How to leave a legacy and also protect your assets

[Editor's Note: The Spectrum published an article in its Jan. 21 Maturity section that had been written in November by attorneys at the Cramer & Anderson law firm in New Milford, before new tax laws became effective. At our request, Cramer & Anderson has written the following updated article reflecting the law change. We apologize to Cramer & Anderson and our readers for publishing the earlier, outdated article.]

The federal estate tax has been in a state of constant flux and change over the past decade.

In 2002 and 2003, the federal estate tax exemption was at $1 million but, by 2009, the exemption was at its height, sitting at $3.5 million per individual.

In 2010, the federal estate tax was suspended entirely, and 2010 was aptly named the year to die.

As we begin the second decade of the new millennium, Congress decided to kick the can down the road, passing a new law which only continues the uncertainty over future estate tax rates and postponing the debate into the middle of the 2012 presidential election.

For 2011 and 2012, the real estate exemption was set at $5 million and the maximum rate at 35 percent, unless you have a larger estate and decide to elect to apply the 2010 estate tax law of no tax but limiting the step up in basis.

Most interesting is that Congress has given us a gift for two years, allowing one to gift up to $5 million without incurring a federal gift tax topping the $3.5 million Connecticut gift tax exemption.

With all this happening and the continued threat that in 2013 the exemption for estate and gift taxes will revert to $1 million, it is more important than ever to do effective estate and gift planning to remove asset value from your estate, so you can avoid taxation and leave a legacy to your family.

One very effective way of reducing your estate tax liability is by use of a Qualified Personal Residence Trust (QPRT). This estate planning vehicle permits you to transfer either your primary or secondary residence or both into the trust.

You would be able to have use of the house rent free for the entire trust term. Once the trust term ends, you can continue to live there, but you must pay rent either to the trust that now owns it or to your children, if they are the beneficiaries of the trust.

The rent is just a way to gift more money without it being considered a gift, which helps you avoid both gift taxes and using up your federal and state tax exemptions.

The largest advantages are the property will also be protected from possible creditors as the trust is the owner of the property; the value of the gift is reduced by your retained use of the house; all future appreciation in the house will be removed from your estate; and reduction of estate tax liability, all while allowing you the continued benefit of the property's use and the continued tax-free gift giving disguised as rent.

There are many other factors needing to be considered when using a QPRT, so please consult with your attorney.

Many of us don't have estates exceeding the federal exemption amount, but your assets are no less important and in need of protection, so our children and grandchildren can receive their full benefit. The best way to protect our largest asset (the home) from the dreaded grips of the Medicaid spend down is by using a strategy of gifting and a family trust.

Many of us are aware either from personal experience or from our friends that, in order to qualify for Medicaid, you need to spend down your assets to a meager $1,600, that the home is not protected if you and your spouse no longer occupy it, and there is a five-year look back period to see if gifts were made that would disqualify you. This leaves you little to nothing to pass to your family.

The basics of the protection plan are that you will make a gift of your house to your children. You will retain life use in the house, meaning no one can remove you from the property.

If the gift is made directly to a trust, Connecticut law allows the state to invade any trust if they determine the transfer was made to protect assets from Medicaid.

This is why we gift the home to the children and have the children simultaneously transfer the home into a Family Trust.

By doing this, the home will be protected from your creditors as well as any creditors of your children. Even in the case of your child's death or divorce, the house is protected.

Since your children put the home into the trust even if you receive Medicaid, the state will not be able to go after your home if the gift was made five years before applying for Medicaid.

If you ever find yourself in the position of needing money, the trustees of the trust can take out a home equity line of credit on the house or sell the house and use the money to buy you the extras you require without any of it being assessable by Medicaid.

Upon your death, either the property can be distributed to your children or it could be held in trust for their benefit.

They would also receive a step up in basis which will allow them to limit capital gain taxes if they decide to sell the home after you are gone.

It is very important to note this strategy must be put into effect well before Medicaid care is needed.

Advanced planning is necessary as you need to surpass the five-year look back period from the time the initial gift of the home is made. However, with a little advanced planning, you will be able to leave a legacy for your family's future generations.

With the two-year reprieve given to us by Congress in postponing the scheduled change of the federal estate tax exemption back to $1 million, and the estate tax rate hike up to 55 percent, it is more important than ever to be proactive with your estate planning strategies.

Even if you feel the tax changes will not effect you, it is quite advantageous to engage in advanced planning to protect your home from Medicaid so you can save one of your largest assets and have the ability to pass it along to your family.

The Weinshanks and Ms. Schiesel are attorneys with Cramer & Anderson, with offices throughout Litchfield County.

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Dolores R. Schiesel

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Arthur C. Weinshank