FINANCIAL PLANNING FOR THE
LAWYER AT LARGE, LLC.
MICHAEL LYNN GABRIEL
ATTORNEY AT LAW
B.S., J.D., M.S.M., Dip (TAX), LL.M. (Tax)
TABLE OF CONTENTS
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
PART ONE: INDIVIDUAL TAX PLANNING . . . . . . . . . . . . . . . . . . . . 5
1. Tax Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
2. Investment in a Home . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41
3. Real Property Rental . . . . . .. . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . 79
4. Collecting Debts in Small Claims Court . . . . . . . . . . . . . .. . . . . . . . . 105
PART TWO: INVESTMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128
5. Limited Partnerships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .130
6. Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .150
7. Bonds and Government Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . 163
8. Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . 183
9. Commodities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . 190
10. Mutual Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . .200
11. Money Market Vehicles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222
12. Real Estate Investment Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232
PART THREE: DEBT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242
13. Living with Debts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243
14. Filing Chapter 7 Bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267
INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .299
TABLE OF CONTENTS
PART ONE: INDIVIDUALS ENGAGED IN BUSINESS ............................. 1
1. Partnerships ....................................................................................................2
2. Doing Business as a Corporation ................................................................35
3. Limited Liability Companies ........................................................................62
4. North American Free Trade Agreement .....................................................86
5. Guarding Against Employment Problems .................................................104
PART TWO: AFTER RETIREMENT .........................................................132
6. Social Security ............................................................................................133
7. Supplemental Security Income ..................................................................170
8. Disability Benefits ......................................................................................189
9. Medicare .....................................................................................................211
10. Nursing Home Care ..................................................................................235
PART THREE: ESTATE PLANNING .........................................................246
11. Revocable Trusts ..................................................................................... 250
12. Probate .......................................................................................................270
13. Joint Tenancies and Gifts .........................................................................305
14 Durable Powers of Attorney ......................................................................318
INDEX ............................................................................................................ 358
PART I: INDIVIDUALS ENGAGED IN BUSINESS
This section of the book is for those persons who are or will be engaged in business. Obviously, one of the best ways to make money is to earn it. There are, in practice, only three legal ways to earn money: working for others, working for yourself or winning a lottery. Only the first two methods are dependable and, as to them, there are benefits and drawbacks with each.
As an employee, a person has the stability of knowing that fixed paycheck will be coming in each week. The drawback is that the employee does not share in the profits of the business and does not have the time to form his business. In contrast, a person in business for himself shapes his own destiny. No money is earned unless the person earns it himself. When no client comes into the office for advice or services, the lawyer does not earn any money. At that point, five degrees do not earn the money that a hamburger flipper with McDonald's makes. A self-employed business, however, has the opportunity to make more money annually than a salaried employee doing the same work. In addition, a self-employed person can set the hours, goals and objectives because he owns the business. A person who decides to go into business for himself or with others is to be congratulated.
Two or more people who are not married to each other and wish to conduct a business together have only two options available in structuring the business. They may incorporate and operate as a corporation or they may operate as a partnership. Corporations are discussed in the next chapter.
Partnerships are used because they are simple. A partnership is not required to be in writing to be legal; although it makes a great deal of sense to have it in writing. Partnerships are usually created between family members or close friends. There are two types of partnerships: general partnerships, which are discussed in this chapter, and limited partnerships, which are discussed in Chapter 10.
While general partnerships are simple to form and operate, that does not mean they are unregulated. On the contrary, a complete body of partnership law has been developed both by case law and statutory law. The rights and obligations of partners and those persons dealing with partnerships are covered by a state's general partnership law in the absence of written agreement of the partners to the contrary.
This chapter is intended to educate the reader about the differences between partnerships and corporations, but, most importantly, it is intended to raise the awareness of what is legally required of persons doing business in the form of apartnership. It is important that anyone considering the possibility of forming a partnership possess a good understanding of the rights and obligations that arise from a partnership arrangement.
I. THE UNIFORM PARTNERSHIP ACT
The National Conference of Commissioners on Uniform State Laws wrote the Uniform Partnership Act (UPA). The Act has been adopted by every state except Louisiana. The UPA provides the rules on how a partnership is to operate when the partnership agreement does not have sufficient detail: the UPA fills in the blanks in a partnership agreement. The partners can agree not to use the UPA provisions. They can write their own replacement provisions if they elect to do so.
A partnership is two or more persons or entities working together as co-owners to run a business for profit. The Internal Revenue Code defines a partnership in Section 761(a) as:
"a syndicate, pool, joint venture or other unincorporated organization through which...any business is carried on...and is not a corporation, trust or an estate (meaning sole proprietorship)."
A partnership may be formed by a written agreement, or it may be formed by an oral agreement of the parties. The factors that determine if a partnership exists are:
1.Whether the parties intend to form a partnership, and
2.Whether they intend to make a profit from the activities.
Once the foundational elements of a partnership are met, the partnership is formed and governed either by the terms of the written agreement or the UPA or (in the case of Louisiana) its own state partnership law.
A joint venture is a partnership that was created to accomplish a narrow purpose. Most partnerships exist to make a profit while engaging in a particular type of business. A joint venture seeks to make a profit usually on a one-time basis. The joint venture automatically terminates when the purpose of the partnership is completed. An example of a regular partnership is where two persons form a cement- paving company. An example of a joint venture is where two persons agree to work together to pave just one job. A joint venture, as with a regular partnership, is governed by the partnership law of the state where it is formed. Like any partnership, the agreement should be in writing or else its provisions will be set by the state. Except for the limited purpose of the joint venture, it has the same issues, problems and elements of a regular partnership.
III. TAX TREATMENT
Partnerships are treated for federal tax purposes as "pass-through" vehicles. All profits and losses of the partnership pass through the partnership and are attributed to the partners. The effect of this pass through of profits and losses is that the partnership itself is not taxed. Partnership income is not subject to double taxation as is the income of a regular C corporation. To achieve this same tax benefit for small corporations, Congresscreated the S Corporation.
The partnership does not pay any taxes on the income from the partnership. All partnership profit and loss is passed through to the partners. The partnership files its Form 1165 partnership return and its K-1 to inform the IRS how the profit and loss is being allocated to each partner. Each partner is treated for tax purposes as a self-employed individual. Each partner is required to estimate his share of the partnership income and make estimated quarterly payments to the IRS.
Under the 1986 Tax Reform Act, profits and losses passing through to partners retain the same character they had in the partnership. A passive profit or loss to the partnership remains a passive profit or loss to the partner. The same treatment exists for an active profit or loss. A partner who materially participates in the partnership business will receive his portion of the attributed profits and losses and declare them "active" for tax purposes. A partner who does not actively participate in the partnership business will likewise receive all of his share of the profits and losses and will declare them "passive."
Generally a joint venture is treated the same as a partnership for tax purposes. There are certain Internal Revenue Code differences or elections, however, that pertain only to joint ventures:
1.The joint venture, like a partnership, must file an informational return except for certain real estate joint ventures.
2.The joint venture makes tax elections for computation of its taxable income.
3.The joint venture can adopt its own tax year but it must have I.R.S. permission to use a tax year different from any principal partner.
4.A joint venturer, one of the partners in the joint venture, may enter a business transaction with the joint venture and be treated as an outsider for tax purposes.
5.The members of the joint venture may elect to be excluded from some or all of subchapter K of the Internal Revenue Code (which defines how partnerships are taxed) if the joint venture is basically a passive investment .
The above tax aspects of joint ventures give them a better degree of flexibility than general purpose partnerships.
IV. PARTNERS' LIABILITY FOR PARTNERSHIP DEBTS
The main drawback to any general partnership is the fact that the partners are personally liable for the debts of the partnership. By forming a partnership the partners have agreed to guarantee payment of any debts or judgments taken against the partnership. Partners are not liable for the personal non-partnership related debts of the other partners.
Under the Uniform Partnership Act the partnership (and thus the partners) are liable for "any wrongful act or omission of any partner in the ordinary course of the business of the partnership. Where loss or injury is caused to any person by the partnership, the partners are individually liable for payment of the damages.In addition, the partners are liable for money damages that arise from the actions of any partnership employee or the other partners during the course of their work for the partnership. Example: A partner is involved in a car accident and kills two people while engaging in partnership work. All of the other partners will be liable to pay the damage award that the heirs of victims receive in wrongful death action against the partnership. If the award is $1,000,000 and the partnership only has assets of $200,000, a personal judgment will be taken against each partner for $800,000.
This is the main drawback of the partnership. The general rule of thumb is if a partnership is formed and it has employees, the partners should either carry a great deal of insurance or incorporate. Either of these entities will carry their individual personal liability for the partnership's debts.
V. FIDUCIARY DUTIES OF PARTNERS
By law each partner is an agent of the partnership. Each partner owes fiduciary duty to the partnership and to the other partners to act in their best interests. Some of the most important things that partners cannot do are:
1.A partner may not usurp a partnership benefit. This means that a partner must give the partnership the right of first refusal on any business opportunity he discovers that may benefit the partnership. Example: The partnership is in the paving business, and a partner finds that a school is intending to repave its parking lot. The partner cannot bid on the job for himselfwithout first informing the partnership of the job and giving the partnership the option of bidding.
2.A partner may not divert partnership assets for his own personal use. Such conduct is a breach of trust and may even expose the partner to criminal liability.
3.The partner must fully disclose all material facts affecting the partnership and its affairs to the other partners.
A partner who breaches any of these duties may be sued by the other partners for their lost profits or other damages suffered as a result of the partner's misconduct. If a partner usurps a partnership benefit, he may be ordered to pay all of the profits realized from the transaction to the partnership on the theory that the partnership should have received it.
VI. AUTHORITY TO ACT FOR PARTNERSHIP
In a general partnership each partner has full authority to act on the partnership's behalf in the normal course of its business. Each partner can bind both the partnership and the other partners to contracts that the other partners never authorized or approved. This unlimited power on the part of one partner to bind the partnership and the other partners is the biggest concern of most investors. The partners may agree to limit their authority to bind or act on behalf of the partnership.
People dealing with a partnership are entitled to assume that any partner has the right and power to act for the partnership inthe normal course of its business. Even though a partner may actually have limited authority to act for the partnership, the apparent authority of the partner may nevertheless bind the partnership to contracts with third parties. Contracts entered with people who did not actually know the partner lacked authority are binding on the partnership.
Moreover, there are some acts that a partner can never do unless the authority is specifically granted in a partnership agreement. Anyone dealing with a partner is presumed to know that he cannot execute a valid contract in these special areas unless the partnership agreement gives him the specific authority to act.
The Uniform Partnership Act states the following acts are invalid and not binding on the partnership unless the partnership agreement expressly states that a partner has the authority:
1. Transfer of a partner's interest to another.
2. Conveyance of partnership property.
3. Mortgaging of partnership property.
4. Confession of a judgment against the partnership.
5. Submission of partnership claim to arbitration.
6. Performing any act that would make it impossible to continue the business of the partnership.
Anyone dealing with a partnership should always ask to review the partnership agreement to assure himself the partner executing the contract does indeed have authority.
VII. CONSIDERATIONS BEFORE DECIDING TO FORM A PARTNERSHIP
Before forming a partnership, the parties should consider thefollowing issues and decide for themselves how they should be addressed:
1.Name of the partnership.
2.Term of the partnership.
3.Purpose of the partnership.
4.Scope of objective: joint venture or partnership.
5.Capitalization: funding the partnership.
6.Distribution of profits and losses.
7.Admission of new partners.
8.Expulsion of old partners.
9.Withdrawals of contributed assets.
11.Salaries and draws of income by partners.
12.Responsibilities of partners.
13.Dissolution of the partnership.
14.Staffing and management.
15.Comparison with the alternative of incorporating.
16.Extent of possible personal liability for partnership debts.
These are important considerations. They are not the only ones. Each partnership is different because each is composed of different people with different viewpoints. What must be remembered is that anything not covered in the partnership agreement will be decided in accordance with the state's Uniform Partnership Act. If the partners do not want the UPA to apply on a particular point, they must expressly create their alternative provision.
VIII. RIGHTS OF THE PARTNERS
All partners have certain basic rights in a general partnership. These rights are:
1.To insist on a partnership accounting. Along with this right is the right to have the books examined by an outside accountant.
2.To dissolve the partnership in accordance with the terms of the partnership agreement or the Uniform Partnership Act of the state.
3.To restrain the partnership from performing acts prohibited under the partnership agreement.
4.To bring legal action for breach of the partnership agreement.
These are implied rights in any partnership agreement. Provisions in partnership agreements that waive such rights are usually found to be invalid and against public policy.
IX. PROFITS AND LOSSES
One of the most important issues in any partnership is how profits and losses are divided. After all, the partners formed the partnership in order to conduct a business to make money. Therefore, it is important to know the manner of accounting and distributing partnership profits and losses.
Under the Uniform Partnership Act all profits and losses of a partnership are divided equally among the partners. The equal division of profits and losses occurs even if the partners own unequal interests in the partnership or have contributed unequalamounts of work or property to it. The partners can agree to an unequal division of profits and losses. Unequal divisions are usually based on partnership ownership interests or contributions. Any agreement for an unequal division of profits and losses should be detailed with particular clarity in order to make clear that the UPA does not apply.
X. PARTNERSHIP PROPERTY
Under the Uniform Partnership Act property which is titled in the partnership name is owned by the partnership. A partner who contributes property to a partnership gives up ownership in the property. Likewise, property purchased with partnership funds is owned by the partnership.
The property held by a partnership can be legally sold, transferred or conveyed only by the partnership. Since partnership property is owned by the partnership, it cannot be directly attached to satisfy any court judgment against a partner. A partner's ownership interest in a partnership can be attached and sold by a creditor, but not the underlying property in the partnership.
XI. ADDITION OF NEW PARTNERS
The Uniform Partnership Act requires unanimous consent of all partners before the admission of new partners. Unless the partnership agreement has a clause to the contrary, the UPA requirement controls, and the admission of new partners requires unanimous consent. Requiring unanimous consent makes sense. If unanimous consent is not required, new partners can be added overthe objections of existing partners who would not be in the partnership had they known the identity of the new partners. The personal liability of each partner being at risk, it is essential that each retain the right to select whom he will share this responsibility.
Under the Uniform Partnership Act a new partner is liable for the partnership debts incurred before becoming a partner only to the extent of the amount of his contribution to the partnership. The partner is liable, as any partner, for all of the partnership debts incurred after becoming a partner. Example: George joins an existing partnership which owes $200,000 in debts. George contributes $50,000. After he joins, the partnership adds another $100,000 to its debt. George is liable for $150,000 of the total partnership debt: $50,000 of the pre-existing debt plus $100,000 debt after joining. The other partners are liable for the whole $300,000.
XII. TAX EFFECT OF CONTRIBUTING PROPERTY TO A PARTNERSHIP
A tax consideration that all persons forming a partnership should bear in mind is the tax consequence of contributing services for an equity interest in the partnership. Under federal tax law a partner has to recognize as income the value of partnership interest purchased by services rendered or to be rendered. A person cannot acquire a partnership tax free by bartering services. Example: George agrees to become a partner by providing services. The partnership interest acquired will be worth $10,000. George will have to report the $10,000 as income on his tax return.
The tax consequence of purchasing a partnership interest with services may result in the transaction not being financially worthwhile personally. Often those who contributed services and perhaps some money resent the partner who contributed only money. In a successful partnership it is common for the partner who contributes most of the work to feel slighted when a partner who does less but who contributed the start-up capital receives a bigger share of the partnership by virtue of that capitalization.
XIII. ASSIGNABILITY OF THE PARTNERSHIP INTEREST
Generally, a partner may freely sell or convey his interest in the partnership unless the partnership agreement says otherwise. If the other partners do not approve of the transfer, they can usually dissolve the partnership. The remaining partners do not have to dissolve the partnership if they object to the transfer. The Uniform Partnership Act protects the remaining partners by authorizing them to restrict the new partner. The remaining partners may continue partnership operation as before but not accord the new partner all of the rights of a full partner. Example: The new partner could have the right to receive the selling partner's share of profits but be prohibited from demanding an accounting or inspecting corporate books or participating in management of the business.
XIV. EXPULSION OF A PARTNER
Partnerships which have a large number of partners sometimes have a provision in the partnership agreement which permits the expulsion of a partner without the dissolution of the partnership.Expulsion clauses in partnership agreements are valid if they exist to protect the partnership from harm caused as a result of the expelled partner's breach of the partnership agreement or fiduciary duties.
The procedure for the expulsion must be in the partnership agreement. An expulsion is obviously against the wishes of the expelled partner. Therefore, the courts will narrowly construe an expulsion clause to determine if it violates state law or is otherwise against public policy.
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XVII. COMPARISON WITH A SUBCHAPTER S CORPORATION
A partnership is subject to its own peculiar tax treatment under federal tax law. Most unincorporated associations and trusts that conduct business are taxed as though they were corporations. Partnerships, however, are treated differently. In a partnership the income is attributed to the partners according to their percentage of partnership interest. The partnership pays no income tax itself on the federal level. Example: A partnership earns $1,000,000. It will pay no taxes. Each partner will include his pro rata share of the $1,000,000 on his personal tax returns. Assuming a 28% federal tax rate, the partners will pay a total of $280,000, not the total $519,200 that a C corporation and its shareholders must pay.
An S corporation is a corporation that is allowed to pass its income to the shareholders. In that respect, it resembles a partnership. The major differences between a partnership and anS Corporation are:
1.Partnerships may admit anyone as a partner and may have any number of partners; whereas S corporations are limited to 35 members of special status.
2.Partnerships can divide profits and losses in a manner not related to the partners' ownership interests. By contrast S corporations must divide profits and losses among the shareholders according to their percentage of stock ownership. In most cases these differences are not important because the S corporation usually does not want additional shareholders and does want profit and losses allocated according to shareholder investment.
3.Partnerships thrust personal liability onto each partner. The most important difference between S corporations and partnerships is that there is no personal liability on the part of the shareholders for the corporation's debts. By comparison, the general partners (but not limited partners) have personal liability for the partnership debts.
Persons considering doing business as a partnership should weigh the relative merits of both a partnership and an S corporation and elect the one that best suits their type of business.
XVIII. FICTITIOUS NAME
Most states require a partnership to file a fictitious business name if they are doing business with the public. Allstates require a partnership doing business under a name other than its own to file a fictitious business name statement. The purpose of a fictitious name statement is to give notice to the world concerning who actually is running the business. Usually the filing is in the county clerk's office where the business is run under the fictitious name. If the partnership does business under a fictitious name in several counties, the filing must be in every county where it does business.
XIX. A FEDERAL IDENTIFICATION NUMBER
Any employer is familiar with the federal identification number (FIN). All employers are required to have one. A sole proprietor who has no employees is not required to have an identification number because his social security number is used instead. Once a partnership is formed, it needs an identification number because the partnership is also an employer.
A federal identification number is obtained by filing Form SS-4 with the IRS. It should be filed as soon as possible after the partnership is formed. A sole proprietor who joined a new partnership will need a new identification number. The old number used by the sole proprietor in the previous business will not transfer to the new partnership.
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XXIV. LIMITED LIABILITY PARTNERSHIPS
The most important change in partnership law since the creation of the limited partnership is occurring now. A few formof partnership has been enacted by some states called the REGISTERED LIMITED LIABILITY PARTNERSHIP or just the LIMITED LIABILITY PARTNERSHIP (LLP). The limited liability partnership is a cross between the two existing types of partnerships: the general partnership and the limited partnership. On the whole, a LLP is the treated the same as a general partnership except for the fact that the LLP provides a degree of protection to the partners for the liabilities of the partnership. A LLP must, the same as any other type of partnership, be composed of two or more persons, trusts, or companies who have joined together to engage in a business for profit.
The driving force behind the enactment of LLP Acts is that professionals are permitted to practice their profession through the use of the LLP. As discussed in the chapter, LIMITED LIABILITY COMPANIES some states, most notably California, does not permit professionals to do business through the use of a limited liability company, LLC. In such states, professionals are limited to doing business in a corporate form, as either a regular corporation or subchapter S to limit their liability for the debts of the business. In order to provide professionals to get together and conduct their profession with some degree of limited liability for professionals working together, some states have enacted limited liability partnership acts. California is a state that does not permit professionals to operate through a LLC and instead adopted in October 1995, one year after the enactment of its LLC Act, a LLP Act. Other states which permit LLP's are Delaware, Minnesota, NewYork, New Mexico, Texas along with the District of Columbia. More states may be adopt such acts in the future. As of January 1996, 46 states along with the District of Columbia have enactment limited liability company acts. A LIMITED LIABILITY COMPANY OFFERS THE OWNERS (MEMBERS) THE SAME DEGREE OF FREEDOM AND OPERATION AS AN LLP ALONG WITH EVEN GREATER PROTECTION FOR LIABILITY FOR THE BUSINESS'S DEBTS. Usually, if a person can do business in either the LLC or the LLP form, the LLC form is better. As stated above, however, not all states permit their professionals to do business in the LLC business form. Therefore, in such states, the LLP is the only alternative to a forming a corporation if it is available in the person's state
A. STATUS OF A PARTNER
The LLP is for most purposes the same as a general partnership. All of the discussions previously,in this books, regarding a general partnership except for the personal liability of the partners applies to the LLP. A partner of a LLP is a general partner not a limited partner. One of the major differences between the LLP and a general partnership is that the LLP is governed and managed by a written partnership agreement whereas the general partnership is not required to have a written partnership agreement.
As with a general partnership or limited partnership, the partners are the owners of the partnership in accordance to the terms and conditions set forth in the partnership agreement. As with any partnership, the partners are responsible for themanagement of the partnership either directly or through management which they elect or appoint. The partnership agreement will govern, when stated, those disputes that normally arise during the normal course of business. When the partnership agreement does not cover such instances, the normal business disputes or matters are handled by the majority vote of partners. When the disputes,in questions, are outside the normal course of business, the dispute can only be resolved by the unanimous vote of the partners, RUPA section 401(J).
One of the common concerns that arise in the creation of a partnership,be it a general partnership, limited partnership or LLP, is how the partnership can be capitalized. Every business needs money to operate and a partnership is no different. The question is, however, how the partnership will get its money and what would happen if the company fails. Partnerships almost always have to rely on capital contributed by their partners. The issue is, then, whether the capital will be treated as a loan or the purchase of an equity interest. Loans have to be repaid but do not entitle the lender to an ownership interest in the partnership. Whereas a contribution to equity is not repaid but does purchase a percentage of the partnership. This issue is important if the partnership fails and there is not enough cash to return the capital to the partners after the payments of the partnership debts. The law is settled on this point it is in practice that difficulties arise. Any partner, even for a LLP, can lend money to the partnership and transact business with it in accordance withstate law. On dissolution of the partnership, the partners stand on the same footing as regular creditors to the extent of their loans,equity interest remain separate. The treatment of loans by partners to the partnership is the same for LLP's as with other types of partnership as discussed in the earlier termination chapter.
B. A PARTNER'S LIMITED LIABILITY FOR THE PARTNERSHIP DEBTS
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DOING BUSINESS AS A CORPORATION
A corporation is an artificial entity created in conformity with a particular state's law. As a distinct legal entity, a corporation is considered to be separate and apart from all of the people who own, control or operate it. A corporation holds most of the rights of a legal person. A corporation is able to execute contracts, incur debts, hold title to both real and personal property and pay taxes. The attractiveness of a corporation stems from the very fact that it is held to be a separate legal entity from its owners (the shareholders), which gives it unique advantages over both a sole proprietorship and a partnership as an entity for conducting business.
A corporation is said to have perpetual existence: a corporation will legally exist forever unless it is dissolved or terminated under state law. One of the main grounds for a corporation's existence being terminated is its non-payment of taxes. Usually, as long as a corporation pays it taxes, it will remain in effect.
A corporation's perpetual existence is an important advantage over other forms of business. A partnership terminates upon the death of a partner, and a sole proprietorship also terminates upon the death of the owner. A corporation continues regardless of the death of a shareholder. The perpetual existence of a corporationis one of its most compelling features. The fact that a corporation continues regardless of the death of shareholders gives it stability. Most people are reluctant to invest in a business that is not a corporation and that may terminate upon the sudden death of any partner. Likewise, most lenders will not loan money to a partnership because it could suddenly terminate upon the death of a partner. The stability of a corporation derives from its continuity of existence beyond that of its shareholders.
The main advantage that a corporation has over a sole proprietorship or a partnership is that the shareholder is not personally liable for the debts of the corporation or the actions of the employees. Consider a partnership or sole proprietorship. If a partner or employee does an act in the scope of their employment that injures another person, each of the partners or the owner (of the sole-proprietorship) is personally liable to pay for the resulting damages. On the other hand, the most any shareholder can personally lose if a monetary judgment is taken against the corporation are the assets they contributed to the corporation in payment for their stock.
This limited liability for corporate shareholders is vastly different from a partnership or sole proprietorship where the owners are totally liable for all debts of the business. The creditors of the business can seek and attach every dollar and piece of property that a partner or sole proprietor owns in order to settle a judgment against the partnership or sole proprietorship. Such personal attachment of the assets of ashareholder is not allowed to satisfy corporate debts. The reason most people incorporate is to avoid this unlimited liability for the debts of the business. Few people would ever invest in a business if they would be risking everything they had earned or would earn in the future.
