State tax credits expiring in two months

There are two Michigan state tax credits that are expiring at the end of 2011: contributions to public agencies, including public radio and TV stations, and contributions to food banks and homeless shelters. Both of these credits are limited to 50% of the contribution or $100, whichever is less. Both will be discontinued beginning in 2012.

The fact that these are credits essentially means that you can redirect that much of your state tax payments to these recipients.

The complete listing of public agencies, from the instructions to the state tax return:

Gifts qualify for credit if given to:
• Michigan colleges or universities and their fund-raising organizations
• The Michigan Colleges Foundation
• The State Art in Public Places Fund
• The Michigan Historical Museum
• Michigan public libraries
• Michigan public broadcasting stations
• A Michigan municipality, or a nonprofit corporation affiliated with a Michigan municipality, for an art institute in that municipality or to benefit the art institute (art institutes are those whose primary function is the displaying and teaching of visual arts)
• The State of Michigan for the preservation of State archives.

Social security planning

Should you retire at age 62? at 66? at 70? The answer you give makes a big difference to how much you and your spouse will receive in Social Security benefits.

Did you know that the spouse of a worker whose earnings were much higher can elect to receive a benefit based on the worker's earning history?

How much will the lower wage-earning spouse receive as a spousal benefit? Should he or she choose to receive benefits based on his/her own earnings history or instead elect to receive spousal benefits?

We can assist with these issues. We can run a series of calculations based on the reports that you have received from the Social Security Administration, and provide a comparison of the amounts that you and your spouse will receive based on different retirement dates. We can calculate the "family maximum" that limits the amount that the worker and the spouse can receive if both draw benefits based on the worker's earning history.

This information will allow you to make more knowledgeable choices.

Retirement plans and creditor claims

There are a number of laws that provide that money in a retirement plan cannot be attached by creditors, either in bankruptcy court or after entry of a civil judgment.

ERISA protects "qualified retirement plans", which include traditional defined benefit plans and 401(k) accounts. Under the ERISA "anti-alienation" provision, 29 USC 1056(d)(1), the funds cannot be "assigned or alienated", and are not subject to attachment to pay the debts of the participant.

For some time, there was uncertainty about the status of IRAs. Since they are not qualified plans and not governed by ERISA, the anti-alienation provision of that law does not apply. The Federal exemption under U.S. bankruptcy law, at 11 USC 541(c)(2), protects money in a "trust", including an IRA, that contains a "restriction on transfer" that is enforceable under "non-bankrutpcy law". In In re Yuhas, 104 F. 3d 612 (3rd Cir 1997), the court, drawing on a 1992 decision of the U.S. Supreme Court involving an ERISA plan, found that an IRA was protected under the bankruptcy law by virtue of the protection afforded under New Jersey law.

Under the bankruptcy system, a debtor is allowed to choose between Federal and state exemptions. Hence, when state exemptions are chosen, the protective provisions of state law must be examined.

In Michigan, the protection from attachment on a judgment is provided under MCL 600.6023(1)(k), and the state protection of IRAs for bankruptcy purposes is found at MCL 600.5451. The protection under both sections applies to both individual retirement accounts and individual retirement annuities. The protection does not extend to any contribution to the account made within 120 days of filing for bankruptcy.

There are some differences. The protection under section 5451 applies to Roth IRAs as well, while section 6023 is silent on Roths. Section 5451 also protects distributions from the accounts after they are made.

There are certain creditors against whom these protections are not effective. The IRS has the power to reach any retirement account of a delinquent taxpayer. Special provisions under sections 401 and 408 of the Internal Revenue Code provide for division or transfer of a qualified retirement plan and IRA by a court in the course of divorce proceedings. The Michigan provision regarding IRAs mentions this exception as well, and further allows the court to order that the funds be used to meet the participant's child support obligations.

For several years, there was an ongoing controversy about whether the protection of IRAs covers only the participant's account. Some litigants argued that the interest of a non-spouse beneficiary in an inherited IRA should not receive the same protection. There have now been a number of Federal and state cases which have held that an inherited IRA is entitled to the same protection from creditors. The most recent such case was In re Chilton, 426 B.R. 612 (E D Tex 2010).

