacy Rule gives individuals the right to request alternative means or locations for receiving PHI communications. For example, a patient could ask a doctor to communicate with the patient through a designated telephone number or address. Another reasonable accommodation might be sending medical information to a patient in a closed envelope rather than on a postcard.
Policies and Procedures
The Privacy Rule requires covered entities to set up policies and procedures to protect the confidentiality of PHI. Written privacy procedures must identify staff with access to PHI and describe how such information will be used and when it may be disclosed. There must be training of employees in privacy procedures and designation of an individual to be responsible for insuring that those procedures are followed.
Covered entities may continue existing disclosures of health information for certain public responsibilities, subject to limits and safeguards that are specific to such circumstances. Examples include emergencies, identification of the body of a deceased person, and public health needs. If there is no other law that mandates disclosure to meet a particular public responsibility, covered entities may use their professional judgment to decide whether to make disclosures.