Several years ago, a person who owned a fast food franchise visited a corporate attorney for general tax advice. Since he was not incorporated, the attorney suggested that he incorporate so as not to be personally liable for any of the acts of his employees. The client, however, decided to rely on his insurance policy to protect him from any personal liability. As if on cue, less than three months later, the attorney opened his newspaper to read in the headlines that one of client's employees had hepatitis and passed it to over three hundred patrons. One person had died, another person had irreversible brain damage and the rest had varying degrees of discomfort. Later that day, the client called the attorney and asked what could be done to limit his liability. Unfortunately, the attorney had to explain that if the client's insurance did not cover all the damages that would be awarded, he would have to pay the difference. The upshot was that the client may be forced into bankruptcy simply because he had not incorporated. Had the client incorporated, he would not have had to face the possibility of personal judgments of hundreds of thousands of dollars in damages because of the acts of an employee. The moral of this all too true tale is that whenever a business has employees, the owners must either carry a great deal of insuranceor be incorporated (or if the sate permits being doing business as a limited liability company as discussed in the next chapter) in order to be protected from any judgments obtained as a result of the employees' or other partners' actions. Incorporation acts as a one-time insurance premium.
In addition to limited liability, special tax treatment for small corporations make them as attractive as partnerships. Normally, except for S corporations, the federal government taxes corporate income twice. Corporate income is taxed when the corporation first earns it, and it is taxed again when distributed to the shareholder. The federal corporate tax rate is:
1.15% of the first $50,000 of taxable income.
2.25% of the next $25,000 of taxable income.
3.34% of the remainder over $75,000 of taxable income.
Corporations having income between $100,000 and $335,000 are taxed at a 39% rate.
When after-tax income is distributed to the shareholders as dividends, the shareholders must include it on their tax returns as income. The shareholder has to pay income tax on the income he receives that has already been taxed as corporate income.
One alternative to this double taxation is for a small corporation to pay most of the income as legitimate salaries to the shareholders for work done. A salary is deductible by the corporation whereas a dividend payment is not deductible. Thus if the income can be paid as salaries, corporate taxes are reduced.
The taxing of a regular corporation is regulated by subchapterC of the federal tax code: it is called a "C corporation" and is subject to a different taxing structure than either a partnership or sole proprietorship. A special corporation whose taxing is regulated by subchapter S of the federal tax code is called an "S corporation" and is taxed quite differently from a C corporation.
The income tax of a C Corporation is subject to double taxation. It is taxed first when the corporation files its corporate tax return. The C corporation is taxed again when the corporation pays dividends to its shareholders: the dividends that a shareholder of a C corporation receives are includible in the shareholder's income on his Schedule B of Form 1040. Example: A C Corporation had $1,000,000 in net profit. It will pay approximately $340,000 in taxes. After it distributes the remaining $640,000 to the shareholders, they will have to pay taxes on it again. Assuming the shareholders' tax rate is 28%, the shareholders will pay an additional $179,200 in taxes. The total tax on the corporate income is $519,200 which means that the joint tax exceeds 51%.
Partnerships provide more flexibility than S corporations in a few areas:
1.Partnerships may admit anyone as a partner and have any number of partners; whereas S corporations are limited to 35 members of special status, and
2.Partnerships can divide profits and losses in a manner not related to the partners' ownership interest. In contrast, S corporations must divide profits and losses among shareholders in proportion to their percentage of stock ownership.
Generally, these differences are not important because the S corporation usually does not want additional shareholders and does want profit and loss allocated according to stock ownership.
An individual who incorporates a business is given the opportunity to employ certain tax advantages called fringe benefits. A corporation is allowed to deduct from its pre-tax income the costs of certain fringe benefits that are not deductible by persons in a partnership or sole proprietorship. One of the main areas of tax advantage is in retirement plans. A corporate employer may contribute, tax free, significantly more to the employees' retirement plan than a self-employed person's Keogh plan. In addition, employees of corporate plans may borrow amounts to a maximum of $50,000 of the funds contributed to a plan without penalty which is not the case with Keogh plans. Other fringe benefits that are deductible by a corporation but not by a partnership or sole proprietorship are health, life and disability insurance and a $5,000 death benefit. These benefits are deductible by the corporation and usually are tax free to the corporate employee.
The costs for incorporating a business vary somewhat from state to state. In California the costs for filing the Articles of Incorporation and the minimum franchise tax fee is about $915. In addition, the corporate books, which include the minute book, stock book and the corporate seal, cost between $75 and $125. Attorney fees are normally $800 to $1,000 in California. Most states are not as expensive as California and charge $300 to $500 for an incorporation. In like manner, attorney fees in these states vary from $300 to $1,000. The cost of incorporation should be viewed as a one-time insurance premium. Once the business is incorporated, the shareholders are protected from individual liability caused by the actions of the corporation or its employees. After incorporation, shareholders no longer have everything they own at risk. Peace of mind is an important consideration when deciding to incorporate. After a corporation is formed, the yearly requirements for meetings and record keeping are not much more than required for any non-corporate business.
A. STEPS FOR INCORPORATION
There is no mystery to forming a corporation nor is it difficult. In its simplest sense, a corporation is merely a license to do business in a particular manner. In that sense, the articles of incorporation are the application for the license, and, when accepted for filing by the secretary of state, become the license. In fact, a corporation is said to be "licensed to do business" once the articles are filed.
The act of incorporating a business is simple. All it entails is the filing of the articles of incorporation and the subsequent issuance of stock. The actual act of incorporating is no more than standing in line before a clerk in the secretary of state's office and having the articles filed and stamped. It can also beaccomplished by mail.
There are many companies that provide corporate kits which include basic articles, minutes and by-laws specifically designed for use in just one state. The usual cost is between $50 and $100. The corporate kit, however, does not address the many issues or provide the information contained in this book. This book, traveling beyond the mere corporate kit, provides guidance and advice on the considerations that arise in forming any corporation. Before filing any articles a person should decide what additional provisions he may want in the articles. In addition, a person should read those provisions in the state's corporation code (available in most public libraries) to assure that the state law has not changed in content.
There are many choices that an incorporator faces in forming a corporation. Many of these choices can be difficult given the many options available and the particular concerns of each business. One example of a choice that must be made is whether or not to become a "CLOSE CORPORATION" which requires the shareholders to agree to operate the business pursuant to a shareholder's agreement rather than under the formalized procedures of the state's corporate law. Another choice to be made is whether a Subchapter S tax treatment is desired. If it is, should the election be made at the first directors meeting. Nothing can replace the cold, practical consideration of the person forming the corporation. That person knows the business purpose and how it will be operated. The most any book can do is steer the incorporator tothose provisions and issues of concern and practical use.
There is no set definition of a small business. The definition varies among the states and is different under federal law. Simply, it means a corporation with a limited number of shareholders. When a business qualifies as a small corporation it has the opportunity of availing itself of special advantages. Under federal tax law a small business (less than 35 shareholders) may elect subchapter S tax treatment, which allows the corporation to be treated as a partnership for tax purposes. Many states have similar subchapter S laws for small corporations. Several states also permit small corporations (in Delaware it is 30 shareholders; in Ohio it is unlimited provided there has never been a public offering) to elect to become closely held corporations.
The steps for incorporating a business are simple. They can be summed up as simply filing the articles of incorporation and issuing the stock. In arriving at this result, the corporation will go through these steps:
A. CHOOSE A CORPORATE NAME
A corporation must have a name that denotes that it is a corporation and not a partnership or sole proprietorship. The name usually must contain the word "Incorporated", "Corporation" or "Limited." The name must not mislead the public into believing it is an agent of the federal or state government. The name of the corporation must not mention or suggest involvement in a regulated or licensed field unless the corporation has that license. Forexample, selecting the name Dr. Peter Jones Medical Corporation for a corporation would not be valid unless Peter Jones, as the principal shareholder, actually had a medical license.
In practice, the main concern is that the proposed name may be so similar to an existing corporation's name that it misleads the public. No state will permit two corporations to have the same name or one so similar that they are confusing. To avoid the possibility of having the articles rejected because of similarity to the name of an existing corporation, the incorporator should conduct a name search with the secretary of state's office. If the name is not taken, it can be reserved for a period of 60 days or longer. The reservation fee is nominal. The search can be done by mailing a request with the name and a check for the search to the secretary of state. The amount of the check and where to send it can be obtained by telephoning the secretary of state's office. A search through the secretary of state's office will take about 30 days. There are attorney service firms (in the phone book for the state capitol) that will search the name and reserve it within two days for about $30. These firms also usually sell, for under $100, corporate kits for the state,If the corporation will be doing business in other states, it may have to operate under a fictitious name if the corporate name is substantially similar to an existing business in any of those states.
B. PREPARE AND FILE ARTICLES
After the corporate name is reserved, the incorporator prepares and files the articles of incorporation. Each state hasit own requirements for the contents of the articles. There are sold in every state, corporate kits that contain the basic articles, stock and filing materials needed to become a corporation under that state's law. Such kits cost between $50 and $100. In addition, there has also been written a companion book to this series on incorporation which contains the Articles, Bylaws, stock certificates and minutes in more detail than any corporate kit and, yet, at a cheaper price. Most attorneys charge between $800 and $2,000 to, in essence, tailor make a set of Articles for filing which usually are not necessary.
After the articles are prepared, they are filed with the secretary of state's office. Most states require the articles to be filed in triplicate originals, all signed by the incorporator. Four or more originals should be filed and a conformed, file-stamped copy requested and received from the secretary of state. Filing can be done by mail. It will take thirty 30 to 60 days to get a return. The alternative is to use an attorney service to file the articles. Such a firm usually takes a week to get the articles returned and charges about $50 for the service. The advantage of the attorney service is that any problem can be corrected faster. When the articles are filed, the incorporator must pay the filing fee and the yearly franchise fee for the corporation. The fees vary from state to state. For example, in California the total fee is $917 ($117 filing and $800 franchise tax). The correct amount of the fees can be obtained by calling the secretary of state's office. If an attorney service is used, theywill know the fees.
C. ISSUE STOCK
After the articles are filed, the corporation exists in a de facto mode which means that it exists on paper. It is not until stock in the corporation is actually issued that it will exist at law (de jure). Outstanding shares in the hands of shareholders is the defining characteristic of a corporation.
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THE LIMITED LIABILITY COMPANY
The most recent development in business law is the creation of the Limited Liability Company (LLC). The first LLC was created in the 1970's. For many years LLC's were not popular because the tax laws subjected them to more taxation than either a corporation or a limited partnership. In 1977, the first LLC was created in Wyoming for an oil company. The company was granted a private tax ruling stating that it would be treated as a partnership. In 1980, the U. S. Treasury issued proposed regulations that stated an LLC would be taxed as a corporation because its members did not have a partner's liability for the company's debts. In 1988, the Internal Revenue Service finally issued Revenue Ruling 88-76, 19882 CB 360, stating that an LLC could be taxed as a partnership. This revenue ruling calmed concerns about forming LLC's. As a result, the number of states permitting LLC's has increased dramatically.
An LLC is a cross between a corporation and a partnership. The characteristics shared with a corporation or a partnership are:
1. It bestows limited liability on its members just as a corporation does on its shareholders and a limited partnership does on its limited partners.
2.It can provide for the free transferability of its membership interests the same as a corporation or partnership.
3. It can provide for continuity of life after the death, resignation, expulsion or bankruptcy of a member the same as a corporation or a partnership.
In addition, an LLC may give full management and control to just a few managing members, which is the same treatment that is available in a partnership and similar to that of the board of directors of a corporation.
The following, however, are the major differences between LLC's and corporations or partnerships:
1.Unlike a corporation, which can have perpetual existence, an LLC can only exist for a stated period of time (30 years in many states) before it is terminated.
2. Unlike the partners of a general partnership, the members of the LLC are not personally liable for the debts of the company, which is the same basic treatment as that of shareholders of a corporation or limited partners of a limited partnership.
3. Unlike a corporation, the company does not have the corporate restrictions on financing. Example: The company does not need to create a special surplus account for distributions.
4. Unlike a corporation, in the majority of states, absent an agreement among the members to the contrary, profits and losses of an LLC are allocated in accordance witheach member's percentage of capital contributions. A few states have adopted the per capita partnership rule: if there is no agreement on decision, profits and losses will be allocated equally among members. Either method is different from that of a corporation. Division of corporate profits and losses must be based upon the number of shares that a shareholder owns in the corporation.
These characteristics are important. If an LLC has any three of them (as discussed below), it will be taxed as a corporation. Such taxation would be detrimental to members so care must be taken in deciding which common characteristics the company should share with a corporation.
The main advantage of an LLC is the limited liability that it provides its owners, who are called members. In an LLC, the most that its members can lose in a lawsuit against the company are the assets they contributed to the LLC. The limitation of liability would naturally not extend to any personal guarantees of company debts by a member. If a member personally guarantees a company loan of $100,000, the member is personally liable for the repayment. The member's liability arises not because the person is a member of the company but because the member guaranteed that he personally would repay the loan. It is immaterial that the money may have gone directly to the company. The limited liability for members is quite different from that of a general partnership where the partners are totally liable for all debts of thebusiness. The creditors of a general partnership can seek and
attach every dollar and piece of property that a partner owns in order to settle a judgement against the partnership. Such personal attachment to satisfy company debts cannot be taken against the assets of a member. People either incorporate or form an LLC to eliminate this unlimited business liability exposure. Few people will invest in a business that risks everything they have or will earn.
LLC's are relatively new and has taken time for them to catch. Even so, 48 states and the District of Columbia now permit them to be formed or recognize them. Only Hawaii and Vermont have as yet to join the majority, although there are bills before their legislatures to enact a LLC Act. It is expected that soon these states will also enact a LLC Act.
The fact that some states have yet not decided to permit the existence of LLC's causes a degree of concern for any foreign LLC that wishes to do business in a state that does not permit the formation of LLC's. Such a state could treat a foreign LLC in one of two ways:
1.It could grant full force and credit to the company and permit it to do business in the state in its limited liability form in accordance with the terms of its operating agreement. Hence, members would retain their limited liability for all company debts incurred in the state (absent personal guarantees).
2.It could treat any LLC doing business in the state as ageneral partnership and disregard the terms of the operating agreement where they contradict existing state law.
It is commonly felt among corporate and tax attorneys that most of the four states that do not permit their citizens to do business as an LLC will permit foreign citizens to do so. An LLC that is considering doing business in one of these three states should consult with both a corporate and a tax attorney to determine how that state would treat the company. It may well be that by the time the company wishes to do business in Hawaii or Vermont, the state may have, by then, adopted a LLC Act which settles the issue.
An LLC is considered to be separate and apart from all of the people who own, control and operate it. An LLC holds most of the rights of a legal person. An LLC is able to validly execute contracts, incur debts, hold title to both real and personal property and pay taxes. The attractiveness of LLC's is that they are held to be separate legal entities from owners, the members, which gives them unique advantages over both corporations and partnerships.
An LLC is a statutory creation. It can only be formed by strict compliance with the state law under which it is being created. An LLC just as with a corporation or a limited partnership requires a public filing of its formation documents. The filing of the articles of organization is required:
1.To give public notice that the company is formed in a way that bestows limited liability on the members for the debts of the company, and
2. To give the public notice where the company is located and who can act in its behalf.
Most states require an LLC to have more than one owner. This is a different requirement than imposed on corporations, which are permitted to legally have only one shareholder. Several states which include Arizona, Colorado, Delaware, Illinois, Iowa, Kansas, Louisiana, Maryland, Minnesota, and Virginia permit only one person to form an LLC, but the company is not given legal effect until it has more than one member. The states requiring the LLC to have two or more members also usually require that the organizers sign the Articles of Organization or, alternatively, a subscription agreement prior to filing the articles. If a company falls below the minimum number of members for an LLC, it will not only be dissolved but it will lose the limited liability shield for its members to the extent necessary to dissolve the company. A company will be treated harshly if it continues to do business for an undue period after ceasing to have the minimum number of members. Those states that have the two member requirement use it to insure the availability of the partnership classification for tax purposes. A partnership requires, by definition, two or more persons engaged in business.
B. ARTICLES OF ORGANIZATION
Articles of organization is an application by a group ofindividuals or entities for a license to do business as an LLC. Once the articles are accepted and filed, the LLC is thereafter formed. Each state sets its own requirements for the contents of the articles, however, they all require:
1.A name for the company which does not mislead the public but does disclose that it is an LLC.
2. The address of the company's principal place of business.
3. The name and address of the company's registered agent in the state.
The requirement for listing both the resident agent and the registered office is also imposed upon a company which is incorporating. Listing of registered agent ensures that someone is authorized to receive legal process against the company. The resident agent is the person who is served any legal notices or summons and complaint on behalf of the company. A company maintains a resident agent in the state, or by default agrees to let the secretary of state serve as the resident agent. The registered office is the location where the company's authority is kept in the state. The registered office's address gives notice to the world where any complaint against the company can be served.
Several states also require additional provisions to be included in the articles, such as:
1. How capital contributions will be made to the company.
2. Whether the company will be treated as a corporation or partnership for tax purposes.
3. Name and address of each organizer.
4. Whether all the members or a centralized management will manage the company.
The states of Colorado, Florida, Minnesota, Nevada, West Virginia and Wyoming require the articles to state if the company will continue in effect upon the death, bankruptcy or withdrawal of a member.
This book attempts to provide a general set of articles sufficient for most states and has provided specific articles when necessary. The reader should, nonetheless, familiarize himself with the particular LLC law of the state where the LLC will be formed. There are possibly current changes not reflected in this text. The provisions contained in the articles of organization for an LLC can only be altered or changed by the filing of an amendment to the articles. Members frequently place important management provisions in the articles because it is difficult to amend them. The articles contained in this book are all that are needed to meet minimum requirements under state law. In practice, the entire operating agreement or any of its provisions can be included in the articles. Remember, once something is listed in the articles, it can only be changed by filing an amendment.
Before the articles are filed they must be approved and adopted. The person who will file the articles calls a meeting of potential members where they decide what provisions will be contained in the articles. They also decide another important detail: whether all the members or a centralized panel of selected managers will manage the business. Once the articles are adopted,they must be signed either by all the selected managing members, or
by all of the members (if no managing members are selected. Usually, the operating agreement for the company is also created and adopted at this meeting.
C. OPERATING AGREEMENTS
After the LLC files its articles, it exists on paper; it does not exist at law (de jure) until membership certificates are actually issued. It is the fact that the company has outstanding membership certificates in the hands of members that is the defining characteristic behind the existence of an LLC. Similarly, a corporation is not deemed to be in effect until it has sold and issued stock. Following the filing of the articles, the potential members of the LLC meet to purchase their membership certificates and adopt the operating agreement for the business. After the membership certificates have been issued, the company is fully formed.
Operating agreements are the rules for the general day-to-day management and operation of the LLC. Contained in the operating agreement are the terms of the company concerning:
1. Capitalization of the business,
2. Distributions made from the business,
3. Admission and withdrawal of members,
4. Management of the business,
5. Fiduciary duties owed to and by the members, and
6. Dissolution of the company.
The operating agreement is adopted by the members and thereafter can be amended only by a majority vote of the members. An operating agreement is an attempt to resolve the many areas of potential conflict within an LLC and to delegate duties and assign responsibilities. A proposed form for a basic operating agreement for use in the 48 entities that permit LLC's is in the company book for Limited Liability Companies of this series.
Operating agreements can be general in nature or tailored to the needs and desires of the members. Most operating agreements contain or mention most of the issues covered in the Operating Agreements chapter. A few states do not require the operating agreement to be in writing. Only if the agreement is in writing can the actual intent of the members be ascertained with confidence.
Operating agreements are not set in concrete and, in fact, quite flexible. Members can change the operating agreements by simple amendments. The purpose of operating agreements is to establish procedures for daily administration and management of the company. As the company develops the operating agreement must be amended to meet new requirements.
As can be seen from the foregoing discussions, the steps for forming a business as an LLC are simple:
1. File the articles of organization,
2. Adopt the operating agreement, and
3. Issue the membership certificates.
Once these steps have been accomplished the LLC is formed and cancommence operations. An LLC is easier and less expensive to create than a corporation or a limited partnership provided ordinary caution and care are undertaken.
Members are the owners of the LLC. Usually an LLC must have two or more members. Texas alone permits a company to have only one member. Members own the membership certificates of the LLC and have the right to vote in the election of managing members. The extent of ownership interest a member has in the company is usually based either:
1.Upon a member's percentage of contribution to the total contribution of all the members,
2. Upon an equal division among all the members irrespective of contribution (per capita), or
3. Upon some other agreement between the members.
Members are not personally liable for the debts of the LLC beyond the extent of their investment in the LLC. Exception: A member is personally liable for a company debt or obligation if he personally guarantees repayment.
Members may agree for all members to manage the company or agree to elect a few members to manage, who will be called "managing members." In addition to electing any managing members, the members are required to vote on the following:
1. Amendment of the articles of organization,
2. Sale, option or lease of substantially all of the LLC's assets,
3. Merger or consolidation of the LLC with another LLC,
4. Amendment of the operating agreement,
5. Removal and replacement of managing members, and
6. Dissolution of the LLC.
The term "managing member" refers to all of the managing members. Managing members must be elected if the operating agreement does not reserve the management to all of the members. If managing members are elected, they alone are responsible for running the day-to-day business of the LLC. When the LLC is taxed as a corporation, the managing members are permitted reasonable compensation for their services. In small LLC's, the managing members usually serve for free to protect their investments. Caveat: The decision to have the LLC managed by elected managing members is an element of corporate existence. If the company also has free transferability of its shares or continuity of life, it will be taxed as a corporation and not as a partnership.
Most operating agreements for an LLC require an annual members' meeting to review business affairs and conduct. The members also will elect or re-elect the managing members for another year. Members are usually given votes proportional to their percentage of ownership in the company. A majority of those membership interests voting is needed to carry a resolution or any other matter brought to the floor.
A member has a duty of loyalty to the LLC. A member cannot usurp a company benefit that could go to the LLC. A member owes the LLC the right of first refusal on any business opportunity hediscovers that could affect the company. For example, if the company is in the paving business, a member could not form a competing paving business and solicit business from the LLC's existing clients. When a member has a personal interest on a matter before the board, the member is only allowed to vote on it when:
1. The member's interests has been fully disclosed to the board, and
2. The contract is just and reasonable.
A member cannot be sued by other members for losses incurred as a result of the member's actions or decisions provided they were reasonable and prudent. As agents of the LLC, members have the authority to bind the company by their actions. Members can execute contracts for the company and can subject the company to liability for damages arising from negligent or intentional acts they may commit on behalf of the company.
All of the states which permit LLC's hold that an assignment of a member's interest only passes financial right unless the operating agreement states otherwise. The assignee (person who acquired a member's interest in the company) only acquires the right to participate in the management of the company through a majority vote of the other members. Usually, a consensus is required.
This is important enough to repeat. The non-assigning members must agree to let the new member participate in the management unless the operating agreement states otherwise. This lack of fulltransferability of interest means interests do not have "free transferability." As a result, the value of the company is lessened and the company is assisted in obtaining tax treatment as a partnership.
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F. SECURITY LAWS
A membership interest in an LLC is a security just like stock in a corporation or interest in a limited partnership. Thus a membership certificate cannot be sold unless it is either registered or exempt from registration under both federal and state law. Registration for sale of a security under federal law costs thousands of dollars and takes months. Fortunately, there are several specific exemptions that a qualified LLC can use to avoid the federal registration requirement. Most small LLC's have at least one exemption available to avoid registration. The exemptions are:
1.The company is exempt under section 3(a)(1) of the Securities and Exchange Act. This is the most popular exemption for small companies. It is available where all the members reside in the same state where the LLC is incorporated and doing business.
2. The sale of the membership certificates is a non-public offering under section 4(2) to sophisticated investors and there was no public advertisement or solicitation for the membership certificates sale.
3. The sale complied with SEC Regulation D requirements byadhering to strict SEC disclosure regulations.
Once the requirements for claiming an exemption have been satisfied, then the LLC can issue its membership certificates without fear of violating federal security laws.
In addition to the federal registration requirement, all states have registration requirements for securities sold in their jurisdictions. Just as there are exemptions from the federal registration requirement, the 48 states that permit LLC's have exemptions. Usually, an LLC of less than 15 members can simply sell membership certificates and notify the secretary of state of the sale. An LLC using this exemption is generally not required to identify the members who purchased.
If a membership certificate is sold without complying with both federal and state exemption procedure, the sale is voidable at any time by the purchaser. If the company fails, the members could use the fact that no exemption was ever obtained to sue the organizer for their money. A California case provides an actual example of how security laws are applied. A limited partnership was sold to fund the drilling of an oil and gas well. At the time the legal exemption was for a maximum of five persons (it has since been increased to 35). The interests were sold to nine members. The well was drilled and was dry. Two of the investors sued to get their money claiming the sale was not exempt because more than five persons bought interests. The general partner faced criminal charges for selling an unlicensed security and had to refund the full investment money to all of the investors. If the sale hadbeen to only five persons, there would not have been a problem. The lesson to borne in mind is that it is not only necessary but critical to open both the state and federal security laws.