A real bucket list

Other than a will and a set of substitution documents (power of attorney, patient advocate form), one of our basic recommendations is that you prepare a comprehensive listing of your assets and contacts - a personal and financial road map for your family to follow in the event of your death or disability. When unexpected disaster strikes, determining where to look and whom to call is one of the most difficult tasks for the family. The listing could include:

• insurance policies, with policy numbers, names and addresses of agents, and locations of policies
• bank accounts, brokerage accounts, and retirement accounts, with account numbers and contact information for custodians
• e-mail logins, passwords for social sites and online accounts

Leave one at home where your spouse or family can find it, and leave one in your safe deposit box or with your attorney, in case the unexpected disaster involves the destruction of your home.

Reasons to keep the home out of the trust

There are two common reasons not to include the home in the trust when creating a revocable living trust for the client.

Medicaid planning - if the client is concerned about qualifying for Medicaid in the event of a nursing home admission, the home held by a trustee is non-exempt in Michigan.

Home loans - for mortgages, refinanced mortgages, and home equity loans, the lender will not lend and title insurance will not insure a home held under a trust.

In both instances, the recommendation is typically to transfer the home out of the name of the trustee, finalize the needed transaction, then transfer the home back to the trustee. Unfortunately, as described in this item, clients sometimes forget to do the last transfer. Worse, sometimes they are not aware that the transfer took place. Either way, the client's planning has been disrupted, and this can often lead to undesired results.

For these reasons, it is often recommended that the home not be included in funding a revocable trust.

I just inherited an IRA. Now what?

A designated beneficiary of an IRA has a couple of choices to make regarding distributions from the account, but most of the provisions of the law are mandatory. As always, unless it is a Roth IRA, distributions from the account are taxed as ordinary income. Unless a spouse inherits the account, mandatory annual distributions must begin by December 31 of the year after the death of the IRA owner.

The words and phrases that we use are defined as follows:

• The participant is the original owner of the IRA, the person whose earnings were contributed while working.
• The designated beneficiary (DB) is a person who has been properly named on the account. The DB must be a natural person or, if properly designed, a trust.
• The contingent beneficiary is a person who has been named as such. If the DB predeceases the participant, the person named as contingent beneficiary succeeds and has the rights of the DB as described below. Note that the contingent beneficiary has no interest in the account if the DB dies after the participant.
• The life expectancy of a participant or beneficiary is calculated using formulas and tables that the IRS has devised for this purpose.
• The required beginning date is the date by which the participant is required to begin taking distributions from the account. It is defined as April 1 of the year after the participant "reaches age 70½".

The "stretch" effect, the ability to delay mandatory distributions of taxable income and allow the principal to continue to grow tax-free, is available to the successor of a participant under age 70 only if he was properly named as a DB by the participant. (A 50-year-old DB of an IRA worth $100,000 is required to take a distribution of $3,021, for example. The required distribution to a 20-year-old DB would be less than $2,000.)

If the DB is the spouse of the deceased participant, he may elect to convert the account to his own name. If he does so, then his required beginning date and his life expectancy will apply. He will not have to take mandatory distributions until after he reaches age 70.

If the DB is a non-spouse, the rules are:

1. If the participant had not reached his required beginning date before his death, the custodian of the account must begin making annual distributions based on the life expectancy of the DB.

• If there are two or more people named as DB, the life expectancy of the oldest must be used. Alternatively, the account may be divided into two or more separate accounts, and the separate life expectancy of each will govern his part.
• Dividing the account is a way to keep the ability to stretch out distributions if a charity has been named as one beneficiary. There is a time limit for doing this.

2. If the participant had already reached the date on which he was required to begin taking distributions, then the distributions to a DB will also be based on that DB's life expectancy. (If the non-spouse DB was older than the participant, though, distributions will continue based on the participant's life expectancy.) If there is no DB, the distributions will continue on the same schedule that applied to the participant, using his life expectancy.

If the participant had not taken his required distribution for the year he died, it must be taken by December 31 of that year. It is taken by the beneficiary, not by the participant's estate.

The DB should always take steps to name his own beneficiary of the account and a contingent beneficiary. This person may not be a "designated beneficiary", as that term is used under the statute and regulations, but if not, he or should would continue the schedule of distributions that the DB had started.

If there was no DB on the account, such as a situation where the account is payable to the estate of the participant, the "stretch" is lost. A shortened payout period applies if the participant had not reached his required beginning date: the funds have to be distributed in full within five years of the participant's death to the person(s) entitled to them. If he had reached his required beginning date, however, the distributions may continue based on his life expectancy.

More: The Zucker Law Firm discusses the Five Options available to beneficiaries