Tuesday, November 22, 2011

Case report: IRAs and money judgments

We have previously noted on this page that Michigan has a statute which exempts funds held in an IRA from execution on a money judgment entered against the IRA owner. On November 1, 2011, the Michigan Court of Appeals, in the unpublished case of Vinyl Tech Window Systems, Inc. v. Blodgett, held that this statute did not protect several IRAs owned by the defendants, and ordered the release of the funds in execution on a judgment. It thus upheld the ruling of the circuit court.

In conformance with the principle that "hard cases make bad law", the circuit court's ruling and reasoning were quite clumsy and difficult to decipher. The facts of the case were particularly egregious. Blodgett, who worked for Vinyl Tech as its comptroller, had embezzled large sums of money and diverted the funds to a company owned by her husband. The circuit court entered a judgment in favor of the employer in the amount of $1.72 million against Blodgett, her husband, and his company.

The circuit court opinion indicates that the husband had created a number of IRAs through some form of trust arrangement. It appears but probably was never proven that most of the funds ending up in the IRAs originated from the embezzled funds. It also appears that the circuit court had entered an early order freezing the funds held by the defendants; it noted that the creation of the IRAs had been done in violation of its order.

In its opinion, the Court of Appeals noted an early Michigan case, Long v. Earle, 277 Mich 505, 511-512 (1936), in which the Michigan Supreme Court had held that, despite the statutory homestead exemption from execution on judgment, one cannot embezzle money, buy a homestead with the proceeds, and then try to claim the exemption.

The problem in applying the Long case here may well have been the uncertainty whether the funds used to fund the IRAs were traceable to the embezzled funds. Since the embezzlement had gone on for many years, it is likely that that had been the case, but it does not appear that the plaintiffs were able to establish that that had occurred.

Rather than accept some of the questionable rationales pronounced by the circuit court, the Court of Appeals upheld its decision based on the defendants' failure to cooperate with a number of post-trial proceedings. They did not respond to discovery requests, they failed to appear for a creditors' examination, and they tried to prevent the discovery of assets that had been transferred to relatives. As a result of this behavior, the Court ruled, they had failed to meet their burden of proof of demonstrating that they were entitled to the exemption. The order that the funds be paid over to the judgment creditors was upheld.

Full text of case (PDF)

Saturday, November 19, 2011

Supreme Court upholds most of the pension tax

In an opinion released yesterday, the Michigan Supreme Court upheld the constitutionality of most of the changes to Michigan's income tax on pensions and IRA distributions. (We previously discussed it here.)

The court did find that the provision that phased out eligibility for the exemption for higher-income taxpayers did create a graduated income tax, in violation of Article 9, section 7 of the state constitution. This part of the new law will need to be redone or eliminated.

The state of state estate taxes

No one, it seems, pays attention to state-level estate or inheritance taxes when talking about what can pass to one's heirs free of tax on death. The North Carolina Estate Planning blog provides a list of the 19 worst states to die in - the states which have the lowest exemption amounts or the highest tax rate, as either estate tax (imposed on estates before distribution) or inheritance tax (imposed on beneficiaries when they receive the funds).

Michigan currently has neither an estate tax or an inheritance tax. To quote Shel Silverstein, Michigan "is tough on the living", but it leaves the dead pretty much alone.

The Federal government currently applies a $5 million per person exemption to its estate tax. There is no Federal inheritance tax.

Friday, November 4, 2011

Reasons not to do it

Many people believe that putting the family home or other real estate in joint tenancy with their children is the best way to provide for post-death succession, without the need for involvement of the probate court. There are several complications which suggest the need to act cautiously.
  1. Once a parent puts a child on the title of the home as a joint owner, the child is from that point forward a full joint owner. The parent cannot later decide to sell the house, rent it out, or seek a mortgage or home equity line from a bank or credit union, without the agreement of the child.
  2. An older parent who is facing the prospect of admission to a nursing home in the next few years will find that the act of adding a child as joint owner of the home will be regarded by the Department of Human Services as a partial divestment of property, and this will result in a period of ineligibility for Medicaid benefits.
  3. Depending on the circumstances, the creation of a new joint tenancy may result in the inadvertent “uncapping” of the taxable value of the real estate, resulting in higher property taxes. 
  4. If the child who is added as a joint owner later has a judgment entered against him by a court, the judgment will have to be paid if the house is to be sold - even though the parents were the ones who paid for the house. 
Balanced against these, the only reason to add one or more joint tenants on a home is to avoid having to have the home subject to probate on the death of the current owner. For many clients, the reasons not to do it will outweigh this one consideration.

Under the General Property Tax Act, there is a limit (“cap”) on increases to property tax assessments while the property remains under the same ownership. In most cases, a transfer in ownership removes that limit and allows for “uncapping” the assessment, often leading to a higher property tax liability. The law provides for a number of exceptions.

The March 2011 decision of the Michigan Supreme Court in Klooster v. City of Charlevoix changed the general understanding of how and when the creation, modification, or termination of a joint tenancy will uncap assessed value.

Under the newly clarified rule explained in that case, you will not uncap the taxable value of the property by adding one or more new joint tenants if
  • you or your spouse were an owner immediately after the most recent uncapping event and
  • you have remained as an owner continuously since then.
If, on the other hand, someone else (other than a spouse) added you as a joint tenant, and then died leaving you as the surviving owner, adding a new joint tenant will uncap the taxable value.

Update 1-24-15: John Payne's article The Curious Case of the Persistent Step-Up deconstructs a myth that misleads many lawyers. So long as the property is included in the decedent's estate, the surviving joint will still receive the step-up in basis. Thus capital gains considerations should not affect the decision on whether to use this probate avoidance technique.