How an LLC will be taxed is the second most important concern, the first being the limited liability of members. Because an LLC has elements of both a corporation and partnership, it can, depending on the facts, be treated for tax purposes as either a corporation or a partnership. When the LLC is taxed as a partnership, its income is passed to its members and double taxation is avoided. On the other hand, when an LLC is taxed as a corporation, its income is taxed twice, first upon being earned and second when distributed to its members as dividends. It is almost always better for an LLC to be taxed as a partnership so as to avoid the double taxation.
Regardless of how a LLC is treated for tax purposes, be it as a partnership or as a corporation, the members of the LLC will not have personal liability for the debts of the company.
The IRS has developed a four-prong test for determining whether an LLC will be taxed as a corporation or a partnership. If an LLC possesses any three of the four following corporate characteristics, it will be taxed as a corporation and not as a partnership:
1.Limited Liability For Its Members. All LLC's will have this characteristic. It is to obtain limited liability for the members and the members elected to conductbusiness as an LLC.
2. Centralized Management. The states which permit LLC's allow the members to vest the management of the business in certain managing members. When this is done, the management of an LLC assumes the corporate characteristic of a board of directors.
3. Free Transferability of Interests. The right to sell, transfer or convey an interest in a business freely and without restrictions is a corporate characteristic. Such a right is similar to a person being able to sell his stock in a company. If the non-selling members must consent before the new member can participate in the management, then there is no free transferability, and this corporate characteristic would not be present.
4. Continuity of Life. The most important aspect of a corporation is its continuance after the death or withdrawal of one of its shareholders. A corporation, unlike a partnership, does not terminate upon the death of its shareholders. If an LLC is required under the terms of the operating agreement to remain in full effect until its termination date, and even after the death of a member, it will be considered to have the continuity-of-life characteristic of a corporation. If the remaining members must vote to continue the company life, this corporate characteristic does not exist.
When three of the four characteristics listed above are present,the LLC will be taxed as though it is a corporation. It does not make good sense to do business as an LLC unless the company will be treated as a partnership for federal tax purposes.
Another tax concern of an LLC is how its property will be treated for tax purposes. Property which is titled in the LLC name is owned by the LLC, not the individual members. The same is true for property contributed to a corporation or a partnership. A member who contributes property to an LLC relinquishes ownership in the property, and property purchased with LLC funds is owned by the LLC. This company ownership of the property means that creditors of members cannot attach the property. They are limited to attaching the member's interest in the LLC. The property held by an LLC can be legally sold, transferred or conveyed only by the company. The LLC's basis in the contributed property is the basis that the member had before it was contributed.
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An LLC is a legal entity, but because it is an artificial entity, it needs an individual to file any lawsuit on its behalf. When the company is managed by all the members, a suit can be brought by a member only after a majority vote of approval by the members. An exception to the majority vote approval requirement for filing a suit may exist where there is a conflict of interest among the members or members are breaching their fiduciary duties. The non-agreeing members would be excluded from the voting, and only the votes of the disinterested members would be considered. If thesuit is commenced, and it is later found that the members whose votes were ignored were not in violation of their fiduciary duties and had no conflict of interest, the persons bringing the suit might be held personally responsible for any damages caused by virtue of the suit.
When a suit is brought by virtue of a majority vote of approval by all members, no member will be personally liable for any damages that might result to the company. When the company is being managed by managing members, it is the managing members who have the authority to file suit on behalf of the company. A manager is bound by the fiduciary standard of care of a reasonable and prudent manager in making a decision about commencement of a lawsuit.
Liability attaches to a member who brings unauthorized or improvident suit that violates the fiduciary standard of care. Should a member act without the approval of the other members to file suit, the company would nonetheless be bound by the decision or settlement. The company may sue a member for any damages which the company suffered by virtue of the member bringing an unauthorized suit or settling one improperly.
As part of the legal series, a book on limited liability companies has also been written.
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NORTH AMERICAN FREE TRADE AGREEMENT
The North American Free Trade agreement (NAFTA) is the most important and expansive trade agreement ever created. The signatories of NAFTA are Canada, Mexico and The United States. Several Central American countries have expressed interest in joining NAFTA as well. NAFTA is the largest free trade zone in the world. NAFTA creates a single $6.5 trillion market with 370 million persons. The primary aspect of NAFTA is its tariff elimination feature. Prior to the enactment of NAFTA Mexican import tariffs were 2.5 times greater on American and Canadian goods than the import tariffs charged by the U.S. or Canada on Mexican goods. Nearly all tariffs on Canadian, Mexican, and American goods are scheduled to be slowly eliminated within 10 years.
NAFTA is in many ways a continuation of the 1988 Canada-United States Free Trade Agreement (CFTA). As a result of the enactment of the CFTA, trade between Canada and the United States experienced unprecedented growth. Both Canada and the United States prospered as a result of the increased trade to an extent that exceeded expectations. Canadian trade in 1992 accounted for 1.5 million U.S. jobs. It was the success of CFTA that prompted Canada and the United States to approach Mexico with the idea of creating asimilar program for all of North America.
Mexico, after decades of isolationism, was receptive to the idea of a North American free trade zone. Until 1986 Mexico's markets had essentially been closed to foreigners. As a result, the Mexican economy had stagnated. In 1986, Mexico had eased some of its restrictions to foreign investment and opened many of its markets. The result was an immediate success. The year Mexico opened its markets (1986) U.S. trade with Mexico was $17.8 billion. In 1992, U.S. trade to Mexico had increased to $40.6 billion, an increase of 228%. Mexico is the U.S.'s second largest market for manufactured goods, much larger than Japan. U.S. trade to Mexico in 1986 supported nearly 700,000 jobs scattered throughout the United States. NAFTA is projected to create another 200,000 U.S. jobs in its first year. Mexico was the third largest trading partner of the United States even before NAFTA. The per capita income for the average Mexican is relatively low compared to a U.S. citizen, but there are over 90 million Mexicans. The purchasing power is impressive.
NAFTA coverage will extend to products and goods originating in North America (Canada, America or Mexico) or goods and products that contain nonregional materials that have been transformed to such an extent by the manufacturing process that they are now considered as originating in North America. There is a de minimis rule for many products that permits as much as 7% of a product to contain non-North American materials without substantial modification.
Special treatment under NAFTA is afforded automotive goods. Tariffs on passenger cars, light trucks and other vehicles and parts are to be slowly eliminated, usually in five years but not more than 10. Cars and trucks must have at least 62.5% North American content (be composed of North American originating materials). Other vehicles and parts must have a 60% content. Mexico has agreed to end its Auto and Auto-Transportation decrees that impose production and sales restrictions by 2004. In 2009 Mexico will begin a 10-year elimination of its imports of North American used vehicles. Estimates for the U.S. automobile industry predict that for the first year NAFTA sales will rise from less than 2,000 vehicles to over 60,000 vehicles.
Most tariffs on textiles and apparel were eliminated immediately upon enactment of NAFTA with the remainder to disappear by 2004. Most U.S. quotas on Mexican textiles and apparel were eliminated on those goods that meet NAFTA's rules of origin (met the required percentage of North American origin).
Broadly speaking, a free trade zone in North America will remove or gradually reduce barriers to trade and permit a more profitable growth of trade between all of the members. Established economic policies of free trade increase efficiency in trade and lead to increased trade and overall improvement in economic well-being. Most economists have predicted that NAFTA will generate a discernible increase in U.S. jobs. The Institute for International Economics predicts a net gain of 170,000 jobs by 1995 with 316,000 new jobs against a loss of 145,000 jobs.
The average Mexican purchases more U.S. imports than the average person in the European community or Japan. Seventy cents of every dollar a Mexican spends on foreign products is spent for a U.S. product. In 1992, the average Mexican spent $450 on U.S. produced products. In contrast, the average Japanese individual only spent $385 on U.S. products. Mexico is the second largest market for U.S. tele-communications exports in the world, which increased 20% between 1991 and 1992.
NAFTA will have both its good points and its bad points. Personal feeling on NAFTA will depend on how it affects the individual on a personal basis. The International Trade Commission has estimated that the U.S.'s horticultural, tuna, apparel, construction and household glassware industries are to be the most adversely affected by NAFTA. In contrast, the greatest gains are estimated in U.S. agricultural and capital goods. Capital goods are goods used in the production of other goods: industrial buildings, machinery, equipment, highways, office buildings, government installations. These goods form a nation's productive capacity.
Capital goods have been the slowest increasing export category of U.S. exports between 1988 and 1993. Capital goods remain the largest single export item to Mexico but the percentage has been dropping. In 1987, the percentage of total U.S. capital goods exported to Mexico was 40%. In 1992, this percentage reduced to 33%. The percentage is misleading to an extent because overall trade with Mexico during this period increased by 228%. So the netcash value of capital exports to Mexico was nearly twice what it had been in 1987. Capital goods account for 40% of all U.S. exports to developing countries and 39% of all U.S. exports in total. The exports of capital goods to Mexico support major employment in high paying U.S. jobs and will continue to do so for many years to come.
Prior to NAFTA, Canada had little trade with Mexico. Canada's reason for joining NAFTA was to assure that it did not lose benefits from its existing free trade agreement with the United States. Canada also recognized the possible advantage that might accrue from having the sizeable Mexican market opened to it. Generally, the tariff reduction schedule established under CFTA remains in force for trade between the U.S. and Canada at lower rates than most of the NAFTA schedules. The result is that most goods traded between Canada and the U.S. are very nearly tariff free whereas goods traded to and from Mexico will still in many cases be subject to tariffs for the next five or 10 years. Canada and the U.S. still have a slight incentive over the next few years to trade between themselves rather than with Mexico until all tariffs are eliminated.
It has been asserted that NAFTA is the best prospect for reducing illegal immigration from Mexico to the United States. A study on the economic impact of illegal immigration was performed in 1991 by Robinson and Hinojosa-Ojeda of the University of California. The report concluded that free trade coupled with internal reforms could reduce immigration (both legal and illegal)by 260,000 to 1.1 million people by the year 2000. Another study by William Spriggs of the Economic Policy Institute (an opponent to NAFTA) concluded that NAFTA would result in 1.4 million fewer Mexicans migrating to the U.S. by the year 2000. It has also been concluded that a reduction of illegal migration to the U.S. will result in the real wages of U.S. residents increasing as much as 6%. NAFTA does not interfere with a member's right to set its own environmental, health or safety standards. Nonetheless, NAFTA requires each country to make laws and set standards compatible with the other two. Supplemental agreements on environmental issues require that each country actively enforce its environmental laws equally and without discrimination against persons or entities from the other NAFTA members.
Commissions are to be established to settle disputes when a government does not enforce its laws with the result that investors, persons or businesses from the other NAFTA countries are placed in a competitive disadvantage. If for a period of time the nonenforcement of the law continues, trade sanctions may be imposed under NAFTA against the offending country. The United States reserves the right to enforce its own trade laws, and if NAFTA is not operating for the benefit of U.S. workers and businesses, the U.S. may withdraw from NAFTA at any time after six months notice.
An argument against NAFTA often heard is that U.S. companies will abandon the U.S. and relocate in Mexico. While this will undoubtedly occur in some glaring instances, it will not be the rule. Even before NAFTA, Mexico permitted regulated foreigninvestment. In addition, there is the maquiladora program that permits American companies to open plants directly across the border and have the finished products shipped to the U.S. tariff free. Despite this fact, only a few foreign companies have opened plants in Mexico and the U.S. is not being overcome with imports from such plants. In fact, the opposite has occurred: U.S. exports from highly paid U.S. workers have flooded Mexico. The economic message is that low wages alone do not guarantee success. Quality of the work and high productivity are more important than low wages alone.
The text of NAFTA may be obtained by calling the U.S. Printing Office at (202) 783-3238 or by fax at (202) 512-2250. Payment for the order may be made by credit card using VISA or Mastercard. Documents can also be ordered by mail sent to:
Superintendent of Documents
U.S. Government Printing Office
Washington, D.C. 40402
The prices for the NAFTA publications are:
TEXT OF NAFTA (volumes 1 and 2) 041-001-00376-2 $41.00
TARIFF SCHEDULES (ANNEX 302.2):
UNITED STATES 041-001-00377-1 $34.00
MEXICO 041-001-00391-6 $34.00
CANADA 041-001-00390-8 $30.00
SUPPLEMENTAL AGREEMENTS 041-001-00411-4 $ 6.50
The tariff schedules are the most important NAFTA books. These schedules list the tariff rate that each party imposes on the imported goods from each of the other members and the tariff elimination schedules.
The greatest practical impediment to trade between countries is the paperwork which exporters must prepare in order to sell their product. The cumbersome nature of the paperwork and long delays in delivery that result from any small technical mistake has caused manufacturers to decide not to export their product. The main reason behind the paperwork is so that the importing country can collect tariffs. As tariffs are eliminated, the need for such paperwork is, itself, gradually eliminated. Towards this end, NAFTA has up customs procedures to reflect the gradually reducing tariffs and thus less paperwork as well.
NAFTA concerns increasing trade between Canada, Mexico and the United States. For that reason, it is important for a procedure to be adopted to determine what is the country of origin for products exported between the countries. Without a viable system to determine truth of origin, non-NAFTA countries can ship their product through one NAFTA country to another in order to avoid import duties.
NAFTA adopted the origin rule of the 1988 Canada-U.S. Free Trade Agreement (CFTA) as its standard. To be covered by NAFTA, exported goods must have undergone processing in North America. Many foreign corporations have significant investments in NAFTA countries. It is hoped these foreign corporations will increase their operations in Canada, Mexico and the United States to qualify for the NAFTA tariff reductions.
I. CERTIFICATE OF ORIGIN
NAFTA creates a uniform certificate of origin for use by NAFTA countries. The Certificate of Origin can be obtained from many stationary stores and from the U.S. Custom Service. The exporter of a product seeking NAFTA tariff reduction must state in the certificate of origin that the product qualifies as an "originating good." An originating good is one that qualifies under NAFTA as a product possessing the required North American content. NAFTA does not require certificates of origin when the value of the exported good does not exceed $1,000. Importers who seek to claim tariff reductions on imported goods under NAFTA must declare the imports qualify as originating goods. The importer's declaration must be based on the exporter's certificate of origin. An importer has one year to seek refund for any excess tariff that was erroneously paid on qualified original goods. For example, assume that a product qualifies for a 10% reduction in tariffs, but the importer mistakenly pays full tariff. The importer can seek a refund for the 10% overpayment within one year of the overpayment.
False statements on a certificate of origin will subject the exporter to the same civil and criminal penalties as an importer who makes false statements to avoid tariff duties. An exporter who voluntarily corrects a false certificate will not be subject topenalties for the false statement.
II. PRODUCT TRACING
NAFTA imposes upon both exporters and importers the burden of having to maintain records for five years on products that were issued certificates of origin and received reduced tariffs. NAFTA requires that the parties keep records on:
1. The cost of the product exported.
2. The value of the product exported (its finished price).
3. Materials used for the products construction (including the source of the materials and their cost).
4. The cost of assembly of non-NAFTA materials.
5. The payment for the product.
The purpose of requiring the maintenance of these records is to assure that goods for which tariff reductions were given did, in fact, qualify for the reductions. The documentation requirement imposes a greater burden on smaller companies than larger companies. Small companies do not usually maintain such detailed records. Revamping their records policy to maintain such comprehensive records will be difficult. When the tariff savings involved are relatively low, the expense in maintaining these records may exceed the amount actually saved. In such an event, the importer may simply decide to pay the full tariff rather than be bound by unprofitable record keeping.
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IV. COUNTRY OF ORIGIN RULE
NAFTA Article 401 determines what exports are covered byNAFTA. Article 401 states:
A good shall originate in the territory of a party where:
(a) The good is wholly obtained or produced entirely in the territory of one or more of the parties;
(b) Each of the nonoriginating materials used in the production of the good undergoes an applicable change in tariff classification set out in Annex 401 as a result of production occurring entirely in the territory of one or more of the parties, or the good otherwise satisfies the applicable requirements of that Annex where no change in tariff classification is required, and the good satisfies all other applicable requirements of this chapter;
(c) The good is produced entirely in the territory of one or more of the parties exclusively from originating materials; or
(d) The good is produced entirely in the territory of one or more of the parties but one or more of the nonoriginating materials provided for as parts under the Harmonized System that are used in the production of the good do not undergo a change in tariff classification because:
(i) The good was imported into the territory of a party in an unassembled or a disassembled form but was classified as an assembled good pursuant to General Rule of Interpretation 2(a) of the Harmonized System, or
(ii) The heading for the good provides for and specifically describes both the good itself and its parts and is not further subdivided into subheadings, or the subheading for the good provides for and specifically describes both the good itself and its parts, provided that the regional value content of the good, determined in accordance with Article 402, is not less than 60 percent where the transaction method is used or is not less than 50 percent where the new cost method is used.
Goods exported from a NAFTA country to another NAFTA country will be covered by the tariff elimination schedule of NAFTA if:
1. The goods were completely manufactured or produced in a NAFTA country from materials that derived entirely from a NAFTA country, or
2. The goods contain non-NAFTA derived parts which weresignificantly changed as a result of production in a NAFTA country, or
3. The goods contain non-NAFTA parts and their assembly into the final product accounted for 60% of the value of the finished product, or
4. The good contains non-NAFTA parts or materials the cost of which do not exceed 7% of the value of the finished products.
V. TARIFF CLASSIFICATION CHANGES
Annex 401.1 describes the tariff changes required to grant North American origin to goods containing non-NAFTA components. Annex 401.1 tariff category listings also state what the manufacturer must do to meet the NAFTA tariff elimination requirement. NAFTA differs from previous tariff treaties in that it does not require a specific percentage of the product value to be derived from the country claiming the tariff reduction. Under the Generalized System of Preference (GSP), 35% of the value of the product must be derived from work or materials provided by the GSP country seeking the tariff reduction.
Article 402 of NAFTA establishes two methods for determining the North American content of the finished products exported between NAFTA countries. Article 402 reads in pertinent part:
1. Each party shall provide that an exporter or producer may calculate the regional value content of a good on the basis of the following transaction value method:
RVC = TV-VNM
where RVC is the regional value content expressed asa percentage.
where TV is the transaction value of the good adjusted to a F.O.B. basis; and
where VNM is the value of nonoriginating materials used by the producer in the production of the good.
Under the transaction value test, the North American content of exported goods between NAFTA countries is determined by subtracting the price paid for non-NAFTA materials used in the products construction from the price of the finished product.
Under the net cost test, the price paid for the non-NAFTA materials used in the product are subtracted from the net cost of manufacturer of the product. The manufacturer is entitled to use either of the above tests in determining whether the product meets the North American origin standard. If the product passes either test, it qualifies for coverage under NAFTA.
VI. AUTOMOTIVE RULES
The importance of the automobile industry to the economies of Canada, Mexico and the United States has resulted in special rules for automotive products. NAFTA Section 403 establishes special origin requirements. Under Article 403, the net cost test is used to determine if the North American origin requirement is satisfied. NAFTA requires that automobiles, light trucks and engines must have new cost basis of 56% starting in 1998 that increases to 62.5% in 2002. For other vehicles and automotive parts the percentages are 55% and 60% respectively. The percentage of North American content is higher than the percentage under CFTA. Under CFTA, the local content was only 50%. The higher limits under NAFTA will nowcontrol automotive imports between Canada and the U.S.
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VIII. EXPORT INFORMATION
To provide assistance to exporters, the government of Mexico, the United States Department of Commerce and the United States Customs Service have instituted several phone services for the dispersement of information. These phone numbers are:
A. UNITED STATES DEPARTMENT OF COMMERCE
1. Office of Mexico (202) 482-0300
2. Office of Mexico, "FLASH FACTS"
Information Line (202) 482-4464
3. Office of Canada (202) 482-3103
4. Office of Canada, "FLASH FACTS"
Information Line (202) 482-3101
5. Office of Textile and Apparel,
Martin Walsh (202) 482-3400
6. Industrial Trade Staff (202) 482-3703
B. UNITED STATES CUSTOMS SERVICE
1. NAFTA HELP DESK (202) 692-0066 2. NAFTA HELP DESK, "FLASH DESK"
Information Line (202) 692-1692
C. MEXICAN GOVERNMENT
1. NAFTA Hotline (011-525) 211-3545
2. FAXLINE (011-525) 256-4737
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GUARDING AGAINST EMPLOYMENT PROBLEMS
From the moment a person in business decides to hire employees, life will never the same. The social engineers have succeeded in passing employment laws that impose onerous and often ridiculous hiring restrictions. The result is that employers can find themselves totally at the mercy of unscrupulous employees or prospective job applicants who file frivolous employment complaints. In addition, the regulatory agencies almost always side with the employees or prospective employees regarding such complaints.
A national television news show devoted an entire program to an example of this plight during the 1992 Presidential campaign. A small employer in Illinois with about 50 employees was charged by the federal government's Equal Employment Opportunity Commission with discrimination against a black woman because she had not been hired. The employer's business was located in a primarily Hispanic part of town. All of the employees were minorities. The only Caucasian was the boss. The number of employees had varied in the past. Many employees would come and go. The employer had other black employees. The Equal Employment Opportunity Commission concluded that, given the demographics of the area, the employer should have had more black employees and ordered him to pay a fine of nearly $100,000. There was no proof of discrimination: only the imposition of the demographic study that the agency claimed was nota quota requirement. The show interviewed former black employees who all stated that they had never in any way felt discrimination or been treated unfairly. The employer offered the woman a job, but she refused, choosing instead to receive the agency's award of lost pay for not being hired. The case is on appeal. Regardless of the outcome, this highlights the concern that an employer should have when hiring employees.
In our society a terminated employee or an unsuccessful job applicant has nothing to lose by filing a false complaint alleging discrimination. Most complaints are not required to be verified. Outlandish claims can be made. In fact, there are some people who deliberately apply for a job with the hope of being rejected so they can file a discrimination suit. After the suit is filed, the person offers to settle for an amount considerably less than the employer would have to spend defending himself against the worthless complaint.
Employment law is not and has never been settled. Each state and the federal government has its own laws regulating employment relations. A corporation operating plants in several states will have unique problems. Such corporations must be careful to obey all state laws. They must be careful not to give unequal treatment to their employees in the different states because of differing state laws.
The penalties for violating labor laws can be astounding. In a case involving sex discrimination, an insurance carrier recently paid more than $250,000,000 in settlements. Given the fact thatcourts can go back years and make awards for hundreds of people regarding past conduct, it becomes absolutely imperative that an employer know, understand and follow the law. Ignorance and good faith mistakes are just not sufficient defenses to violations of employment laws.
This chapter is designed to instruct an individual in how best to hire competent, professional and decent employees without violating state or federal law. This chapter touches upon the major considerations of employment law. An employer should have, at the least, cursory knowledge of them.
I. NON-DISCRIMINATORY QUESTIONS THAT AN EMPLOYER MAY ASK
An employer has the right to establish job-related requirements and to seek the most qualified person for a job. The employer is permitted to ask questions and obtain certain personal information to be used in making the employment selection and the job assignment decisions. The tests for the appropriateness of a certain question are whether they will result in the disproportionate elimination of members of a protected group, or are they a valid predictor of successful job performance.
Despite the above, an employer is prohibited from making any non-job related inquiry which may directly or indirectly limit a person's employment opportunities because of race, color, religion, national ancestry, physical handicap, marital status, sex or (for adults) age.
An employer is not permitted to ask a woman her maiden name. Such information is considered irrelevant to job performance andan unnecessary intrusion into her privacy. Asking such questions may tend to stigmatize an unmarried woman or perpetuate stereotypes that a single woman may get married and quit while a married woman is a more stable employee. Appropriate questions that can be asked instead are, "Have you ever used another name?" or "Is any additional information relative to a change of name, use of an assumed name, or nickname necessary to enable a check on your work or educational record? If so, please explain."
The employer is permitted to ask the applicant for his place of residence. Such information is necessary for the ordinary operation of the business. The employer has a legitimate reason for wanting that information so he can contact the individual when necessary. He also needs it to maintain required tax and governmental records.
The employer has no valid business reason for asking whether an applicant owns or rents a home. Such a question may have the effect of discriminating against a job applicant who is a renter because the employer may feel that a person owning a home would be less willing or able to relocate if a better job comes along. An employer may incorrectly view a person owning a home as being more stable and reliable than a renting employee.
There are conflicting laws regarding the questions that an employer may ask a job applicant regarding citizenship and birthplace. It is illegal to discriminate against a person because of citizenship or national origin; yet it is equally illegal to hire an illegal alien. The problems facing an employer hiringaliens and the necessary compliance provisions are such that an employer doing so should be careful to assure the applicant is legally permitted to work in America. An employer should never ask an employee the following questions or ask him to provide proof of the following:
1.Are you a citizen?
2.What is the citizenship of your spouse, parents, brothers, sisters, uncles or aunts?
3. Where were you, your parents and spouse born?
An employer may not require the applicant to provide proof of naturalization, a green card or work permit prior to the decision to offer the person a job. An employer may ask the following question, "Can you, after employment, submit verification of your legal right to work in the U.S.?" An employer may make a statement that proof of the right to work in the United States may be required after a decision is made to hire the applicant.
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The employer is permitted to ask an applicant the name of the person who referred the applicant for the position. The employer may also request the names of persons willing to provide professional or character references on the applicant. An employer may ask an applicant to furnish the name and address of a person to be notified in the case of an accident or emergency. Such information serves a legitimate business purpose. The employer is not permitted in California to ask the name, address and relationship of a relative to be notified in case of an accident or emergency. From this information may be inferred other information of marital status or national origin that is otherwise improper and irrelevant for job performance. For example, if a parent is listed as the relative to be contacted, the applicant's ethnic background might be determined from that parent's name.
II. AGE DISCRIMINATION
Age discrimination is the firing or hiring of employees based solely upon age. In 1967 Congress passed the American Discrimination in Employment Act (ADEA) to fight age discrimination. Under this Act an employer cannot discriminate in the hiring, firing or promotion of employees between 40 and 65 years of age. In 1978 ADEA was extended to most employees up to 70 years of age with the following exceptions:
1. Executive or high-policy making employees.
2. College or university employees.
3. Bona fide occupational qualifications, such asairline pilots retiring at 60 years of age.
There have been significant and well publicized cases in the last few years whereby employees who were discharged because of their age have recovered huge awards in court.
Age discrimination is against both state and federal law. Yet some jobs may legally have age limitations. Examples: Airline pilots who must retire at age 60 or a bartender in a state where the legal age to drink is 21. Age questions that are illegal or dubious and should be avoided are as follows:
1. What is your age?
2. What is your birthdate?
3. What are the dates of attendance or completion of elementary or high school?
4. General questions that are designed or tend to identify applicants as being over 40 years of age.
Questions that have been held not to promote age discrimination are:
1. If hired can you show proof of age?
2. Are you over eighteen years of age?
3. If under eighteen, can you, after employment, submit a work permit?
An employer may make a statement that employment is subject to verification that applicant meets legal age requirement. Age discrimination for a job is permitted when the type of job requires exceptionally good health. Where the risk to the public increases as the employee ages, the validity for an age limit for employmentor for mandatory retirement also increases. Federal courts have upheld the mandatory retirement of airline pilots at 60 years of age by recognizing that pilots of that age have more strokes and heart attacks than younger pilots. A pilot having a heart attack may result in a plane crash.
III. EQUAL PAY FOR EQUAL WORK
The Federal Equal Pay Act (FEPA) applies to nearly all employers in the United States (Congress exempted itself). Under this act, employers must pay the same amount to men and women working under similar conditions doing jobs that require similar skill, effort and responsibility. Under FEPA salary differentials based upon non-sex reasons such as seniority or work performance are still permissible. Job titles are not dispositive in determining if the work done by men and women are similar. The actual duties need not be identical but they must be substantially equal in order for FEPA to apply.
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V. DISMISSAL FOR ALCOHOLISM
Alcoholism is not considered a handicap under the Federal Rehabilitation Act or in most states. Therefore, in most states it is permissible to fire an alcoholic employee. The reason used for the firing, although work product is not affected, is the anticipated future medical expenses expected to be caused by the alcoholism.
A few states, such as New York, have laws that prevent anemployee from being fired for alcoholism unless the employee is unable to safely and properly perform his duties. A person fired or adversely treated by an employer because of alcoholism can get information about his rights from the National Council of Alcoholism at 733 Third Avenue, New York, New York 10017.
VI. SEXUAL HARASSMENT
The Equal Employment Opportunity Commission states that sexual harassment pertains to either physical or verbal conduct and exists when:
1. Submission to the conduct is made either explicitly or implicitly a condition of employment.
2. Submission to or rejection of the condition is used as a basis for employment decisions affecting the individual.
3. The conduct substantially interferes with an individual's work or creates an offensive work environment.
If an employer is informed of sexual harassment and does not take sufficient corrective action, he can be sued in federal court or a complaint can be filed with the EEOC. The employer is responsible for the elimination of sexual harassment of employees at work under both state and federal law.
A woman or man can sexually harass, and the harassment does not require overt contact. There are many lawsuits in which women have sued other women for creating a hostile work environment. Women have claimed that the harassing women have caused them severe emotional distress by explicit sexual or profane language. TheNinth Circuit Court of Appeals (West Coast, U.S.A.) has held that the test to determine if conduct is harassment is the "reasonable woman" standard: if a "reasonable woman" would be offended, it is harassment even if the average reasonable man would not consider it harassment.
VII. WORKERS' COMPENSATION
Workers' Compensation is a state-sponsored program involving employer participation (usually mandatory) that ensures all employees against injuries on the job. The program provides cash benefits and medical care for workers who become disabled through injury or sickness related to their job. If death results from the job related injury, benefits are paid to the surviving spouse and dependents. The program has a "down side": injured employees are barred from suing their employers for the injuries suffered on the job. An injured worker is not precluded from suing third parties, only from suing the employer.
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XI. CIVIL RIGHTS ACT OF 1991
The Civil Rights Act of 1991 pertains to discrimination in employment. The key provisions of the act permit:
1. Compensatory and punitive damages against an employer for victims of intentional discrimination based on sex, religion, disability, race or natural origin. Damages are capped based on the size of the employer.
2. Jury trials in cases involving compensatory and punitive damages.
3. An easier burden of proof for the plaintiff.
4. An expansion of existing law to cover racial harassment on the job and discharge based on discrimination.
Under the Civil Rights Act of 1991 the Rehabilitation Act and the American with Disabilities Act were amended to permit victims of intentional discrimination on the basis of sex, disability or religion to sue for compensatory or punitive damages. Victims of racial discrimination were already permitted to sue for such damages under Title 42 U.S.C. Section 1981. Recovery of damages is not permitted in cases of unintentional discrimination caused by the impact of neutral employment practices.
Plaintiffs may recover both compensatory and punitive damages for violations of the Civil Rights Act of 1991. Punitive damages, however, are not recoverable from a government agency or political subdivision. It must be proven that the employer acted with malice or reckless disregard of the employee's civil rights to win punitive damages. Recovery for both compensatory (future pecuniary losses, pain and suffering, etc.) and punitive damages is limited by the size of the employer:
MAXIMUM RECOVERY NUMBER OF EMPLOYEES
$ 50,000 15-100
$300,000 501 or more
There is no limit on compensatory damages for past pecuniary losses, nor are damages suffered as a result of racialdiscrimination limited under Title 42 U.S.C. 1981.
As strange as it seems, prior to the Civil Rights Act of 1991, while it was unlawful to discriminate on the basis of race in hiring and promotions, it was not unlawful to harass an employee based on race. The United States Supreme Court had held that previous civil rights laws did not protect workers from racial discrimination on the job.
The 1991 Civil Rights Act now permits claims for racial discrimination in preparation, performance, modification and termination of employment contracts as well as discrimination in the enjoyment of all benefits, privileges, terms and conditions of the contractual relationship. In short, an employer is no longer permitted to harass employees because of their race.
The 1991 Civil Rights Act makes it easier for an employee to maintain a legal action for an alleged civil rights violation in employment. Once an employee demonstrates that a particular practice by an employer causes a disparate impact on minorities and women, the burden of proof shifts to the employer to justify the practice. The employer is required to show that the challenged practice is job related for the position in question and consistent with business necessity. The employee may also prove unlawful disparate impact by showing that a less discriminatory alternative is available and the employer refuses to adopt it.
Prior to the 1991 Civil Rights Act, many employers, specifically governmental agencies, routinely adjusted upward theemployment test scores for minorities. This procedure was called gender or race norming. Supposedly these practices were intended to adjust for the fact that women and minorities were not exposed to the educational system to the extent of white males. Had they been, according to the theory, they would have actually achieved these higher scores. The Civil Rights Act now prohibits race and gender norming. In December 1991 the federal government prohibited state employment agencies from increasing the scores of minority applicants on federally sanctioned aptitude tests.
Mixed motive discrimination exists when an employer acts, at least in part, for a discriminatory reason but proves that it would have reached the same decision based on non-discriminatory reasons. When the employer shows he would have done the same for non-discriminatory reasons, the court may prohibit the employer from considering the discrimination motive in the future and award declaratory relief, attorney fees and costs. The employee still may not recover damages, reinstatement or promotion.
Prior to the 1991 Civil Rights Act, plaintiffs alleging age discrimination had two years from the alleged discriminatory act (three years for willful discrimination) to file a lawsuit. The time was tolled for one year if the EEOC attempted to get voluntary compliance. Previously persons claiming racial discrimination under the 1964 Civil Rights Act had 90 days to file a lawsuit after receiving a letter from the EEOC notifying of a "right to sue." The Act amends the Age Discrimination in Employment Act (ADEA). The EEOC is now required to notify the complainant upon termination ofthe complaint proceedings. Then the complainant has 90 days to file suit.
Prior to the 1991 Civil Rights Act, plaintiffs could not recover the fees expended for expert witnesses over $40. This made getting a recovery in many cases worthless because it was expended on expert witness fees. Cases went to trial without experts because of the costs involved. The 1991 Civil Rights Act now awards the plaintiff expert witness fees if the plaintiff prevails.
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XIV. HANDICAP DISCRIMINATION
The Federal Rehabilitation Act states:
"No otherwise qualified handicapped individual shall, solely by reason of his handicap, be excluded from participation in, be denied the benefits of, or be subjected to discrimination under any activity receiving federal financial assistance."
Under this Act, a handicapped person is any person who has or has had a physical or mental impairment that substantially limits major life activity. Persons with serious illnesses or diseases, such as heart disease and cancer, are considered handicapped. The act applies to any employer receiving federal financial assistance or any employer having federal contracts of over $2,500. Most states also have laws similar to the Federal Rehabilitation Act that preclude discrimination based solely upon a person's handicap.
A handicapped person is any person who was born with or has acquired a physical or mental impairment, has a record of such impairment, or is regarded as having such an impairment, which limits one or more major life activities, such as self-care,performing manual tasks, seeing, hearing, speaking, breathing, and working on a temporary or permanent basis. A physical or mental impairment is any physical disorder, disfigurement, or anatomical loss or limitation of movement, or any mental or psychological disorder acquired as a result of illness, accident or birth.
Under both federal and California law, AIDS is classified as a physical handicap. It is unlawful for an employer to discriminate in employment regarding persons afflicted with AIDS. An employer may not ask an applicant questions that may disclose the AIDS affliction. A physical examination for the job may be required which may disclose the AIDS infection. The law is still being developed in AIDS discrimination. In California as long as the person can perform the job, and the job does not involve food preparation or handling, the employer is not permitted to discriminate because of the presence of the HIV virus. If the applicant has already begun to have medical problems associated with AIDS, the employer may refuse to hire him. It is still legal to refuse to hire a sick person who may not reasonably be able to do the job or will immediately incur substantial medical treatment.
The Rehabilitation Act was implemented under Title VII of the Civil Rights Act. The Rehabilitation Act contains three main provisions in Title VII which apply to recipients of federal financial assistance, federal contractors and the federal government, sections 501, 503 and 504 respectively. Under section 504 an employer involved with the federal government by virtue of a contract or grant must not discriminate. Regulations promulgatedunder section 504 prohibit an employer who receives federal funds from discriminating against handicapped individuals while the employer is involved in recruiting, advertising, processing applications, hiring, tenure, promotion, transfer, layoffs, fringe benefits, or any other aspect of employment. Coverage under this act pertains only to employers with 15 or more employees.
In order to determine whether an employer has met the requirements to accommodate a handicapped person's disability reasonably, the following elements should be examined:
1. Whether or not the requirements for all positions in which the handicapped person may be hired, promoted, etc. are legitimate, necessary, equitable and reasonable.
2. Whether or not the requirements are equally applied.
3. What specific accommodations would be necessary to enable the handicapped person to perform the tasks.
4. What the impact is on the organization in terms of cost or business necessity.
Reasonable accommodation is determined on a case-by-case basis after giving consideration to all of the above factors. The United States Supreme Court has held that an employer is not required under federal law to make substantial or major adjustments to its employment programs in order to allow a handicapped person to participate. If the handicapped person could not reasonably be expected to perform the tasks required to be performed by a typical graduate of the program, the employer is not required to let the handicapped person participate in the program. An"otherwise qualified handicapped person" is someone who is able to meet the program requirements including relevant physical qualifications despite the handicap. While meaningful access to the program must be available to all handicapped persons, the employer is not required to make such substantial changes in the program that the fundamental purpose of the program will be significantly altered or defeated.
XV. THE AMERICANS WITH DISABILITIES ACT
The Americans With Disabilities Act (AMDA) was a new federal law enacted in 1992. As of July 26,1992 it applies to all employers with 25 or more employees. In 1994 this act will cover all employers with over 15 employees. The Act requires employers to make reasonable accommodations for disabled employees, both in the hiring process and the workplace.
Under the Americans With Disabilities Act a person who has a substantial physical or mental impairment is disabled. Under AMDA a substantial impairment is one that significantly impairs or restricts a major life activity such as hearing, seeing, speaking, breathing, walking, performing manual tasks, caring for oneself or learning. An individual with a disability still must be qualified to perform the essential function of the job with or without reasonable accommodation in order to be covered by this act and protected from discrimination.
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PART II AFTER RETIREMENT OR DISABILITY
Part II of this book pertains to the problems and concerns faced by a person approaching retirement or becoming unable to work as a result of a disability. Part II is divided into four chapters:
1. Social Security. This chapter covers the history of Social Security, its purpose, the basic coverage and application procedure.
2. Supplemental Security Income. This chapter, as with the Social Security chapter, covers the procedure in which an eligible person (usually of retirement age or disabled) may apply for additional income from the Social Security Administration.
3. Disability. This chapter discusses the Social Security disability benefits available to a worker. It is important that a disabled worker be aware of the existence of such disability benefits in addition to any benefits under a state's Workers' Compensation.
4. Medicare. This chapter deals with the benefits available under the Medicare program. This program is one of the largest and most important social programs run by the government. It provides the basic medical coverage for most of the elderly and retired persons in America. It is important to have an understanding of such an important program when engaged in financial planning.
Social Security is one of the first universal social programs implemented in the United States. It was created during the depression to provide for old and disabled workers who could no longer care for themselves. Social Security has developed from a supplemental source of income to the sole source of income for many retired persons. Social Security is funded by taxes on workers. The Social Security taxes collected are used to pay the benefits for those receiving Social Security payments. When Social Security was first created, the average life expectancy was 65 years of age. Today the average life expectancy is 72 years of age for men and 77 years of age for women. When Social Security was first implemented, it was never envisioned that huge numbers of workers would be receiving benefits into their seventies and later. Typically in the 1930's, only one of all four grandparents lived long enough to collect Social Security and he collected for only a few months before dying. This was really how the program was intended to work.
There is a great deal of concern today that the Social Security fund is insolvent. Certainly it was never intended to run the way it is now. When established, Social Security was to invest its funds in income- generating sources. Instead of investing in the private sector and helping to develop the nation's economy, the Social Security administration simply buys federal bonds andthereby increases the federal deficits. In fact, the federal deficit does not even reflect the money owed to the Social Security program. Creative bookkeeping has been employed by Congress to hide the truly disastrous state of the Social Security fund.
Congress has repeatedly raised Social Security taxes and the retirement age in a futile attempt to save the program. Now workers younger than age 40 must work until age 66 before retiring. There are proposals before Congress that call for raising the age to receive Social Security benefits to 70 years. For people currently receiving benefits, Social Security will still exist. Given the dismal state of Social Security predicted for the future, it appears that it will have to undergo massive changes in order to survive.
A congressional report issued in March 1993 concluded that the Social Security fund will bankrupt in 1995. A Democrat proposal to raise revenue for the fund is to raise the limit on wages which are taxed for Social Security. All wages, not just the first $54,400, would be taxed for Social Security. At first blush this seems a fair proposal. Everyone would pay Social Security taxes for the benefits they will receive in the future. If that is done, however, to be fair, the government should also impose income taxes on Social Security benefits received now by individuals who work and earn income over a certain amount. This, however, would be unfair to the individuals who would be paying for Social Security benefits in the future that will then be taxed a second time when received. The reason such benefits are taxed now from high income workers(over $30,000 per year) is that these people may not have paid the same percentage of Social Security taxes for the benefits received as others did. All of this shows how Social Security has become a sacred cow for politicians, and how it is used by politicians to purchase votes. Reliance on Social Security as the sole source of support upon retirement is foolish. Even Franklin Roosevelt, when he created Social Security, intended it to be only a supplement to other sources of income for an individual, such as pensions, savings, individual retirement accounts, etc.
This chapter is written to reflect the current problems, concerns, and benefits available. It is written to give the reader a concise and accurate depiction of the questions and answers to be faced in participating in the Social Security program.
In 1935, Congress enacted the Social Security Act during the depression to provide a measure of economic support for retired workers, disabled workers and their dependents. The rules governing Social Security are complex and highly formalized. This act created the Old Age, Survivors and Disability Program (OASDI) which is administered by the Social Security Administration (SSA). It is the OASDI program that is commonly called "Social Security." The types of programs covered by Social Security have expanded substantially over the years. Nearly all workers participate in Social Security although they may not all be covered for all benefits.
Social Security is a universal program; everyone is required to participate. Every worker is required to have a Social Securitynumber in order to determine a worker's eligibility and benefits. When Social Security was first created, it was specifically stated in the law that a Social Security number was not to be used for identification purposes. Today it is impossible to deal with any governmental agency without furnishing a Social Security number. To insure participation in the Social Security program, Congress requires that children have Social Security numbers in order for parents to claim a dependency income tax exemption for them. Social Security numbers are obtained by applying for a Social Security card from the Social Security Administration (SSA). In applying for a Social Security card, the applicant or child's parent must provide evidence of age, identity and alien status. The SSA will inform the applicant of the types of proof that are acceptable.
Social Security is funded by special taxes on both workers and employers. The Social Security taxes are partitioned as follows:
1. Social Security Hospital Insurance: There is a combined tax rate of 7.65%: 6.2% for old age, survivors and disability insurance (OASDI) imposed on both employee and employer on wages up to $57,600 and an additional 1.45% tax for hospital insurance (Medicare) on wages up to $135,000.
2. Unemployment Compensation: There is a tax of 6.2% on the first $7,000 of wages. Employers are allowed credits against the tax for participation in state unemployment programs to the extent that most employers pay only .8%except when credit reductions are in effect in a state.
Self-employed individuals must pay a self-employment tax which is 15.3% on the net self-employment income. This rate consists of 12.4% for OASDI and 2.9% for Medicare. The OASDI earnings base is $57,600 and the Medicare earnings base is $135,000.
Social Security is a tax program. There is no absolute right to receive Social Security. The United States Supreme Court has held that Congress can change Social Security laws and benefit requirements without violating any contractual rights with taxpayers. For example, Congress raised the age to receive Social Security benefits from 65 years of age to 66 years of age. There is currently a proposal to raise the requirement age again to receive Social Security benefits at 67 years of age starting in the next century.
This chapter is intended to apprise the reader of the workings of the SSA and the benefits available under the Social Security Act. After reading this chapter, a person should have a good understanding of Social Security and be able to seek more specific information from the SSA in a knowledgeable manner.
II. TYPES OF BENEFITS
Social Security benefits fall into four categories:
1. Old age benefits that are payable to the retired worker.
2. Disability benefits that are payable to the worker.
3. Support benefits for dependents of retired or disabled workers.
4. Survivor benefits for a surviving family of a deceasedworker, including a lump sum death benefit payable to the survivors.
In order to receive Social Security benefits, a person must apply for them. The government will not search for an eligible person to inform him of the right to receive Social Security benefits. Since it is up to each individual to apply for benefits, it becomes vital that everyone know their entitlements.
III. CALCULATION OF BENEFITS
The benefits received under Social Security depend on the following factors:
1. How much the worker contributed into the program.
2. Whether the worker has dependents.
3. How long the dependents survive.
As a result of these factors, the amounts of entitlements will vary from person to person. A single person without dependents will receive less benefits than a married person or a person with dependents even though they both worked the same number of years. Since benefits to a worker continue until death, it is possible for a person to receive more in benefits than the taxes paid into the system.
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V. DISABILITY BENEFITS
Under the Social Security Act, disability is defined as follows:
"(the) inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last fora continuous period of not less than 12 months."
The SSA has accepted some diseases as automatically rendering the afflicted person disabled. These diseases are compiled in a list entitled "Listing of Impairments." Some of the diseases on the list are epilepsy in acute form, arthritis in major joints, and advanced tuberculosis. A person not suffering from a listed disease (or one found to be medically equivalent to it) may still be found to be disabled. The worker is disabled if the physical or mental impairments are so great as to render the worker unable to do his previous work or engage in other substantial gainful work. The applicant for disability benefits has the burden of proving the existence of the disability.
Often the SSA will have the matter reviewed by their own experts. A hearing on the denial of disability benefits may be scheduled and an appeal taken as a result of the denial of those benefits. To receive disability benefits, a worker must meet the following requirements:
1. A disabled worker younger than 24 years of age needs 1½ years of covered work, which is six quarters earned within three years of the disability.
2. A disabled worked between 24 and 31 years of age needs to have earned coverage for at least half of the time from age 21 to the time of the disability. Example: A person 30 years of age must have 4½ years (18 quarters) of coverage; a person 25 years of age must have two years (8 quarters) of coverage.
3. A disabled worker older than 31 years of age must be fully insured and have five years of covered work (20 quarters) within the 10-year period preceding the disability.
As with retirement benefits, a disabled worker's family is entitled to disability benefits when a parent or spouse is disabled. Disability is discussed in greater detail in a later chapter.
VI. SURVIVING SPOUSE BENEFITS
A surviving spouse who is 50 to 60 years old and disabled or who is 60 years of age or older will receive monthly survivor benefits upon the death of a fully insured spouse. A surviving divorced spouse who meets the above requirements, is unmarried and was married to the deceased person for at last 10 years is also eligible for survivor benefits. To be a surviving spouse, the person must have been married to the decedent worker for at least nine months or have adopted a child with the deceased worker. The survivor benefit is between 82½% and 100% of the deceased spouse's retirement benefit.
For a husband or wife to receive survivor benefits, there must be a valid marriage. The existence of the marriage is usually not difficult to prove. A marriage certificate, an affidavit by the person performing the marriage or an affidavit from the witnesses to it will be accepted by the SSA as proof. A more difficult scenario exists when there is a common law marriage.
A common law marriage is one in which the man and woman live together for a fixed amount of time and hold themselves out ashusband and wife. Only 14 states permit common law marriages. Most states, like California, do not recognize common law marriages. A common law marriage is accepted by the SSA if it is valid in the state where it occurred.
A common law marriage may be proven in two ways:
1. If both spouses are alive, by a joint affidavit that they are married.
2. If one spouse is dead, an affidavit by the surviving spouse and two blood relatives (preferably of the deceased spouse) that there was a marriage as evidenced by the conduct of the parties.
Even if the surviving spouse is too young to receive survivor benefits, the surviving spouse may be entitled to some other benefits. If the deceased spouse died fully insured, and the surviving spouse is caring for the deceased spouse's dependent children, the surviving spouse is eligible for a parent's insurance benefit. This parent's benefit is about 75% of the deceased spouse's basic monthly benefit. Prior to 1975, a surviving husband could not receive this benefit unless he proved that he received half of his support from the deceased wife. The law has since changed, and either parent can now receive these benefits provided the eligibility requirements are met.
VII. PARENTS' ELIGIBILITY FOR SURVIVOR'S BENEFITS
The parents of a deceased worked are eligible for survivor benefits upon the death of a child if all of the following requirements are met:
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IX. PROOF OF SUPPORT
It is necessary to prove that half of the applicant's support was provided by the deceased or disabled worker to obtain some survivor benefits. As proof of support, the SSA wants the applicant to show that the worker supported the applicant for the year preceding the application. If support cannot be proven for the 12 months because of illness, unemployment or death the applicant must prove that the worker provided support for at least three months and that no other person contributed substantial support during that period.
Children's dependency can be shown by proving the dependent and worker lived together in the same household. A financial statement is usually required to divide the income available to the applicant and the income supplied by the worker.
X. THE SSA DECISION ON THE APPLICATION
The SSA sends letters to applicants informing them of acceptance or rejection of their applications for benefits. When applications are accepted, the reply letters will state the amount of benefits the SSA will pay to the applicant. When the application is denied, the SSA letter usually will give a brief statement as to why it was rejected and inform the applicant of the right to appeal the denial.
If the SSA pays less than the amount a recipient feels it is supposed to pay, the SSA should be notified immediately. If the SSA agrees that it made a mistake, the underpayment can be recoveredby issuing a check for that amount or paying it during the next seven payments. If the SSA insists that the amount was correct, the recipient should ask for an immediate reconsideration by the SSA. If the SSA does not change its position during reconsideration, a hearing before an administrative law judge of the SSA's Office of Hearing and Appeals should be requested.
When the SSA decides to reduce or terminate benefits previously awarded, it must give written notice of that decision to the recipient. The notice is given before the benefits are reduced or terminated. After the required notice is given, the Social Security benefits are reduced or terminated unless reversed on appeal.
XI. APPEALING A SSA DENIAL OF BENEFITS
An appeal is an administrative review of an SSA decision to deny, reduce or terminate Social Security benefits. No decision of the SSA is final until the time to file and appeal has run or all appeals have been exhausted. The SSA has prepared a complex procedure for processing appeals. After each administrative step, an individual upset with the decision may seek review of a still higher review group. Until the entire course of administrative review is run, an individual cannot seek court review of the SSA decision.
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XII. RECEIPT OF BENEFITS WHILE WORKING
Social Security retirement benefits were not intended to be paid to persons who were working. It was intended to replace incomelost or reduced because of retirement. Given today's economic reality, many retired people are being forced to return to the job market to survive. This causes a conflict with the seniors' need to survive and the Social Security program that was intended to help the senior worker.
A person is only permitted to earn a limited amount of money and still retain full Social Security benefits. If more than the allowable limit is earned, Social Security benefits are reduced one dollar for every two dollars earned over an annual ceiling of $7,680 if the beneficiary is less than 65 years of age. If the beneficiary is between 65 and 69 years of age, the annual ceiling is $10,560, and the reduction of benefits is one dollar for every three dollars earned. This is known as the "Retirement Test" and applies to all workers receiving retirement benefits below 70 years of age. After 70 years of age, the worker can earn any amount of money without loss of benefits. Before any retired person goes back to work, the following factors should be carefully considered:
1. If the person is receiving a pension from his job, pension benefits may stop if he returns to work with the former employer.
2. Social Security, federal income taxes and state income taxes must be paid on the wages even though Social Security benefits are being received.
3. Medical expenses are not deductible until they exceed 7.5% of the adjusted gross income, which increases because of work.
4. The Retirement Test will reduce Social Security benefits one dollar for every three over the annual ceiling until age 70. After age 70, there is no reduction for work.
For example, a person receiving $8,000 per year in benefits who earns $12,000 working will net about $16,100 after deducting for taxes and lost benefits. The net amount received after all adjustments may not be enough to make working worthwhile.
Besides reducing benefits for a person while working, the receipt of such benefits may also be subject to income taxes. This is simply double taxation. The taxes to pay for these benefits were collected from the worker's earnings, and now the benefits are taxed again when received. Social Security retirement benefits that will be included in recipient's gross income are the lesser of:
1. One-half of the net benefits received, or
2. One-half of the excess of the combined income over a base amount ($25,000 for an individual, $32,000 for a couple filing jointly, $0 for a couple filing separately).
For example, assume a couple has an adjusted gross income of $30,000. They receive $7,000 in Social Security benefits and $4,000 in tax-exempt interest.
1. Adjusted gross income $30,000
2. Plus tax-exempt interest $4,000
3. Modified adjusted gross income $34,000
4. Plus one-half Social Security benefits $3,500
5. Combined income $37,500
6. Less base amount $32,000
7. Excess above base amount $5,500
8. One-half over base amount $2,750
9. One-half of social security benefits $3,500
10. Amount included in tax return (lesser of 8 and 9) $2,750
A recent government report estimates that people in their 40's will receive only about $.82 in benefits for every dollar paid in Social Security taxes. Again, they will pay income taxes on this $.82 that is a return of money on which they have already paid income taxes. Remember, taxpayers pay taxes on their earnings before the Social Security taxes are paid. So these $.82 of benefits have already been totally taxed. This was not a tax-free contribution like a tax-deferred pension. The closest analysis is the purchase of an annuity with after-tax money. No one would purchase an annuity that would only pay $.82 for every dollar invested and then be taxed on the $.82.
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SUPPLEMENTAL SECURITY INCOME
Supplemental Security Income (SSI) is a specialized program implemented under Social Security to provide for aged or disabled workers in need. As with other Social Security programs, it has developed over the years from supplemental source of income to, in many cases, the sole source of income for many persons. To keep from becoming a general welfare program, Supplemental Security Income benefits are limited to needy persons who are blind, over 55 years of age or otherwise disabled. To be in need requires that the recipient be without assets over a certain value and not receive monthly income over a certain amount. Supplemental Security Income benefits are available only to citizens of the United States and lawful aliens in permanent residence in the United States.
The receipt of SSI benefits is not mutually exclusive nor a bar against participation with other federal and state welfare programs. In particular:
1.It is legal for an eligible person to receive both Social Security and SSI benefits. In fact, according to SSA figures, over one- half of all recipients of Social Security benefits also receive SSI benefits.
2. It is possible for an eligible person to receive both Medicaid and SSI benefits. Most states treat a person as eligible for SSI and automatically eligible for Medicaid. An applicant for SSI benefits should apply forMedicaid.
3. In some states an eligible person can receive both Food Stamps and SSI benefits. The States of California, Wisconsin, Oregon, Utah, Vermont, Virginia, New York and some counties in both Minnesota and Ohio deny food stamps to persons receiving SSI benefits, although there are proposals to change the law. An applicant for SSI benefits should apply for food stamps. As long as the applicant tells the truth, there is nothing to lose. Even in California and Massachusetts, the law may change, and the applicant may become eligible.
This chapter is written to reflect the current problems, concerns, and benefits available. It is written to give the reader a concise and accurate depiction of the questions and answers to be faced in participating in the program.
The Social Security Administration (SSA) administers the federal program which handles Supplemental Security Income (SSI). The program provides cash assistance to aged, blind or disabled individuals who have little income and few assets. Under the program, the qualified individual receives a monthly check based upon need, determined on a sliding scale from $354 per individual to $552 or more for a married couple. These figures are not absolute and are likely to change with the budget increases each year. The bottom line is that workers in need may be eligible for such SSI payments. A few states supplement SSI by paying anadditional amount. Therefore, any individual receiving SSI should also check to determine if aid is also available through their state's welfare department.
The following persons are eligible to receive SSI benefits:
1. A person over 65 years of age.
2. A blind person.
3. A disabled person.
In addition, each of the above persons must be in need. This means that their income and total assets cannot exceed a certain level. To reach this minimum level, some applicants transfer their property to their children. Such transfers may be valid if performed in accordance with the law. For transfers after July 1988, there is no penalty for transferring assets to another person for less than fair market value in order to qualify for SSI. This must be a legitimate transfer with title actually passing free and clear with no conditions for future use or a life estate being retained by the applicant. While such a transfer may be permitted for SSI, it still does not apply for Medicaid. Medicaid will not pay the applicant's nursing home expenses for 30 months following the transfer.
SSI benefits are available only to citizens of the United States and aliens lawfully admitted to the United States for permanent residence. As a result, illegal and undocumented aliens cannot participate in the program despite the fact that they may pay Social Security taxes.
II. DETERMINATION OF NEED
To receive SSI payments, a worker must be in need. That need is determined by a comparison of the debts and obligations of the worker with his income and assets. Obviously, a person with millions in assets but no income will not be found in need and eligible for SSI payments.
In making its need determination, the SSA considers any assets which a person can convert into cash as equivalent to cash and available to pay for his support or maintenance. When the person is married, the SSA also considers the assets of an applicant's spouse as available for the applicant's care and support. By law the SSA looks for "cash or other liquid assets or any real or personal property that can be converted into cash" by or for the use of the applicant for SSI benefits.
To be eligible for SSI benefits, the applicant cannot have assets worth more than $2,000 if single or worth more than $3,000 if married. Not all assets are counted in determining an applicant's eligibility. Furthermore, an applicant may give $500 or less to children before filing for SSI benefits and still be eligible.
By law certain assets are exempt when determining a person's eligibility to receive SSI benefits. The exempt assets which an applicant can have and still receive SSI benefits are:
1. Life insurance policies. These are exempt altogether from the calculation of an applicant's total assets. Other types of insurance policies are also excluded if their cash surrender value is less than $1,500.
2. One automobile with a value of $4,500 is exempt for SSI purposes. If the value exceeds $4,500, only the excess is counted in computing the SSI eligibility. If the vehicle is specially equipped for a handicapped driver or otherwise needed for transportation for specific medical treatment, it may be treated as fully exempt for SSI purposes.
3. Household goods up to $2,000 are exempt for SSI purposes. Not included in SSI eligibility calculations are wedding and engagement rings along with medically necessary medical devices such as wheelchairs, oxygen tanks, walkers, etc.
4. Insurance proceeds used to replace destroyed, lost or damaged exempt property are also exempt if the proceeds go to replace or repair the exempt property.
5. The family home is totally exempt for SSI purposes if the applicant lives in it as a residence. The house may be totally paid for and worth any amount of money and still be exempt.
6. Property essential for self-support is exempt up to $6,000. This property is determined on a case-by-case basis. The SSA decides if such property is necessary for the applicant in producing income for support.
All of this exempt property is not included in determining the eligibility of an applicant for SSI. Any decision by the SSA to include such property in an applicant's list of available assetscould be appealed.
Generally, property held by an applicant's spouse is attributed to the applicant for the purposes of determining eligibility to receive SSI. Therefore, if any property is held jointly with a spouse, that property will be attributed to the applicant. Property held jointly with persons other than the applicant's spouse may still be attributed to the applicant in determining eligibility to receive SSI benefits. It is considered the applicant's asset if the applicant's interest in the property can be sold without the consent of the other owners. If the property can be sold without the other owner's consent, then the applicant's interest in the property will be included in the applicant's list of assets for determining eligibility. If the applicant's interest in the property cannot be sold without the consent of the other owners, the applicant's interest is exempt from use in determining the applicant's eligibility to receive SSI benefits.
If an applicant for SSI benefits has a joint bank account with a spouse, the entire amount is attributed to the applicant for the purpose of determining SSI eligibility. The law is different when the joint bank account is with someone other than the applicant's spouse. Since 1982, the SSA will attribute to the applicant all of the funds in the bank account except those that can be proven to have been contributed by the other person on the account. The applicant is required to state in writing and under penalty of perjury the facts necessary to substantiate the amount of fundswhich belong to the other person in the joint account.
Just as common law marriages are recognized for SSI purposes, the SSA will recognize a de facto marriage, even though it might not be valid under state law. When the persons hold themselves out as married, the SSA will attribute to the applicant for SSI benefits the income and assets of the other person as though the other person was indeed a valid, legal spouse. Factors considered by the SSA to determine if the couple held themselves out as married are:
1. Their names which they use in public.
2. How they introduce each other to strangers.
3. How they receive mail.
4. How they sign leases and deeds.
If they both qualify for SSI benefits and are found to be holding themselves out as married, they will receive the married couple benefit (which is less than two single benefits). In 1989 the married couple benefit was $552, and the individual benefit was $354. The amounts increase a bit each year.
Generally, the only relative whose property will be attributed to an applicant is that of a spouse. All of the spouse's property will be attributed to the applicant for the purposes of determining eligibility to receive SSI benefits. Property held by children or other relatives is not included in the applicant's estate unless some of that property was transferred by the applicant solely to make the applicant eligible. Such property transferred to a child may be attributed to the applicant.
When an applicant is determined to have too many assets, the applicant is denied SSI benefits. The applicant is told that to receive SSI benefits he must reduce his estate to below the threshold amount. To do this, he may spend cash or sell assets until the estate is within the maximum amount allowed by law. An applicant can also purchase a home, or he can invest in improving a home rather than spending the cash in other nonproductive ways. There is no law against an applicant divesting himself of his assets in order to become eligible, provided the assets are truly given away. Special qualification rules exist when the total countable assets do not exceed $3,000 for an individual or $4,500 for a couple, and liquid resources (cash, stocks, bonds) do not exceed $533 for an individual or $800 for a couple.
In order for a couple to receive SSI benefits, there must be a valid marriage. The existence of the marriage is usually not difficult to prove. A marriage certificate or an affidavit by the person performing the marriage or the witnesses to it will suffice. Likewise, a valid marriage is needed before the SSA can attribute the assets and income from the person of the opposite sex to the applicant.
A more difficult scenario exists when there is a common law marriage. A common law marriage is one in which the man and woman live together for a fixed amount of time and hold themselves out as husband and wife. Only 14 states permit common law marriages. Most states, like California, do not recognize common law marriages. A common law marriage will be honored by the SSA if itis valid in the state where it occurred. A common law marriage may be proven in two ways:
1. If both spouse are alive: a joint affidavit that they are married.
2. If one spouse is dead: an affidavit by the surviving spouse and two blood relatives, preferably of the deceased spouse, that there was a marriage as evidenced by the conduct of the parties.
A valid common law marriage bestows upon the surviving spouse of the worker and the children born of the marriage all of the rights and protections that are afforded in a traditional marriage. A recipient of SSI benefits is required by law to keep the SSA informed concerning changes in income or living conditions. This reporting helps the SSA to redetermine the recipient's eligibility for SSI benefits and the appropriate amount of such benefits as the recipient's conditions change. The SSA can require a recipient to file forms each year stating the recipient's current assets and income. Failure to make the required reports can result in the recipient being overpaid and thus responsible for repayment of the overpayment of SSI benefits. The SSA also has the authority to fine the recipient $100 for failure to file the report.
A. EARNINGS BY AN APPLICANT
Income for the purposes of determining eligibility to receive SSI benefits is defined as:
"the receipt by an individual of any property or services which he can apply, either directly or by sale or conversion, to meeting his needs for food, clothing and shelter."
This definition of income includes both earned and unearned income and personal property received in lieu of cash which is called "in-kind" income. The SSA has complex rules for determining an applicant's income. Some income is exempt altogether while other "in-kind" income is attributed to the applicant. For this reason, an applicant should appeal any finding on excessive income that he feels is erroneous. Generally, to be eligible for SSI benefits, an applicant cannot receive as income more than the monthly SSI benefits. In 1989, the monthly benefit was $250 for an individual and $400 for a couple, but as the benefit increases, so does the amount that can be earned without losing eligibility.
The SSA will look only at the income of a single person in determining eligibility to receive SSI benefits. A child's income will not be attributed to a parent for the purpose of determining a parent's eligibility to receive SSI benefits. If the applicant is married and living with his spouse, both incomes, including income exclusions available to each spouse, will be counted in determining the applicant's eligibility to receive SSI benefits.
Certain types of income received by an applicant are either totally or partially exempt from calculating the applicant's countable income for SSI eligibility. Example: The first $20 per month earned by an applicant is exempt whether it is from earned or unearned income. In addition, the following income is not counted when determining an applicant's countable income for SSI benefits:
1. Income tax refunds.
2. Property or sales tax refunds.
3. Insurance payments for replacement of damaged or destroyed property.
4. Welfare or AFDC payments.
5. Housing assistance payments.
6. Foster care payments.
7. Wages received from VISTA, Foster Grandparent Program, the Retired Senior Volunteer Program and the Senior Companion Program.
8. Proceeds received from the sale of assets.
Partially excluded income is the first $65 earned each month along with one-half of the income earned thereafter. With these exclusions on earned income, an applicant can earn over $100 per week and still qualify for SSI benefits. Since one-half of the applicant's earned income is used in determining eligibility, it is necessary to know what the SSA considers to be earned income. "Earned income" is any property, including cash, that the applicant receives in payment for the performance of a job. The SSA considers earned income to be gross wages that an applicant receives from a job and the net earnings from self-employment. In both cases, the SSA looks at the income before deductions for taxes and insurance.
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The Medicare program was established by the federal government in 1965. As the name infers, Medicare provides medical care by covering some of an eligible person's health expenses. Medicare has been altered almost every year of its existence to keep pace with advances in medical science and the ballooning cost of medical expenses. Today it is estimated that an elderly person spends in excess of fifteen percent (15%) of his gross income on medical expenses. A recent medical study states that the average person spends more on health expenses in the last year of life than in all the other years together.
There are many misconceptions as to what expenses Medicare will pay. Medicare does not pay all of the expenses that a person may incur. For most services Medicare requires cost-sharing with the person being covered. The practice of cost-sharing has often caused severe financial problems on the elderly. Many retired couples have no retirement or receive retirement benefits below the poverty level. They often cannot afford their share of the cost and receive no treatment.
The fact that Medicare does not cover all medical expenses hasresulted in many insurance companies offering supplemental insurance policies to pay what Medicare does not cover. Most people have seen advertisements for these policies on the television, and many retirement organizations also have such policies for their members. Extreme care is warranted in purchasing a Medicare supplement. While many of the policies do an adequate job in supplementing short-term care, few cover the person for long-term care. Yet the cost for long-term care poses the greater financial and medical risk for a person. Medicare pays for most of the cost of the usual hospital stay. Medicare statistics, however, show that 5% of the population over 65 years of age will need long-term care.
Medicare is divided into two parts: hospital insurance (called Part A) and supplementary medical insurance (called Part B). Part A benefits are used primarily for the payment of services rendered by hospitals and nursing homes and are funded through Social Security taxes. Part B coverage is optional and is purchased by monthly premiums paid by the recipient of the benefits.
Everyone over 65 years of age is eligible for Medicare. They should be aware of the coverage of the plan so they can plan their anticipated needs in the future. Congress has considered denying Medicare coverage or taxing the benefits received by those recipients earning over a certain amount. This effort has been thwarted in large part by the lobbying efforts of the elderly.
Medicare does not cover everyone. Only persons who fall withinfixed classes will be covered by Medicare, regardless of need. The classes for coverage under Medicare are:
1. People who are 65 years of age or older and are also eligible to receive benefits under the Social Security Act or the Railroad Retirement Act. A person over 65 years of age can receive Medicare without retirement provided the person is eligible to receive Social Security or Railroad Retirement benefits.
2. A person who has reached 65 years of age but is not eligible for Social Security or Railroad Retirement benefits is eligible if he has amassed a minimum number of Social Security quarters.
3. A person 65 years of age who has not obtained the minimum number of Social Security quarters may enroll in the Medicare program by making premium payments. Voluntary enrollees must enroll in both Part A and Part B. In 1989 the combined premium was $189.10 per month.
4. A person under 65 years of age who is disabled and is eligible to receive Social Security or Railroad Retirement benefits for at least 24 consecutive months is also eligible for Medicare.
5. A person suffering from chronic kidney disease who is eligible for Social Security or Railroad Retirement disability benefits is also eligible for Medicare benefits.
When a person 65 years of age or older applies for Social Security or Railroad Retirement benefits, he automatically applies for Medicare coverage, both Part A and Part B. Since Part B is optional, the person must ask not to be included under it. Aperson who receives Social Security or Railroad Retirement benefits before reaching 65 years of age must specifically apply for Medicare benefits when reaching 65 years of age. Enrollment in Medicare is not automatic when Social Security or Railroad Retirement benefits have been received prior to reaching 65 years of age. If a person is over 65 years of age and not eligible for Medicare, he can voluntarily enroll in Medicare by applying at the local Social Security office.
III. PART A BENEFITS
Part A benefits for Medicare are available for the following three services:
1. Inpatient hospital services.
2. Inpatient care in a "skilled nursing facility."
3. Home health services.
Not all hospitals and nursing homes accept Medicare payments for the services which they render. Furthermore, Medicare only pays the amount for services which it considers reasonable. The extent of any bill which Medicare does not cover, along with any deductible, is to be paid by the individual.
There is a minimum yearly hospital deductible after the maximum deductible is paid, the covered person may have an unlimited hospital stay with full Medicaid coverage at Medicaid maximum level. The yearly deductible as of January 1, 1989, was $560.00. The deductible is expected to increase in order to help reduce Social Security insolvency. The current deductible figure can be obtained by calling the Social Security office or ahospital.
Medicare pays the following benefits for hospital services:
1. A semi-private room (a room with no more than two beds).
2. All meals and special diets.
3. Regular nursing services for the unit in which the person is hospitalized.
4. Intensive care when in special care units.
5. Drugs prescribed by physicians in the hospital.
6. Blood transfusions.
7. Hospital charges for lab tests, x-rays and radiotherapy.
8. Medical supplies used in treatment.
9. Use of medical equipment while hospitalized, such as wheelchairs, hospital beds and oxygen tanks.
10. Operating and post-operating room charges.
11. Rehabilitation charges incurred during the inpatient stay.
Medicare pays for an unlimited number of hospital stays after the once-per-year deductible is met, provided the stay is medically necessary. After the deductible is met, the person does not have to pay it again as long as he is in the hospital (even for years). If the person leaves the hospital and returns the following calendar year, a new deductible must be paid.
"Skilled nursing facility benefits" refer to care provided by registered and licensed practical nurses when ordered by attendingphysicians. Such care includes respiratory therapy, tube feedings, physical therapy, occupational therapy and speech therapy. Such care is covered for 100 days per year. No prior hospitalization is required. The first 20 days is covered entirely by Medicare, and for the next 80 days Medicare covers everything except a co-payment of $67.50 per day. Co-payments are expected to be increased further in response to Social Security insolvency. To be authorized by Medicare, a skilled nursing facility:
1. Must be certified to participate in the Medicare program.
2. Must have a physician certify that the recipient requires skilled care.
3. Must conduct ongoing utilization review to assure that the person is actually receiving skilled care.
When skilled care is no longer required, Medicare coverage ceases. Medicare does not pay for nursing home care just because the person can no longer take care of himself. It must be medically necessary
Hospice care for the terminally ill is unlimited, being medically necessary. Congress is expected to reduce this benefit because of Social Security's projected insolvency. The patient must elect to qualify for hospice care, and the election limits the patient's options for obtaining Medicare coverage for treatment of the terminal illness outside the hospice program. After January 1, 1990, hospice care can be given for more that 210 days provided the care is being given by a Medicare-approved participating hospice.
Since January 1, 1990, health care is paid by Medicare seven days per week for 38 consecutive days. After the 38 days there must be a lapse of at least one day before it can start again for another 38 days.
"Respite care" is in-home care for the chronically disabled. It provides a rest for the care giver. Care giving can be nursing, homemaking, and personal care. Since January 12, 1990, Medicare pays the first 80 hours per year.
Medicare is not a long-term solution to pay for nursing home care. Medicare does not cover intermediate or sheltered care: the two prevalent types of care the elderly need.
IV. PART B BENEFITS
Part B coverage requires paying a monthly premium. The amount of the monthly premium is adjusted July of each year. The premium is intended to cover 25% of the program costs. The remainder of the program costs are covered from the Medicare trust fund and general tax revenues. The Medicare Catastrophic Coverage Act of 1988 added an additional premium for catastrophic coverage and drug benefits of $10.20 per month beginning January 13, 1993. Premium charges are related to the recipient's federal tax liability and cannot exceed $1,050. This figure can be expected to be raised to get more money into the system. The premiums are deducted automatically from Social Security or Railroad Retirement benefits. Direct payments must be made to the Social Security Administration for Medicare coverage if a person covered byMedicare is not receiving Social Security or Railroad Retirement benefits. There is a yearly deductible before coverage begins. There is also a 20% co-insurance charge for most medical bills where the provider accepts the assignment. Even with Part B coverage, a recipient is expected to pay the deductible, co-insurance, non-covered items and all charges that exceed Medicare's determination of reasonable charges. All of which is called the "Medicare gap."
There is a yearly limit on out-of-pocket expenses for Part B services. Out-of-pocket expenses in 1993 were limited to $1,900, after which Medicare paid 100% of approved charges. Physician charges in excess of the approved charges are not considered as a Medicare out-of-pocket charge.
Medicare pays for most physician services provided in a hospital. In some instances the care provided by chiropractors, dentists, podiatrists and other medical professionals will be paid by Medicare. Physician services can be provided in the hospital, office, nursing home or patient's home. In addition, surgery and consultation services can also be covered. Moreover, most outpatient treatments such as electrocardiograms (EKG), X rays and physical therapy are covered. Outpatient psychiatric services are covered to a maximum of $1,000 per year as of January 1, 1989. In-patient psychiatric hospitalization is covered for 190 days.
Since January 12, 1990, Medicare covers at-home administration of intravenous antibiotics; additional intravenous drugs are expected to be added for at-home administration. There is adeductible for such drugs of $652 that will be increased in the future. Since January 1993, Medicare pays 80% of the cost minus the deductible. The deductible for the drugs does not apply if their use started in a hospital and was continued at home.
Outpatient prescription drugs are paid by Medicare after an initial deductible for $600. Medicare pays 80% of the approved cost of such drugs after January 1993.
Mammography screening is covered by Medicare screening. Since January 1990, Medicare pays 80% of the costs for the first year if less than $50.
Under Part B, Medicare also will pay for some of the outpatient hospital services. Some are those provided in an emergency room, an outpatient clinic, or a diagnostic laboratory. Except for outpatient laboratory tests, Medicare will pay 80% of the approved charge minus the appropriate deductible.
V. WHAT PART B DOES NOT COVER
What Part B does not cover is probably more important than what it does cover. Many people have the mistaken belief that anything related to a person's continued good health is covered by Medicare as long as it is prescribed by a physician. This is not the case. Medicare pays only for what is considered to be medically necessary to treat a medical condition. The following services are usually excluded from coverage:
1. Routine physical check-ups.
2. Routine eye examinations.
3. Prescription eyeglasses or contact lenses for ordinary vision correction.
4. Hearing aids.
5. Routine foot care and orthopedic shoes.
6. Cosmetic surgery.
7. Routine dental exam and services.
This list demonstrates that the main impetus of Medicare is to treat serious medical conditions. It does not become involved with preventive medicine or care. Therefore, it is best that a person on Medicare determines if it is medically necessary or if it is preventive in nature before being treated. In one instance Medicare will pay for it, and in the other Medicare will not pay for it.
VI. KIDNEY DISEASE
Medicare has special treatment for those persons who are disabled as a result of kidney disease. The normal 24 month waiting period is reduced to three months for a person on dialysis. The three month period is even further reduced for persons entering into a training program for self-dialysis. A candidate for a transplant operation is eligible for coverage the month he enters a hospital provided the transplant takes place within three months. A person on dialysis does not have to be totally disabled. A person on dialysis may work without the work affecting his disability status for Medicare eligibility.
Once covered by Medicare, the person will remain covered for 12 months after the dialysis has been discontinued. If the person has received a kidney transplant, Medicare coverage will continue for three years after the transplant operation.
VII. PREVENTIVE TREATMENT
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The threat of permanent disability hangs over every person. Statistics from insurance companies show that one out of 10 people will be disabled at least temporarily at least one time in their lives. Disability always has a subdued terror for most people because they remember what it was like in the Great Depression, when a person could not work because of an injury. During the depression, when a person was disabled, he and his family starved unless they fell upon public charity. Congress created a disability program for workers to prevent this tragic scenario from continuing.
The Social Security Disability Insurance (SSDI) program was established under Title II of the Social Security Act. As with Supplemental Security Income (SSI), it was designed to provide benefits to disabled workers, widows, widowers and dependents. The main difference between SSI and SSDI is that the disabled worker must have been fully insured under SSDI at the time of disability if he wishes to qualify under SSDI. Disability benefits can be received by surviving spouses and surviving divorced spouses on the death of a disabled spouse. The decision to award SSDI benefits to disabled surviving spouses is based solely on individual medical factors regarding their disability and is not based on age, education or work experience.
A close relative was permanently disabled years ago in an industrial accident. The relative was not 55 at the time and so did not qualify for SSI coverage. If not for the disability coverage under this program, his family would have been forced onto welfare until he reached age 62 and could receive regular Social Security. The system works. Disabled persons should not be afraid to apply for the benefits. The system exists to help the disabled worker, and there is no shame in receiving benefits that the truly disabled worker has earned.
This chapter was written to make it as easy as possible for a disabled person to understand his rights and to remove the unnecessary fear and confusion in applying for benefits. It is necessary for people applying for benefits to understand their rights so that they can competently represent themselves and their family before the Social Security Administration in most areas.
There are two separate disability programs overseen and managed by the Social Security Administration in accordance with the Social Security Act. The first program is contained in the Supplemental Security Income (SSI) program. SSI will pay qualified disabled individuals monthly benefits provided their assets and countable income fall below a set cut- off point. The second program is the Social Security Disability Insurance (SSDI) program established under Title II of the Social Security Act. It was designed to provide benefits to disabled workers, widows, widowers and dependents. The disabled worker must have been fully insured at the time of disability to be covered under this program.
An interesting feature of the two disability programs is that they are not mutually exclusive. It is possible for a person to receive both SSI benefits and SSDI benefits provided the person qualifies separately under each program. If the Social Security benefits received by a disabled worker or dependent are below the income limit for SSI and other qualifications are met, the recipient of the benefits may also receive SSI benefits.
A disabled person 62 to 65 years of age has the option of applying for either disability or retirement benefits, but not both at the same time.
Usually, it is more beneficial financially to apply for disability benefits rather than retirement benefits when the rights overlap. The disability benefit is the same as if the person retired at age 65; the early retirement benefit, however, is reduced 5/9ths of one percent for each month of retirement before the person reaches age 65.
Many states have tied the SSDI program to the state's Medicaid program, and a person receiving SSDI benefits will receive Medicaid coverage automatically. So there is a bigger incentive to apply for SSDI benefits in these states because the monthly benefits are higher and the individual also receives Medicaid coverage. For surviving spouses and surviving divorced spouses, there is a reduction of disability benefits of a maximum of 28.5%, based on actuarial tables, if they seek the benefits prior to attaining 65 years of age.
I. DEFINITION OF DISABILITY
The Social Security Act defines a disability for both SSI and SSDI benefits as an inability by a worker to:
"engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months..."
In addition the SSDI definition also states that:
"An individual shall be determined to be under a disability only if his physical or mental impairment are of such severity that he is not only unable to do his previous work but cannot, considering his age, education, and work experience engage in any other substantial activity."
This requirement that "no other substantial gain activity can be possible" is the basis for nearly all rejections of disability claims and a multitude of litigation over wrongful denials of benefits.
Under the SSDI program disability benefits can be received by both surviving spouses and surviving divorced spouses. Eligibility requirements to receive SSDI benefits are much stricter and more tightly construed than under the SSI program. Eligibility is determined solely on medical factors pertaining to the disability. The Social Security Administration does not consider age, education or work experience of a surviving spouse or ex-spouse in determining eligibility to receive disability benefits under the SSDI program.
II. ELIGIBILITY FOR SSDI BENEFITS
To receive SSDI benefits, a worker must meet the following requirements:
1. Be disabled, and
2.Have the requisite number of quarters of covered employment which are:
a. A disabled worker younger than 24 years of age needs 1.5 years (six quarters) of covered work earned within three years of the disability.
b. A disabled worker between 24 and 31 years of age needs to have earned coverage for at least half of the time from age 21 to the time of the disability. In other words, a person 30 years of age must have 4.5 years (18 quarters) of coverage. A person 25 years of age must have two years (eight quarters) of coverage.
c. A disabled worker older than 31 years of age must be fully insured and have five years (20 quarters) of work within the ten-year period preceding the disability.
As with retirement benefits, a disabled worker's family is entitled to disability benefits when a parent or spouse is disabled.
A disabled person should file for benefits immediately upon becoming disabled in order to start the clock running. Under SSDI a person is entitled to 12 months retroactive benefits from the date of application for benefits; however, there is a five-month waiting period from the date of the disability. This means that a maximum of seven months benefits will be paid for the first year of disability.
SSI disability benefits do not have a special earning requirement as do SSDI benefits, and there is not a five-monthwaiting period for SSI payments to begin. On the other hand, there is no retroactive payment of SSI benefits which is another reason to file immediately.
Disability benefits are also dependent on the domicile (legal residence) of the applicant. The domicile of an applicant for SSDI benefits is important because there is a wide variation among the states concerning whether they supplement federal SSDI and to what extent. SSDI benefits are not available to persons living outside the United States. This includes Puerto Rico, Guam and the Virgin Islands.
An individual living in a public institution such as a prison or a state hospital is not eligible for SSDI benefits. If the applicant lives in a nursing home where more than 50% of the cost is paid by Medicare, the monthly SSDI benefit is also reduced. If an individual lives in a retirement home, the monthly benefit may actually be increased because retirement homes are not paid by Medicare, and retirement home cost is expensive.
III. DETERMINATION OF DISABILITY
The Social Security Administration uses a multi-step procedure to determine if a person is disabled. The SSA's test for determination of disability is as follows:
The first step is to determine if the person claiming disability benefits can engage in substantial gainful activity. The SSA defines "substantial gainful activity" as work for pay or profit that requires substantial physical or mental activity. To determine substantial gainful activity, the SSA looks at thefollowing factors:
1.Pay or property received for the work.
2.The extent of education, skills and responsibility required.
3.How well the work is done, and how long it takes.
If the applicant earns less than $200 per month, the worker is not engaged in substantial gainful activity. If the applicant earns over $400 per month, the SSA considers the person to be engaged in substantial gainful activity. For amounts between $200 and $400, the SSA makes its determination on a case-by-case basis.
These limits can be expected to change as SSI benefits increase. Every disabled person should apply to determine if disability benefits are awardable under the current law. If the SSA determines that the applicant is able to perform substantial gainful work, benefits are denied. If the applicant is approved in step one, the SSA goes to step two.
The second step determines if the applicant has an impairment likely to last at least 12 months or result in death. If he does not, then benefits are denied. If he does, the SSA goes to step three.
The third step determines if the impairment significantly limits the ability to work. If it does not, benefits are denied. If it does limit his ability, the SSA goes to step four.
The fourth step determines if the applicant meets a listing of disabled impairments. The term "listing" refers to "Listing of Impairments" contained in Appendix 1 of the Social SecurityRegulations. Listings are divided into two sets. One set of listings, Part A, covers individuals over 18 years of age. The second set, Part B, covers individuals under the age of 18. Both sets divide the human body into 13 systems and list the disabilities by degree of impairment. The systems are musculoskeletal, senses and speech, respiratory, cardiovascular, digestive, genito-urinary, renal and lymphatic, skin, endocrine, multiple body, neurological, mental disorders, and malignant neoplastic diseases. Comparing the applicant's listing with the impairments is difficult and complex. A denial of benefits is appealable. If the SSA decides the applicant meets the degree of impairment required, benefits are immediately awarded. If the SSA decides he does not meet the requirements, the SSA goes to step five.
In step five the SSA decides if the applicant has a "residual functional capacity" to return to work: the ability to return and perform work for pay within 15 years of the disability. The ability to do current work is irrelevant. If the SSA believes the applicant can still do the same type of work he once did within 15 years of the disability, the applicant is not disabled under Social Security. Example: A doctor once washed dishes 15 years earlier and subsequently became unable to practice medicine. If he can still wash dishes, the SSA might not find him disabled. If the applicant is found to have a residual functional capacity to work, the benefits are denied. If the SSA finds he does not have a residual functional capacity, the SSA goes to step six.
Any denial of benefits based upon this test in step five should be appealed. The SSA often misapplies the test or is overly harsh. This is the greatest reason for denial of benefits; the test result is most often reversed on appeal.
In step six the SSA determines if the applicant is able to do "substantial gainful activity" in the national economy. When the SSA decides that a person cannot return to past work, the SSA determines what kind of work the applicant can do. In determining that a person can obtain gainful employment, the SSA must consider:
1. The applicant's age.
2. The applicant's education.
3. The applicant's prior work experience.
4. Exertion level in being able work.
5. General skills available.
The SSA uses grids to determine eligibility. These grids are charts used to rate an applicant's disability based on the above factors. The grids are three tables based upon the individual's residual functional capacity after consideration of the disability. Each table rates an applicant in accordance with set rules in order to make a decision on disability. Grids are used where the applicant has been found (in the first five steps) to be unable to return to his former employment, and the impairments are not one of the listings in step five. Instead the impairments are primarily exertional.
Grids are used only in cases where the impairments are exertional in nature, and in those cases they are strictly applied.An "exertional impairment" is generally one that does not involve mental problems, sensory or skin problems, postural or manipulative limitations, pain or environmental restrictions (special sensitivity to fumes or dust in the workplace). Disability will be found using the grids only if the applicant fits all of the grid requirements for disability completely.
Grids are used only where the applicant has established that a return to former work is impossible because of severe medically-determined impairments. There are 82 separate grid determinations, but only 16 grids lead to a finding of disability. As a rule the younger and more educated or skilled the applicant, the less likely he will be found disabled under the grids. The SSA does not always make correct determinations using the grids and a denial of benefits should be appealed. If the applicant is able to do substantial gainful activity in the national economy, benefits are denied. If the applicant is not so able, then benefits are awarded.
There is an important exception for the normal step-by-step determination process of the SSA. This exception exists for applicants who:
1. Have a marginal education of sixth grade or less,
2. Have worked more than 35 years in arduous, unskilled labor, and
3. Cannot return to their former employment because of a severe impairment.
The individuals who meet these exceptions are considered disabled without further analysis.
IV. DISABILITY OF A SURVIVING SPOUSE OR A SURVIVING DIVORCED SPOUSE
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NURSING HOME CARE
For the first time in history a significant number of people are expected to live long enough to require long-term care, usually in a nursing home. Medical advances that have extended the average person's life span from 40 years of age in 1900 to 75 years of age in 1990 are the reason. The extension of life has unanticipated consequences in the quality of lives of those persons living such extended lives.
Cost has become a major consideration for most people as they grow old and look for security. In the 1930's when Social Security was created the average life expectancy was 65 years of age. No one foresaw that the average person would require coverage longer than a few months. Now, however, with people living so much longer, a retired person might well be forced into poverty if he lives a long life. Social Security was intended to be a retirement supplement. Many people never prepared for their retirement (possibly because they never thought that they would live that long). In any event, a large portion of our population has reached retirement without having adequately prepared for the expenses of growing old.
Another consideration in growing old is the lack of companionship. The extension of the human life span has not beenequal. Women outlive men primarily because men shorten their spans by working outside the home in careers which drastically shorten their life expectancy. For example, in 1970 the average life expectancy for a steel worker was 65 years of age and for an auto worker it was 68 years. Persons living long lives will probably outlive their spouse and maybe even their children. It is common, even tragic, for a person to outlive all of the family and friends of a lifetime. A major concern of all decent retirement and nursing homes is depression.
Depression in the elderly is brought about for three reasons. The first cause of depression is a deteriorating medical condition which is understandable. The second cause is loneliness. The third cause of depression is the cost of growing old. A medical report states that the average person will spend more on medical care in the last year of life than in all of the other years of life put together. At the time in a person's life when they usually are not working and are living on fixed incomes, they must concern themselves with the problem of how to pay for their medical treatment. As mentioned earlier, Social Security will not cover everything. Only if a person completely divests himself of nearly every asset acquired during a long life will he become eligible for Medicaid coverage.
In an actual instance, the high cost of medical treatment resulted in forcing a family into bankruptcy. The husband was a retired air traffic controller. His wife had died of cancer after a long period of period of painful treatment. The couple had nomedical insurance other than Medicare and no long-term-care insurance whatsoever. They spent their entire life savings on medical bills. After his wife died, the husband still owed $60,000. The long illness of the wife had bankrupted the husband.
This chapter is written for the person who has acquired assets during a long life and does not want to divest in order to obtain long-term nursing care. This chapter will cover nursing homes and the purchase of long-term- care insurance which can prevent having to become indigent in order to get care. Preparation for the possibility of needing such long-term financial care should be part of any financial plan.
II. NURSING HOMES
Nursing homes are places where people needing care go or are placed by their families. There are three types of nursing homes. They are defined by the level of professional nursing services offered the patient. Present data confirms that 5% of persons over 65 years of age live in nursing homes. In fact, 23% of persons over age 85 are in nursing homes. In addition, 60% of all persons entering a nursing home remain there over a month with the average stay being 15 months. Furthermore, 73% of all nursing home residents are women.
A skilled nursing facility is the one which most often is pictured when a person thinks of a nursing home. Patients who are seriously ill, but do not need a hospital are placed in a skilled nursing home. There are nearly 10,000 such nursing homes with nearly 700,000 beds in the United States. To be covered by Medicarea skilled nursing facility must have a physician as a medical director and at least one registered nurse on duty at all times.
Another type of nursing home is called an intermediate care facility. Such a nursing home is closer to the concept of a retirement home. In an intermediate care facility the medical care and services provided are far less than in a skilled nursing facility. A registered nurse only has to be on duty eight hours per day, and a medical director is not required by Medicare. There are nearly 5,000 such nursing homes with about 250,000 beds in the United States.
The final type of nursing facility is a board-and-care home. These facilities are not true nursing homes and provide no nursing services. They provide room, board and basic cleanliness. In most states anyone can open such homes provided they meet basic fire and safety standards. Many of these nursing homes are nothing more than converted private homes in which private bedrooms have been assigned to the patients. Most of the abuses associated with nursing homes have arisen in the board-and-care homes. Such homes are not required to have any professional medical personnel to oversee the quality of the care provided. This is not an indictment of board-and-care homes, but it is a statement that such homes can permit the uncaring to victimize the unprotected.
Information regarding a particular nursing home can be obtained from the local health department, department of social services, or Department of Social Security if Medicare payments are to be made to them. A person can check state corporate-name filesor fictitious business-name filings of a county to determine who actually owns the nursing home. In addition, a check of court records will disclose if the nursing home has ever been sued for negligent service. These are basic steps that everyone should undertake before selecting a nursing home.
III. COST OF NURSING HOMES
The cost of nursing homes increases each year throughout the United States. In 1975 the cost of nursing home care was over $7 billion. In 1987 that figure had increased to nearly $40 billion: a five-fold increase in just 12 years. As covered in the previous chapter, Medicare and Medicaid pay for most of the nursing care in the United States, but they do not pay for all of it. Medicare, for example, paid less than 2% of the nursing-home costs. The Medicare Catastrophic Act of 1988 limits annual Medicare payments for the care provided by a skilled nursing facility to 150 days of coverage. Medicare does not pay for intermediate care or board-and-care facilities because they are not considered medically necessary for treatment of a medical condition. Medicaid paid 52% of the nations nursing-home costs, but only after the covered persons exhausted their financial resources. Social Security, through the Supplemental Security Income (SSI) program, the Veterans' Administration and other federal programs may pay for some of the intermediate facility or board-and-care costs. Still, after all the government programs, individuals either personally or through private insurance had to pay 44% of the nation's nursing-home costs.
Nursing homes are expensive. A skilled nursing home can easily cost $3,000 per month. The costs vary by the type of nursing home and quality of services which they provide. Nursing homes receiving Medicare or Medicaid payments must accept their payments from Medicare and Medicaid as full payment and cannot charge the patient anything for basic services. A nursing home being paid directly from Medicare or Medicaid cannot require the patient to provide a deposit for services. Such a deposit can be demanded of private patients when Medicare or Medicaid is not paying the home directly.
IV. NURSING HOME INSURANCE
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The ultimate in estate planning is cryogenics. Cryogenics is freezing the body of a dead person so it can be brought back to life sometime in the future when the technology to do so is developed. In fact, it is possible to do a lay-away plan where a person has his head cut off and frozen. This is done with the hope that in the future an entire new body can be cloned and the head attached to it. The person first has to be declared dead. The question becomes: What will happen to the body? Whether we believe we come back in another form or pass to a higher plane of existence, we will nevertheless travel to a realm where no one ever returns. We cannot take it with us. That is not to say that people have not tried to do so. The Pharaohs of Ancient Egypt, the Mayans in Central America and the Celtic tribes in Europe all attempted and failed to take their worldly goods with them.
So what then is left for us to do? Lacking a philosophical bent, we can only offer practical and pragmatic answers for the living. The only answer that makes sense is that if a person cannot take the estate with him, it should be given to those for whom the person cared. For most people that means simply giving the estate to family members and loved ones. If the estate is going to be given away, it makes sense to give it to loved ones rather than to the government in the form of avoidable taxes.
The purpose of estate planning is to help a person build a large estate during life and to pass as much of it as possible to the loved ones upon death. This section attempts to present the various types of available estate planning.
An estate plan is the procedure by which a person attempts to preserve the assets of his estate during life and distribute them after death. The main considerations in estate planning are avoiding probate, reducing estate and inheritance taxes and quickly distributing the estate to the designated heirs.
A complete estate plan will consider methods for preservation of the estate during life by maximizing income while reducing income taxes that must be paid. The costs of probating a will are large. An old joke: If the person was not already dead, the cost to probate his estate would kill him.
Probate costs include court fees, appraisal fees, attorney fees and executor fees. Court costs and appraisal fees are modest: a couple of hundred dollars for an average estate. The real costs are the attorney and executor fees. The maximum amounts of attorney and executor fees are set by statute and approved by the court. They are based upon the size of the estate (value of the property to be probated) and increase as the estate increases. In California, for example, attorney and executor fees are calculated as follows:
1. 4% of the first $15,000; maximum $600.
2. 3% of the next $85,000; maximum $2,550.
3. 2% of the next $900,000; maximum $18,000.
4. 1% of the next $15,000,000 and .5% thereafter.
For example, a $100,000 estate probated in California would have to pay maximum attorney and executor fees of $6,300: $3,150 each to the executor and attorney. The attorney and executor can agree to take less or no fee at all.
Avoidance of probate fees is a major inducement for implementing an estate plan. When a revocable trust is used, there are no probate fees. The estate passes immediately to the designated beneficiaries of the trust. No court proceeding is needed to transfer the property of a trust, so no attorney is needed. There are several means to avoid having to probate property. The probate avoidance vehicles are:
1.Summary probate proceedings in the decedent's state. A summary probate is an abbreviated procedure for small estates or for transferring the entire estate to a surviving spouse. Many states have adopted special procedures to by-pass the expense and long delay in probating such estates.
2.Giving the estate away while alive.
3.Placing the property into joint tenancy with the proposed heirs. Upon death, title for the property passes immediately without probate to the surviving joint tenants. Real property held in joint tenancy passes to the survivors without a probate by recording a notice of the death of a joint tenant.
4.Placing the estate into a revocable trust that passes theestate to the designated beneficiaries immediately upon the decedent's death.
This is the most popular form of estate planning. It is fast and bestows the maximum amount of control and property over the estate.
In order to determine the best type of estate plan, one must fully understand the size of the estate, how he wishes to distribute it and the amount of control he wishes to relinquish to effectuate the estate plan.
A revocable trust is usually the best means of estate planning. The creator of the trust, called the "trustor" or "grantor," places his entire estate into the revocable trust. The trustor usually is the trustee (the person who manages the estate). There is a beneficiary (the one who will benefit from distribution of the trust). Upon the trustor-trustee's death, the person named in the trust document as successor trustee becomes the trustee immediately without court approval being needed. Depending on the terms of the trust, the new trustee either dissolves the trust and distributes the assets immediately in the manner designated in the trust document or continues to operate the trust in the manner directed by the trust document.
Since there is no probate, there are no probate costs. The savings for the estate with a revocable trust are several times the cost of creating the trust. Because the trust is revocable, the trustor can alter, amend or revoke it at any time. If the trust is revoked, the trust assets immediately return to the trustor.
The standard estate plan that includes a revocable trust, durable power of attorney, living will, and pour-over will is usually between $500 and $1,100, depending on the type of trust. There are different types of trusts. Different trusts are tailored to whether or not the grantor is married, has children, or wants a joint trust between the spouses. Special trusts such as life insurance trusts, generation skipping trusts or charitable trusts can also be part of an estate plan.
All 50 states and the federal government accept as valid a revocable trust. If the trust was validly created in the original state, all the other states will honor and enforce it. Provisions can also be placed into a trust document stating that the terms of the trust are to be administered by the laws of a certain designated state. All states will apply the laws of the designated state in administrating the trust. Even if the trustor moves to another state, the trust will still remain valid and in effect.
II. FEDERAL ESTATE AND GIFT TAXES
The federal estate and gift tax rate is graduated and increases as the size of the estate increases over the unified credit. Example: A taxable estate of $100,000 has a tax of $23,800; a taxable estate of $250,000 has a tax of $70,000; a taxable estate of $500,000 has a tax of $155,000; a taxable gift of $2,5000,000 has a tax of $1,025.800.
A. UNLIMITED MARITAL DEDUCTION
Under federal law there is no federal gift or estate tax on property transferred between spouses. This is an unlimited credit that has only two exceptions:
1.It must be an actual gift. If the gift is in trust, all of the income must go to the spouse.
2. The spouse receiving the gift must be an American citizen. Gifts to a non-citizen spouse are not eligible for the unlimited deduction but are eligible for a $100,000 annual exclusion (Section 2523 of the Internal Revenue Code). Likewise, property passing from an American spouse to an alien spouse after death does not qualify for an unlimited marital deduction either. Special tax rules apply for such transfers, and a tax consultant should be consulted if the estate of the American spouse exceeds $600,000.
Therefore, a person can generally pass his entire estate to a surviving spouse without incurring any federal estate taxes. This may not ultimately be the best estate plan. If the property given to the surviving spouse boosts the surviving spouse's estate over $600,000, the surviving spouse's estate will have to pay estate taxes upon the death of the surviving spouse. Any gift to a surviving spouse that would boost his estate over $600,000 in value should be made after using the decedent's unified credit.
B. UNIFIED CREDIT FOR GIFTS OR ESTATES
Every person is permitted by federal law to transfer assets totaling $600,000 by either gift or death without incurring a gift or estate tax. Example: A person can give $275,000 in gifts while living and pass an estate of $325,000 after death without the estate paying any federal gift or estate taxes.
About half of the states impose their own estate and inheritance taxes. These taxes should also be a consideration inestate planning. The Internal Revenue Code permits a small credit for state death taxes to be applied against the federal estate. The $600,000 unified credit permits a husband and wife to give to their children a total combined estate of $1,200,000 before incurring any estate taxes. A person giving his entire estate to a surviving spouse is not taking advantage of his spouse's unified credit. It is simply good planning to use the spouse's $600,000 unified credit when the trustor's estate exceeds $600,000.
C. ANNUAL EXCLUSION FOR GIFTS
Under federal tax law every individual may make an annual gift of $10,000 per person without incurring a gift tax or having the gift applied towards the $600,000 unified credit. A parent having four children can give each $10,000 for a total of $40,000 each year free of gift taxes. The advantage of making these gifts is that they help reduce the size of the estate below $600,000, eliminating federal estate taxes.
An alien spouse does not qualify for the unlimited marital deduction. In place of the unlimited marital deduction an alien spouse is permitted to receive as a gift from the other spouse $100,000 per year tax free.
D. GIFT TAX ON CREATION OF TRUST
If the trust is revocable, there is no gift tax because the trustor can always revoke it. All income is still taxed to the trustor. If the trust is irrevocable with the trustor as the beneficiary, there is no gift tax because the trust is still for the trustor's benefit. Such a trust is called a grantor's trust,and all trust income is taxed to the trustor. If the trust is for the spouse, there is no gift tax because of the unlimited marital deduction. If the trust is for someone other than the trustor or the trustor's spouse, a gift tax is owed. The gift tax must either be paid or deducted from the unified credit or annual exclusion.
III. BASIC TYPES OF REVOCABLE TRUSTS
A. A JOINT TRUST
A common estate plan is where both spouses create one joint revocable trust. In this joint trust both spouses create one joint revocable trust and place all their property into the trust. The spouses' property is listed on schedules marked his, hers and theirs. On the death of the first spouse the trust is divided into separate trusts for the surviving spouse and the children or heirs. This joint trust is usually the most economical estate plan because it plans for both estates. The cost for doing the joint estate plan is less than the cost of a separate estate plan for each spouse.
The trust is totally revocable during the joint lifetimes of the spouses; either spouse may terminate it at any time. Upon the death of the first spouse the trust usually becomes irrevocable as to the property of the deceased spouse, but the surviving spouse usually retains full power to revoke the trust as to the property that he contributed to it. This type of trust gives the spouse maximum control over their assets. This flexibility accommodates future changes in the surviving spouse's life following the death of the first spouse.
B. AN A-B TRUST
The A-B Trust is the common name given to the general type of revocable trust used by a married person with children where the trustor's estate exceeds $600,000. It is also called a "marital trust" or a "bypass trust." The trust exists for the benefit of the trustor during his life. At the trustor's death the trust is divided into two parts: the first $600,000 (or the remaining unused unified credit) is placed into the B trust, and the rest is placed in the A trust.
The sole beneficiary of the A trust is the surviving spouse. The surviving spouse has ownership of the A trust and usually has the power to terminate it and receive the assets in her (assuming the wife is the survivor) own name. Since the assets in the A trust go to the wife, and since there is an unlimited marital deduction the estate is not subject to federal estate taxes if the spouse is a U.S. citizen. Upon the surviving spouse's death all of the property in Trust A will be included in the surviving spouse's estate for calculation of estate taxes. Example: Upon the husband's death his $2 million estate was divided $600,000 to Trust B and $1,400,000 to Trust A. Upon the wife's death Trust A had grown to $1,700,000. In addition, the wife had $500,000 of her own estate. So, for tax purposes, the wife's taxable estate will be $2,200,000.
The beneficiaries of the B trust are the children. Income may be attributed to the surviving spouse, but the trust does not qualify for a marital deduction. It does qualify for a deductionto the extent of the trustor's unused unified credit ($600,000). Thus it is possible that there will be no federal estate tax on either trust. In the above example, if the assets in Trust B increased to $1,000,000 at the time of the wife's death, no estate taxes are due because the property placed into the Trust was originally tax free. If the $800,000 was originally placed into Trust B, the excess $200,000 would be taxable; after the taxes are paid, no additional estate taxes will be charged against it upon the death of the wife.
C. A QTIP TRUST
A QTIP trust is a special trust whereby the trustor's spouse is given all of the income from the trust with the principal being distributed to others ( usually the children or grandchildren) upon the surviving spouse's death. QTIP stands for Qualified Terminal Interest Property and is a fancy name for property given to a spouse in a certain type of trust.
A QTIP trust gives the option to the surviving spouse to have the trust property treated as a gift to the surviving spouse for estate tax purposes. If the election is made, the value of the trust will be treated as a spousal gift and exempt from tax because of the unlimited marital deduction. On the surviving spouse's death the value of the trust assets will be included in the surviving spouse's estate for the determination of the surviving spouse's estate tax.
Depending on the size of the surviving spouse's estate it may or may not be good financial planning to make the QTIP election andhave the value of the trust included in the surviving spouse's estate. For example, assume that the surviving spouse's estate is $100,000, and the QTIP trust is $100,000. The unified credit of the deceased spouse has previously been used. Making the election will save the trust from paying federal estate taxes until the surviving spouse dies. In the meantime the surviving spouse could draw a higher interest from the investment of the $100,000. If the surviving spouse's estate grows after making the election, tax will ultimately be required on the growth at the death of the surviving spouse.
D. A GENERATION-SKIPPING TRUST
A generation-skipping trust is a trust that skips one or more generations (grandparent's trust for grandchildren that bypasses the parents). The exception is when there are no parents surviving the grandchildren; then it is treated as a direct trust. A generation-skipping trust is complicated tax-wise. Although easy to create, it should not be created without first consulting a tax advisor because of the inherent tax consequences. $1,000,000 can normally be placed in a generation-skipping trust without incurring an estate or gift tax (provided the uniform credit has not been used previously).
Any amount placed in the trust over $1 million is taxed at a rate of 50% at the time of any distribution. A distribution occurs when the parents of the grandchildren die or the grandchildren receive money from the trust. The purpose of this law is to avoid amassing huge estates by not paying taxes. These trusts onlyaffect very wealthy people. The tax consequences of a generation-skipping trust are so great that one should not consider funding one with more than $600,000 without professional tax advice.
IV. CREATION AND OPERATION OF A TRUST
A trust is created very easily. The trust document is drafted, usually by an attorney, and directs how the trust estate will be administered and distributed. The trustee acts in accordance with the terms of the trust. The trustor and trustee must both sign the trust document. If the trustor is also the trustee, he signs the trust agreement twice: as trustor and or trustee.
The final requirement is that the trust be funded. Funding the trust requires that the trustor place into the trust all of the property the trustor wishes to be in the trust. All of the property of the trustor should be placed into the trust. Anything left out of the trust will have to be probated unless it is joint-tenancy property or insurance policies with designated beneficiaries other that the decedent's estate.
Any property that has a title must have the title specifically transferred to the name of the trust. Merely stating in the trust agreement that such property is to be placed into the trust is insufficient to put the property into the trust legally. For example, assume that the trustor owns a home. Since a home has a title document, the title must be changed to name the trust as the owner. A quitclaim deed by the trustor to himself as trustee must be executed and recorded. This is simple to do and usually is donewhen the trust is created.
Placing a piece of real property into a trust should not trigger a reassessment of property taxes because the transfer is not really a sale or conveyance of the property. The property is put into a revocable trust, which the owner can terminate at any time and title to the property reverts to the owner. California law specifically states that merely placing real property into a revocable trust for estate-planning purposes does not trigger reassessment as long as the grantor is alive. This is just common sense. Reassessment occurs when there is a change of ownership. Placing the real property into a revocable trust is not really a change in ownership because the trustor still controls it and can have the property returned to him at any time.
Personal property that does not have a title (such as a television or furniture) is transferred automatically by a statement in the trust document showing the intent of the trustor to put into the trust all personal property wherever located. Property that has a title (such as a house or car) must have the title specifically changed to make the trust the owner. Merely stating an intent to place the house or other property that has a title into the trust is insufficient. The only way to put property that has a title into a trust is to actually change the title on the property so that the trust is listed on the title documents as the owner. Property once placed into a trust is treated like any other property that is not in a trust.
To sell any of the property that has no title (such as a radioor stove), one merely sells it. To sell any property that has a title (such as a car), one sells it by transferring title. All that is needed to sell real property from a trust is a deed executed by the trustee. The trustee merely signs the deed as the representative for the trust and upon recordation the title is passed. For example, the deed from the trustee will read: "John Doe, Trustee of the John Doe Revocable Trust, hereby deeds, conveys, sells, and transfers to John Smith all right, title and interest in the following property."
A revocable trust is considered for tax purposes a grantor trust. The Internal Revenue Code recognizes a grantor trust as a type of trust created for the benefit of the person creating it: all of the income from the trust is attributed to the grantor for tax purposes. Since all of the income is attributed to the grantor for as long as he is alive, the grantor remains liable for the income taxes. A revocable trust does not save the grantor any money on income taxes because it is not designed to do that. A revocable trust exists to avoid probate and save estate taxes, not to save income taxes.
A trust can be made irrevocable. Sometimes it makes good financial sense to do so. For assets in a trust not to be included in a trustor's estate, the trustor must not have control over the trust and must not have reasonable expectation that the trust will revert back to him. If the trust is revocable, the trustor has a great deal of control over the trust. The fair market value of the assets of the trusts will be included in the trustor's estate upondeath for estate tax calculations. If the trust is made irrevocable, and the trustor has no control over the trust, the assets in the trust and all appreciation in value will not be included in the trustor's estate. This could pass a great deal of appreciation to the trustor's heirs without having it taxed. It is because a life insurance trust is irrevocable that the proceeds of the insurance on the decedent are not included in his estate.
A revocable trust does not need to be recorded. Unlike a will it is a private document. The only documents that need recordation are the deeds transferring real property into the trust. In some states a revocable trust is required to be registered and a copy lodged with the probate court. To register, a short statement is filed listing the trustee and giving some basic information. Registration gives the court jurisdiction to oversee the trust. There are no penalties, however, for failure to register. The states requiring registration are Alaska, Colorado (after the death of the grantor, and no registration is required if there is an immediate distribution to the beneficiaries), Hawaii, Idaho, Michigan, New Mexico and North Dakota. Florida and Nebraska do not require registration with the probate court, but both states allow it and suggest it.
V. THE FEDERAL ESTATE TAX RETURN
Federal estate tax return Form 706 is required to be filed whenever the decedent has an estate greater that $600,000. The requirement to file the estate tax return does not depend on any taxes being due or probate being required. If the estate isgreater than $600,000 the tax return has to be filed.
Form 706 tax return has to be filed even if the entire estate is going to the surviving spouse under a trust and is entirely exempt from estate tax as an unlimited marital credit. Likewise, a Form 706 tax return has to be filed even if the entire estate is given to charities exempt from tax under the Internal Revenue Code.
VI. TERMINATION OF A TRUST
I. DEFINITION OF PROBATE
"Probate" is the name for the entire legal proceeding in a probate court to determine how to distribute the estate of a deceased. Probate is the legal mechanism whereby a court states who gets the estate. Probate of a deceased's estate is necessary when the decedent did not plan his final affairs beyond preparing a Will. Appropriate estate planning avoids probate altogether while providing for the immediate transfer of the estate to the designated heirs.
Probate proceedings are long, cumbersome and expensive. They are avoidable with proper estate planning. In recognition of the difficulties and expense of probate many states have enacted laws waiving probate or streamlining procedures for small estates (usually under $60,000). These summary probates usually involve nothing more than filing petitions with the court stating that the estate is too small to be managed effectively and that it should be distributed without administration to the heirs. Summary probate procedure is available only for small estates. Above a certain value, usually $60,000, a regular probate is required. A person whose estate exceeds $60,000 should develop a simple estate plan and avoid probate.
II. THE PROBATE COURT
The probate of a deceased person's estate is handled througha probate court. It is a special department or court under a court of general jurisdiction. The probate court oversees the administration of the probate estate. The probate court is responsible for performing the following functions:
1. Appointing the legal representative of the estate.
2. Supervising the representative.
3. Receiving and evaluating the inventories, accountings and other reports of the representatives.
4. Assuring that all bills, taxes and claims against the estate are paid by the representative.
5. Overseeing the distribution to the heirs.
6. Closing the estate and releasing the representatives from further responsibility.
The estate remains under the control of the personal representative until the probate court issues the final order of distribution. It can take years for an estate to be closed and the assets distributed to the heirs.
III. THE LAST WILL AND TESTAMENT
A Will is the final testament a person makes to ensure his earthly possessions go to whom he wants them to go. A Will is totally revocable during one's life. A Will usually must be in writing and witnessed by two or more adult persons. The witnesses usually cannot be heirs mentioned in the Will.
In some states an oral Will made in immediate contemplation of death may be valid to distribution of the estate. The creator of the Will (testator) must be legally competent to make the Willand not be insane or otherwise mentally impaired.
Unless a clause of the testator's last Will specifically revokes all prior Wills, all of the Wills of the testator must be read together. The probate court then will determine how the estate will be distributed. Therefore, all Wills should have a simple clause revoking all of the testator's prior Wills.
A Holographic Will is a Will that is written entirely in the handwriting of the testator. Some states, such as Colorado and California, do not require a Holographic Will to be witnessed. Most states require a Holographic Will to be witnessed. Many states will not accept a Holographic Will as valid if there are any pre-printed or typed portions of the Will. Some states will permit pre-printed language in the Will if the material provisions are entirely in the testator's own handwriting. To be safe a Holographic Will should have two or more witnesses. That means, however, that it is no longer a Holographic Will, but an ordinary Will. Generally, Holographic Wills should not be used because they raise the potential issue of forgery. A case in point was the alleged Holographic Will of HOWARD HUGHES. The distribution of his estate of several billion dollars hinged on a purported unwitnessed Holographic Will. After years of legal wrangling, the court ruled that the Will was a forgery, but there are still some experts who believe it wasn't. If it was real, however, the issue of competency then exists because most sane people would not give away millions to strangers.
A Will must be signed, dated and, unless typed, be writtenentirely in the handwriting of the testator or be an approved Statutory Will (a pre-printed Will authorized by statute in the testator's state of residence). Many states have created Statutory Wills. These Statutory Wills comply with all of the terms for a valid Will in the state. They are pre-printed blank Wills on which the testators simply fill the blanks, sign and have notarized. Nearly all states have approved Statutory Wills for their citizens which are sold in stationery and office supply stores. A Statutory Will still has to be probated the same as any other Will. Statutory Wills are usually designed for use in the simplest of estates.
It is important that whenever a pre-printed do-it-yourself Will is used that the person pay particular attention to detail. A telling example of this is an actual case where a woman used a pre-printed Will. She was unmarried and had lived for 30 years with a man. She had a child whom she had not seen for over 30 years. She left everything to her male companion in the Will. Unfortunately, the Will she had bought and used was titled "Single Without Children." Her son filed a claim as a pretermitted heir and was awarded her entire estate. The man who had been with the decedent for 30 years received nothing because the woman chose the wrong pre-printed Will.
If a deceased person's Will cannot be found, the general presumption in law is that the person destroyed it. The estate will be distributed in accordance with the state's laws of intestacy. It is next to impossible to prove the existence of a missing Will and what it contained to the satisfaction of a court. If an heir can do so and also convince the court that the Will was inadvertently destroyed, the court might possibly distribute the estate as intended. Example: George made a Will and gave a copy to a friend and placed the original Will in his son's house, which was destroyed by fire. The court might distribute the estate according to the copy. The evidence needed to prove to the court that the deceased did not destroy a missing Will is overwhelming.
The better tactic is for the person to sign two duplicate Wills with a general provision stating, "I have executed this last Will and testament in duplicate with one copy being held by my attorney. On my death if the Will in my possession cannot be found, it is not to be presumed that I revoked it. The Will in the possession of my attorney can be admitted in probate and treated as though it was the Will in my possession."
Because a lost Will is presumed to have been revoked, a probate court will not accept a copy of a Will into probate unless it can be shown to its satisfaction that the original Will was not destroyed by the deceased. The general presumption is that the decedent revoked the Will if it is missing. Producing a copy of the Will proves the contents of what was in it but does not prove that the deceased did not revoke it. Example: A fire kills the testator and destroys the Will at the same time. It then falls upon the heirs to prove that the testator did not destroy the Will prior to the fire. Therefore, execute the Will in duplicate with a clause that if the Will is not found in the deceased person's possessions, it is not to be presumed to have been destroyed.
IV. LEGAL COMPETENCE TO MAKE A WILL
In order to create a Will that is valid, the testator must be legally competent to do so. The issue of competency is critical when determining the validity of a Will. Will contests based upon competency are the most difficult cases in the law to win. The creator of the Will is dead, and the intent of a deceased testator has to be proven by extraneous and parol evidence that:
1. The testator was an adult or emancipated minor.
2. The testator knew the nature and quality of his estate.
3. The testator knew those who were the natural objects of his bounty (must have known his or her family).
4. The testator was mentally competent and not suffering from any insane delusions as pertained to the members of his family.
5. The testator was not on mind-altering drugs or alcohol when the Will was executed.
6. The testator knew that he was making a Will.
If these elements are not met, the Will is invalid no matter how many witnesses were present when it was executed. Competency is interesting because it does not have to be permanent. A person can be insane, have a temporary return to sanity, sign the Will and relapse into insanity: the Last Will and Testament will be valid.
The issue of competency most commonly arises when an elderly person creates a Will close to the time of death or while under some type of medical treatment that might cloud judgment. Most Will contests arise by someone claiming the decedent was trickedinto signing a Will.
A person is said to have died intestate if that person died without having executed a valid Will. The estate of a decedent whose Will is declared invalid will be treated as if he died without a Will. An unemancipated deceased minor's estate will be treated as though the minor died intestate. Minors cannot write a valid Will. If a Will is declared invalid for any reason (failure to be witnessed, having improper witnesses, being under age, lacking mental capacity, etc.), the decedent's estate will be distributed as though he died without creating a Will.
When a person dies intestate, the estate usually is divided among the immediate family as follows:
1. If there is a spouse and a child, the estate is divided evenly between the two.
2. If there is a spouse and more than one child, one third of the estate goes to the spouse, and the rest is divided among the children.
3. If there is a spouse and parents and no children, the estate is split between the spouse and parents.
4. If there are parents and no spouse or children, it goes to the parents.
5. If there are no parents, spouse or children, the estate goes to any brothers and sisters.
The probate court will keep searching for heirs until it finds someone to receive the estate. To find an heir to Howard Hughes' estate the court ultimately found a distant cousin by adoptionseveral times removed.
V. INVALIDATING A WILL
A probate court will declare a person's Last Will and Testament invalid when:
1. The testator was an unemancipated minor, usually under eighteen years of age.
2. The testator did not sign it or have enough witnesses, or the witnesses were heirs and thus disqualified, or the witnesses were minors. In most states people named in a Will as receiving property cannot be witnesses. Their signatures are invalid. If there are not two, and in some cases three, good witnesses, the Will is declared invalid.
3. The testator was mentally incompetent at the time the Will was executed.
4. The testator was forced to make the Will as a result of fraud, duress or undue influence of another.
5. The oral Will was found invalid because it exceeded the statutory amount that can be passed by an oral Will.
6. A Holographic Will was not entirely in the handwriting of the testator or not signed or not dated.
When a Will is declared invalid, the last valid Will of the decedent will be admitted into probate. If there is no valid previous Will, the decedent's estate will be distributed in accordance with the decedent's state laws.
VI. CONSIDERATION IN MAKING A WILL
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XVII. ESTATE AND INHERITANCE TAXES
A common misconception is that probate exists as a means for the state or federal government to collect taxes. That is not the case. Estate and inheritance tax rates are based on the size of the estate and the relationship of the heirs to the deceased. It is irrelevant to the taxing entities whether or not a probate is conducted when determining the tax liability.
For example, assume that a person gives $800,000 at his death to his children. It makes no difference if the $800,000 comes to the children from probate or through a revocable trust. There is greater cost if the estate is probated rather than passing it through a trust, but the tax rates are the same. The tax is on the money and property distributed after death, not whether or not it comes from probate.
Some states will freeze jointly-held property (such as bank accounts, real estate and brokerage accounts) until the taxing entities have time to assess the value of the decedent's interest in the property. In particular, New Jersey and South Carolina require 10 day's written notice to taxing agencies before securities, deposits or assets of a decedent may be transferred outside of probate. In the states that freeze the assets pending a tax determination, a limited amount may none-the-less be transferred to a spouse or children without having to give the required notice. New Jersey permits $5,000 to be transferred tothe surviving spouse without having to wait the required 10 days.
The purpose of permitting limited transfer for use by the family is to keep the spouse and family from destitution while the taxing authorities determine what amount of tax is owed. It is markedly unfair to seize the joint property of one person merely because the other joint tenant died. Consequently, the notice period is usually small.
There is a lifetime federal unified credit of $600,000 for gift and estate taxes. This means that no federal estate taxes will be owed unless an estate exceeds $600,000 (including the value of lifetime gifts). Under the Internal Revenue Code a personal representative can file a request with the IRS (and sometimes the state taxing agency) for a final assessment of the taxes owed by the estate. The IRS has three years in which to assess additional taxes. If the personal representative makes a request for a prompt assessment, the IRS has to complete the assessment within 18 months. After the assessment is done, the personal representative can pay the tax, distribute the remaining estate to the heirs and be discharged without any liability for future taxes.
XVIII. USE OF JOINT WILLS
Joint Wills are trouble and must be avoided. The problems are obvious. A married couple makes a Joint Will; one spouse dies; the survivor wished to change the Will; the ultimate beneficiaries, usually the children, object. Whether the surviving spouse can alter a Joint Will depends both on the language of the Will and the state law where the Will is probated. If the Will states thatafter the death of one spouse the survivor cannot amend or revoke, most states would enforce that provision on contractual grounds. These states take the position that the deceased spouse would not have executed the Joint Will had he known that it could be changed after death.
If the Joint Will does not have the language making it irrevocable and unamendable, the court Will try to decide the intent of the parties when they drafted it and base its decision on that determination. There simply is not any real justification for running this type of risk. Individual Wills are relatively cheap, especially statutory Wills, so cost should not be the determinative factor in deciding upon use of a Joint Will.
XIX. CHANGING A WILL
A "codicil" is an amendment to a Will. It does not revoke the entire Will, but it does change certain provisions. The probate court will read the Will and all codicils together to determine the final intent of the deceased. A codicil is, in essence, a mini-Will. It is prepared, signed and witnessed in the same manner as an ordinary Will. Particular care must be taken in writing a codicil to define just what changes are to be made in a Will. If an heir is to be removed or added, it must be clearly stated. A codicil should be kept together with the Will to assure that it will not be overlooked when the estate is probated. A codicil is governed by the same rules as a Will. Therefore, if a codicil is missing, it will be presumed to have been previously revoked unless conclusively proven otherwise.
All changes to the Will must comply to the same formalities used in making a codicil or new Will. A person who simply deletes old provisions or inserts new clauses brings the validity of the Will into question. A person can revoke his Will at any time by another Will or simply by destroying the old Will. Some states would consider the writing of the new clauses an effective revocation of the old Will yet ineffectual in creating a new Will.
A person should never write a change on the face of a Will. All changes to a Will should be by a valid codicil or a new Will in accordance with the requirements of the state of domicile. Given the ease with which new Wills can be created, especially Statutory Wills, there is no reason to risk invalidation of an existing Will by writing on it. Just prepare a new Will or a codicil.
XX. WHEN A WILL SHOULD BE CHANGED
Unless changed, once a will is drafted, it is valid forever. As time passes, a person's needs and circumstances change. A will drafted years earlier may no longer fulfill the current needs and desires of the person. A will should be changed to reflect the true intent of the person.
The following changes in a person's life should immediately cause a review of the person's will:
1. A change in marital status. Marriage makes the new spouse a pretermitted heir. A divorce might not cut the ex-spouse out of the will.
2. Children are born or adopted. State laws allowunmentioned children to claim a portion of an estate as pretermitted heirs. These children, however, might not receive under state law what the decedent would have given them.
3. Step-children. In most states step-children of a deceased have no rights to inherit under a step-parent's estate. Therefore, if a step-parent wishes to make dispositions to a step-child, that intent must be specifically stated in a will.
4. The value of the estate changes and the earlier gifts were too much, too little or there is now enough to give to others as well.
5. The intended heirs, executors, guardians or trustees have died.
6. Changes in estate or inheritance tax laws that make changing the will advisable to save on taxes.
7. The necessity for testamentary trusts for surviving spouse and children no longer exists.
A Will should be reviewed every few years for possible changes. Tax laws change frequently, and wills should be reviewed to ascertain their effect on the estate.
XXI. DISINHERITING A CHILD
Most states permit a parent to disinherit a child: prevent the child from receiving anything from the parent's estate. While possible, the intent to specifically disinherit a child must be detailed in writing. The laws of all states presume that a parentdoes not intend to disinherit a child unless specifically stated in the will. If a child is simply not mentioned in the will, the court will presume it was an error and award the child his intestate share of the estate.
Louisiana has several probate laws different from the rest of the nation. While the rest of the nation derived its basic law from English Common Law, Louisiana derived its law from French Napoleonic Code. Louisiana permits the disinheriting of a child only on one of 12 different grounds. Therefore, in Louisiana a parent cannot disinherit a child, no matter how specifically the intent to do so is stated in the will, unless one of the 12 grounds are met. These grounds run from a minor marrying without consent to planning to murder a parent.
XXII. PRETERMITTED HEIRS
A probate court will presume that a parent did not intend to disinherit a child unless the intent is specifically stated in the will. This comes into play in the pretermitted heir situation. A pretermitted heir is an heir, usually a child, who is not mentioned in the will, but who would have inherited under a state law if there had been no will. When the court finds the existence of a pretermitted heir, the court will award that heir his intestate share of the estate. For example, assume that Mary wrote a will leaving her estate to her three children. Mary later had a child out of wedlock and died shortly thereafter. Mary's will did not mention the new baby. The court, however, will find the baby a pretermitted heir and award the baby her intestate share ofthe estate which is one-fourth.
A step-child is not a pretermitted heir and has no right of inheritance under the law. California has created a novel statutory provision that permits a person to claim a defacto adoption if certain elements are met. California requires there be a parent-child relationship between the people and that an adoption was not possible because of some legal impediment. If these elements are met, the court will treat the person the same as an adopted child and award him an intestate share of the estate.
As with a pretermitted heir, a court will presume that a deceased spouse did not intend to disinherit a surviving spouse unless it is specifically stated in the will. A pretermitted spouse is a surviving spouse who is not mentioned in the deceased spouse's will. In all states a surviving spouse will inherit from a deceased spouse's estate, under each state's laws. It matters not that the surviving spouse is pretermitted or disinherited by a clause in the will, the state law will provide for inheritance. When the court finds a pretermitted spouse, it will award that spouse the intestate share of the estate. Example: Mary wrote a will leaving her estate to her three children. Mary then remarried and died 20 years later. Mary's will did not mention the husband. The court will find the new husband a pretermitted spouse and award him his intestate share of the estate, usually a third.
XXIII. EFFECT OF A TESTATOR'S DIVORCE ON A WILL
A few states, like California, have enacted laws that specifically prevent an ex-spouse from inheriting under a deceasedex-spouse's will that had been drafted at the time of their marriage. In most states, however, an ex-spouse will be entitled to share in the estate where the decedent failed to rewrite the will after the divorce. Most states take the view that the decedent must have wanted to make gifts to the ex-spouse because the will was not changed. Those courts will honor that perceived intention.
No one should ever assume that a divorce removes the rights of the ex-spouse to inherit under a will. In cases of divorce, a new will or a codicil should be drafted to state that the ex-spouse is not inheriting under the will. A new will should be written as soon as the divorce papers are contemplated and should certainly be in place when the divorce is filed. Some die during a divorce (in fact its been the basis of many mystery movies). The marriage is still legal. Thus the surviving spouse receives property under the deceased spouse's old will even though granting the divorce would have invalidated the will. Example: An attorney defended a woman charged with the murder of her wealthy husband. The woman had shot her husband six times. He defended her successfully. Because it was not murder, she inherited his estate of $26 million.
XXIV. ANCILLARY PROBATES
An ancillary probate is a proceeding conducted in a state other than the state that was the decedent's permanent residence. Every state is responsible for probating the real and personal property located within it. If a deceased owned property in more than one state, a probate may be required in each such state inaddition to the state of the decedent's domicile. Example: Robert died with a home in Georgia and another in Alabama. Probates must be opened in both Georgia and Alabama for the house in each state. If a decedent owns oil and gas leases in six states, there will be ancillary probates in five of the states plus a probate of the majority of the decedent's estate in the state of domicile.
Additional problems arise if the states have differing requirements for a valid will. Example: The domicile state requires two witnesses, but the state with the ancillary probate requires three witnesses. The will may be invalid in the ancillary probate state, and the property located therein will be distributed by its law of intestacy.
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JOINT TENANCY AND GIFTS
I. JOINT TENANCY
Joint tenancy is a statutorily created form of property ownership which permits co-ownership by two or more persons with the right of survivorship. Upon the death of one of the owners, called a joint tenant, his interest passes automatically to the surviving joint tenants without the need of any probate or judicial proceeding. This automatic passage of property outside of any probate is the reason joint tenancies have become a popular tool of estate planning.
A joint tenancy in property must be expressly created by a written instrument, usually the title or deed for the property. The instrument must contain language that reads substantially "To A and B as Joint Tenants." Anyone can be a joint tenant with any other person. Usually spouses or parents and their children are joint tenants, thereby avoiding probate of the property when one spouse or the parents die. For example, assume that a father has a piece of property. The father executes a joint-tenancy deed which places his four children on the deed with him as joint tenants. Upon the father's death, the father's remaining share in the property is divided automatically without probate among his four children. Each of the children own an undivided one-fourth of theproperty.
The creation of joint tenancy in real property is relatively simple and painless. The one transferring the property states in the deed that the property will be received by the new owners as joint tenants. For example, assume that George Smith sells property to buyers Adam Quick and William Hauser as joint tenants. Upon the death of either Adam Quick or William Hauser, the other surviving joint tenant will inherit the property without the necessity of a probate. Likewise, George Smith places his daughter Alice Smith as a joint tenant on the title of real property that he owns. Upon his death the interest held by George Smith will pass on to his daughter Alice Smith without a probate.
It makes no difference what type of deed is used to create a joint tenancy. A quitclaim deed, warranty deed, grant deed or even an installment sales contract can be used to create a joint tenancy as long as the operative language is included in them. A joint tenancy is created by specific language to the effect that the recipients are receiving the property "as joint tenants." Example: George Smith creates a joint tenancy with Alice Smith with the language "From George Smith to George Smith and Alice Smith as Joint Tenants." The effect of such language is to give Alice Smith one-half of the property immediately plus a right of survivorship in George Smith's remaining share of the property.
Personal property has no title and needs a written document stating it is intended to be joint tenancy property. Common sense dictates that without such a document it is impossible to prove theproperty was held in joint tenancy. For example, assume that a person dies with a ring worth hundreds of thousands of dollars. The ring is personal property and has no title. If the decedent had not previously executed a joint tenancy document placing the ring in joint tenancy with his children, the ring would have to be probated (assuming the ring was not put into a revocable trust).
A joint tenant owns an equal and undivided interest in the property, whether that interest was purchased or acquired by a gift. Each joint tenant's interest can be attached by the creditors of that joint tenant. For a case in point, a young woman's mother had placed her home in joint tenancy with her. The young woman had gotten into an auto accident and did not have insurance. She had been sued for damages and had a judgment taken against her. The creditor was executing against the mother's house to sell it and take the daughter's half interest. The woman was desperate to save her mother from losing her house. A payment plan was negotiated that allowed the mother to remain in her home until her death. Then it would be sold, and the balance of the judgment paid. The main drawback of a joint tenancy is that it is a complete passing of the interest given to the joint tenant.
Not all states permit property to be held in joint tenancy. Other states have laws that severely restrict its use. The following states have implemented laws regulating the use of joint tenancy property:
ALASKA does not permit the use of joint tenancies except between husband and wives.
N. CAROLINA permits joint tenancies only on bank accounts. It is not permitted otherwise even between spouses.
PENNSYLVANIA has had a series of court decisions that question whether there can be a joint tenancy in real property. Personal property joint tenancy still appears to be valid.
TENNESSEE does not permit the use of joint tenancies for any property except between husbands and wives.
TEXAS does not permit the use of joint tenancies for any property except between husbands and wives.
A joint tenancy can be terminated and turned into a tenancy in common (a co-ownership of the property without a right of survivorship) by any of the following acts:
1. Conveyance by one joint tenant of part or all of his interest. Any conveyance will terminate the joint tenancy because the other joint tenants did not agree to give the new co-tenant a right of survivorship in their interest in the property. In most states, such as California, a joint tenancy can be terminated by a joint tenant executing a deed covering his interest in the property to himself as a tenant in common. Example: George is a joint tenant with Ed. George can terminate the joint tenancy by executing a deed from himself to himself with the language "From George to George as tenant in common." George and Ed then become tenants in common. When George dies, his interest in the propertywill not pass automatically to Ed under right of survivorship.
2. Mortgaging by one joint tenant of his share of the joint tenancy property without the consent of the other joint tenants. For example, if George takes a loan on his share of the property. The joint tenancy terminates.
3. Leasing by one joint tenant of the joint tenancy property without the consent of the other joint tenants.
4. A few states permit the termination of a joint tenancy by a statement to that effect in a will. This, however, is a minority view not followed by the majority of states.
Once a joint tenancy is terminated, the right of survivorship also terminates. After the owner's death, the property must be probated to pass to the deceased owner's heirs.
About 20 states recognize a special form of joint tenancy between a husband and wife called tenancy by the entirety. When property is held as tenants by the entirety, neither spouse may obtain a partition of the property or do anything that will defeat the right of survivorship of the other. A tenancy by the entirety cannot be unilaterally terminated by the act of just one spouse. A tenancy by the entirety can only be terminated by the following:
1. A divorce which changes the ownership of the property into that of tenants in common.
2. A mutual written agreement where the spouses agree to terminate the tenancy by entirety.
3. An execution against the property by a joint creditor of both spouses. A creditor of just one spouse cannot execute against the property. In contrast, creditors can take and execute against ordinary joint tenancy property when they have a judgement against only one spouse.
Community property states permit community property to be held in joint tenancy. In such a case, title is taken with the words "community property held in joint tenancy." The significance of these words is not to be ignored. By stating that the property remains community property even though it is held in joint tenancy, the property retains its community property status for tax purposes.
II. TAX BASIS CONSIDERATIONS
Joint tenancy property is treated differently for tax purposes based upon whether the joint tenants are spouses or not. Under federal law, except for married joint tenants, it is presumed that all of the joint tenancy was purchased by the decedent. Thus all of the joint tenancy property is placed into the deceased joint tenant's estate for tax unless the surviving joint tenant provided some of the purchase price. If the surviving joint tenant contributed, the value of the deceased joint tenant's estate will be reduced by that amount. When the property is held in joint tenancy by a married couple, only one-half of the value of the joint tenancy property is placed in the deceased spouse's estate; who actually paid for the property is immaterial.
The basis (value for tax purposes) of the property receivedfrom a decedent through a trust or probate is its fair market value on the date of death. For example, assume that a person bought a home for $10,000 and upon death it is worth $40,000. The basis of the property when the heirs receive it will be $40,000. If the heirs sell it for $40,000, there will be no capital gains taxes due. If the heirs subsequently sell the home for $50,000, they will pay capital gains tax on $10,000 ($50,000 minus the $40,000 stepped-up basis).
Community property, unlike joint tenancy, is considered owned by both spouses and is given special tax treatment. When one spouse dies the federal tax basis of both halves of the community property will be raised to fair market value. Example: A couple bought as community property a home for $20,000 that had increased to $500,000 at the time of the husband's death. The basis of the husband's share of this community property is increased to $250,000. The surviving wife's share is also increased to fair market value of $250,000. The surviving spouse can sell the house for $500,000 without having to pay any capital gains taxes. If the spouse had held the property as joint tenants, only the husband's half would be increased to fair market value. The wife's basis for her half interest in the house would remain at $10,000. If the wife later sold the house for $500,000, she would have to pay capital gains taxes on $240,000 ($500,000 selling price minus $250,000 husband's basis minus $10,000 wife's basis).
The increased basis for community property is a great tax advantage over joint tenancy. If the joint tenancy deed does notstate that the property is community property, upon either spouse's death the IRS will treat the property not as community property but as joint tenancy (separate property owned equally by each spouse). The IRS will not permit the surviving spouse's basis in half the property to be raised to its fair market value. Usually married couples unknowingly take community property as joint tenants and do not include language in the deed that it is community property held in joint tenancy. Upon the death of one of the spouses the survivor suddenly finds he will not get a raised basis solely because of how title was taken.
III. GIFT TAX CONSIDERATIONS
As a rule, a taxable gift is created when a person changes title to create a joint tenancy and avoid probate. The major exception to this rule is the use of joint tenancies between spouses. There is unlimited federal marital credit for all transfers between married spouses when the recipient is an American citizen. A spouse may give any amount of property to the American spouse without incurring a federal gift tax.
The creation of a joint tenancy is a gift of one-half of the property placed into the joint tenancy. The interest transferred to someone other than a spouse is subject to a gift tax. Unless the property is worth less than $10,000 (the annual federal gift exclusion amount per recipient), a gift tax must be paid, or the value of the gift will be used to reduce the $600,000 unified credit that everyone is allowed to pass property free of federal gift and estate taxes.
Besides the tax considerations, there are significant dangers in creating joint tenancies. A person should be aware of these before creating a joint tenancy. When creating a joint tenancy, the interest transferred to the other joint tenant is a full and completed gift. The person creating the joint tenancy has forever divested all control and ownership of the property interest transferred to the other joint tenant.
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DURABLE POWERS OF ATTORNEY
A companion book for Powers of Attorney has been written for this legal series. The use of powers of attorney in estate and financial planning is so important that the basics are set forth in this chapter.
A general power of attorney is a written document wherein a person called the "principal" gives to another person called the "attorney in fact" the authority to act on the principal's behalf. A general power of attorney lapses and becomes invalid at the moment the principal becomes incompetent. At the time it is needed most a general power of attorney becomes invalid and the right of the attorney in fact to act for the principal ceases, lapses, and terminates. This has always been the criticism of a general power of attorney.
To address this situation most states have adopted the Uniform Durable Power of Attorney Act or the Uniform Probate Code or have enacted their own legislation to permit durable powers of attorney.
A. UNIFORM DURABLE POWER OF ATTORNEY ACT
The Uniform Durable Power of Attorney Act was adopted by the following jurisdictions
ALABAMA CALIFORNIA DIST. OF COLUMBIA
DELAWARE IDAHO INDIANA
KANSAS MISSOURI MONTANA
MASSACHUSETTS NEBRASKA N. DAKOTA
PENNSYLVANIA TENNESSEE SOUTH CAROLINA
VERMONT VIRGIN ISLANDS WEST VIRGINIA
The following is the Uniform Durable Power of Attorney Act as adopted by California. This is basically the same form of the Act that was adopted by the other states. It is stated here for reference purposes.
UNIFORM DURABLE POWER OF ATTORNEY ACT IN CALIFORNIA
(the form of the California act is very similar, if not identical, to the Uniform Acts adopted in other states. All references are to the Civil Code of California.)
Section 2400. Durable Power of Attorney Defined
A durable power of attorney is a power of attorney by which a principal designates another his attorney in fact in writing and the writing contains the words "This power of attorney shall not be affected by subsequent incapacity of the principal," or "This power of attorney shall become effective upon the incapacity of the principal," or similar words showing the intent of the principal that the authority conferred shall be exercisable notwithstanding the principal's subsequent incapacity.
Section 2400.5. Proxy by Attorney in Fact Is Not a Durable Power of Attorney
Where a durable power of attorney gives an attorney in fact the power to exercise voting rights, a proxy given by the attorney in fact to another to exercise the voting rights is subject to all the provisions of law applicable to such proxy and is not a usable power of attorney subject to this Article.
Section 2401. Acts of Attorney in Fact Binding on Principal and Successors in Interest.
All acts done by the attorney in fact pursuant to a durable power of attorney during any period of incapacity of the principal have the same effect and inure to the benefit of and bind the principal and his successors in interest as if the principal were competent.
Section 2402. Prior Nomination or Subsequent Appointment of Guardian, Conservator, or Other Fiduciaries.
(a) If, following execution of a durable power of attorney, a court of the principal's domicile appoints a conservator of the estate, or other fiduciary charged with the management of all of the principal's property or all of his property except specified exclusions, the attorney in fact is accountable to the fiduciary as well as the principal. The fiduciary has the same power to revoke or amend the power of attorney that the principal would have had if he were not incapacitated, but if a conservator is appointed by a court of this state, the conservator can revoke or amend the power of attorney only if the court in which the conservatorship is pending has first made an order authorizing or requiring the fiduciary to revoke or amend the durable power of attorney to the fact to make health care decisions, as defined in Section 2430 for the principal.
(b) A principal may nominate, by a durable power of attorney, a conservator of the person or the estate of both, or a guardian of the person or estate or both, for consideration by the court if protective proceedings for the principal's person or estate are thereafter commenced. If the protective proceedings are conservatorship proceedings in this state, the nomination shall have the effect provided in Section 1810 of the Probate Code, whether or not such writing is a durable power of attorney.
Section 2403. Effect of Death or Incapacity of Principal - All Powers of Attorney, Durable or Otherwise.
(a) The death of a principal who executed a written power of attorney, durable or otherwise, does not revoke or terminate the agency as to the attorney in fact or other persons who, without actual knowledge of the death of the principal, act in good faith under the power. Any action so taken, unless otherwise invalid or unenforceable, binds successors in interest of the principal.
(b) The incapacity of a principal who has previously executed a written power of attorney that is not a durable power of attorney does not revoke or terminate the agency as to the attorney in fact or other persons who, without actual knowledge of the incapacity of the principal, act in good faith under the power. Any action so taken, unless otherwise invalid or unenforceable, binds the principal and his successors in interest.
Section 2404. Acts of Attorney in Fact in Good Faith Reliance on Power-Affidavit Showing Lack of Actual Knowledge as Conclusive Proof of Nonrevocation orNontermination.
As to acts undertaken in good faith reliance thereon, an affidavit executed by the attorney in fact under a power of attorney, durable or otherwise, stating that he did not have at the time of the exercise of the power actual knowledge of the termination of the power by revocation or by the principal's death or incapacity is conclusive proof of the nonrevocation or nontermination of the power at that time. If the exercise of the power of attorney requires execution and delivery of any instrument that is recordable, the affidavit when authenticated for record is likewise recordable. This section does not affect any provision in a power of attorney for its termination by expiration of time or occurrence of an event or other than express revocation or a change in the principal's capacity.
Section 2405. Application and Construction of Act to Effectuate Uniformity.
This Article shall be applied and construed to effectuate its general purpose to make uniform the law with respect to the subject of this Article among states enacting it.
Section 2406. Title.
This Article may be cited as the Uniform Durable Power of Attorney Act.
Section 2407. Provisions Severable on Invalidity.
If any provision of this Article or its application to any person or circumstances is held invalid, the invalidity does not affect other provisions or applications of the Article which can be given effect without the invalid provision or application, and to this end the provisions of this Article are severable.
B. UNIFORM PROBATE CODE
The Uniform Probate Code has been adopted by the following states:
ALASKA ARIZONA COLORADO CONNECTICUT
HAWAII IOWA KENTUCKY MAINE
MARYLAND MICHIGAN MINNESOTA NEVADA
NEW JERSEY NEW MEXICO NEW YORK OHIO
OREGON RHODE ISLAND SOUTH DAKOTA UTAH
Section 5 of the Uniform Probate Code is the pertinent provision that authorizes durable powers of attorney and reads as follows:
POWERS OF ATTORNEY
Section 5-501. When the Power of Attorney is Not Affected by Disability.
Whenever a principal designates another his attorney in fact or agent by a power of attorney in writing and the writing contains the words "This power of attorney shall not be affected by disability of the principal," or similar words showing the intent of the principal that the authority conferred shall be exercisable by him as provided in the power on behalf of the principal notwithstanding later disability or incapacity of the principal at law or later uncertainty as to whether the principal is dead or alive. All acts done by the attorney in fact or agent pursuant to the power during any period of disability or incompetence or uncertainty as to whether the principal is dead or alive have the same effect and inure to the benefit of and bind the principal or his heirs, devisees and personal representative as if the principal were alive, competent and not disabled. If a conservator thereafter is appointed for the principal, the attorney in fact or agent, during the continuance of the appointment, shall account to the conservator rather than the principal. The conservator has the same power the principal would have had if he were not disabled or incompetent to revoke, suspend, or terminate all or any part of the powers of attorney or agency.
Section 5-502. Other Powers of Attorney Not Revoked Until Notice of Death or Disability.
(a) The death, disability, or incompetence of any principal who has executed a power of attorney in writing other than power described in Section 5-501, does not revoke or terminate the agency as to the attorney in fact, agent or other person who, without actual knowledge of the death, disability, or incompetence of the principal, acts in good faith under the power of attorney or agency. Any action so taken, unless otherwise invalid or unenforceable, binds the principal and his heirs, devisees and personal representative.
(b) An affidavit, executed by the attorney in fact or agent stating that he did not have, at the time of doing an act pursuant to the power of attorney, actualknowledge of the revocation or termination of the power of attorney by death, disability or incompetence, is, in the absence of fraud, conclusive proof of the nonrevocation or nontermination of the power at that time. If the exercise of the power requires execution and delivery of any instrument which is recordable, the affidavit when authenticated for record is likewise recordable.
(c) This section shall not be construed to alter or affect any provision for revocation or termination contained in the power of attorney.
C. STATUTORY ENACTMENTS
All states have enacted some type of legislation authorizing the use of durable powers of attorney for financial affairs. Most of these states have also created their own statutory forms for durable powers of attorney for health care. These forms, where their use is mandatory or whose requirements significantly differ from the basic form in this book, are included at the end of this chapter. It is recommended that the reader compare his individual state durable power of attorney for health care form to decide whether to use it rather than the basic form contained in this book.
A durable power of attorney is a special type of power of attorney. It contains specific language stating that the principal intends for the power of attorney to remain in full force and effect during any period of mental incapacity that may afflict the principal.
A durable power of attorney has the effect of eliminating and replacing the necessity of a voluntary conservatorship or a guardianship of either or both the Principal and the Principal's estate. A durable power of attorney can also give the attorney infact the power to make decisions of any type or just specific health care decisions when the principal is unable to do so.
Many states have approved statutory forms for durable powers of attorney. Usually the use of these forms is not mandatory as long as the form actually used contains the same basic information. The use of a statutory form is recommended over a nonstatutory form because there is less chance of a dispute concerning the meaning or intention of clauses contained in the forms. Virtually all states have adopted a durable power of attorney for health care act (sometimes called a medical health proxy or medical directive). This chapter also contains a basic uniform durable power of attorney for health care form that can be used in those states that have not adopted a statutory form of their own or which do no requirement the use of their statutory form. It is always a good idea to consider the use of the statutory form if the state has one, even if it is not required, so as to limit potential attacks against its validity. Even so, the basic form, in this book, often presents the grant of authority and the Principal's wishes in a clear and more concise fashion that most optional statutory forms.
II. DURABLE POWER OF ATTORNEY FOR FINANCIAL AFFAIRS
In all states except Louisiana and Pennsylvania a general or limited power of attorney lapses immediately on the principal becoming mentally incompetent. Traditionally under state law when a person became incompetent the court appointed a conservator or guardian for both the person and his estate. Allowing a general power of attorney to remain in effect would impair the ability ofthe conservator or guardian to manage the affairs of the estate and provide for the incompetent principal.
A general power of attorney gives the attorney in fact the authority to act on the principal's behalf and becomes invalid when it is needed the most, at the time the principal becomes incompetent. In order to be a valid durable power of attorney, the instrument must contain specific language stating the intent of the principal that the power of attorney will continue during the period of the principal's mental incapacity.
A durable power of attorney for financial affairs is exactly what the name states. It is a power of attorney to handle the financial affairs of the principal during the time that he is incompetent. This power of attorney is limited only to financial affairs and does not extend to making health care decisions. To make health care decisions for the principal, separate durable power of attorneys for health care or a combined financial and health care durable power of attorney must be executed. A durable power of attorney for financial affairs might be limited to specific purposes, but generally that is not the case. If a durable power of attorney for financial affairs is limited in scope and a matter arises that is included in the power of attorney, a conservatorship or guardianship must be opened, which was what the durable power of attorney was designed to avoid. It is possible for a principal to give to more than one attorney in fact a durable power of attorney. One attorney in fact might have a limited durable power of attorney; whereas the other attorney in fact mighthave a general durable power of attorney.
A durable power of attorney for financial affairs can have a clause in the instrument that states that the power of attorney does not become effective until and unless the principal becomes incompetent. This is a safety feature that prevents the attorney in fact from acting for the principal until it is proven that the principal is in fact incompetent. For this reason it is called a "springing" power of attorney because it "springs" into force only when the principal is declared incompetent. The declaration of mental incapacity is usually covered in a clause that requires two or more medical doctors to diagnose the principal as incompetent. A notable disadvantage of a springing durable power of attorney is that during the period of time the principal is incompetent and before the doctors make the necessary diagnosis, no one is authorized to make valid business and health care decisions for the principal.
A durable power of attorney lapses on the death of the principal or the arrival of the termination date in the durable power of attorney instrument, regardless of the principal's competency. The whole purpose behind durable powers of attorney is to have a person authorized to act on the principal's behalf when the principal becomes mentally incompetent. In reality, this is the time when such a power of attorney is most necessary. Under the Uniform Durable Power of Attorney Act, all acts undertaken by the attorney in fact after the death of the principal but while in ignorance of the principal's death are still valid contractsagainst the principal's estate.
In executing a power of attorney for financial affairs, the attorney in fact is usually not required to give the principal annual accountings unless required by the power of attorney instrument. A few states such as North Carolina require the attorney in fact to file an annual accounting with its court, but a competent principal can waive the requirement.
A major concern many people have over a durable power of attorney is that the attorney in fact may take and otherwise mismanage their assets, after their mental incapacity, and their beneficiaries will be helpless to stop it. This is never the case. The probate court always has jurisdiction to oversee every durable power of attorney regardless of whether or not such power is documented in the durable power of attorney document. No court will ever let an attorney in fact intentionally mismanage or steal assets over which he may have control by virtue of a durable power of attorney. Anyone can raise their concerns to the court, and the court will order a hearing to investigate the matter. All states permit concerned persons to petition the court to review the administration of a durable power of attorney. An attorney in fact is a fiduciary and owes the principal a fiduciary duty to act both reasonably and responsibly. If the court finds an attorney in fact has breached his duty of care, it will remove the attorney in fact and surcharge (find the attorney in fact liable) for all of the damages caused by the attorney in fact's misconduct. Even if the durable power of attorney document states otherwise, probate courtsalways have the power to review the actions of an attorney in fact for improper conduct. The court will never permit an attorney in fact to misuse the faith and power of his position and then hide behind the durable power of attorney document to avoid judicial scrutiny. Anyone can take their suspicions of abuse to the court, and those suspicions will be investigated.
Under the Uniform Durable Power of Attorney Act, if a court appoints a conservator or guardian for the estate of a person who has created a durable power of attorney for financial affairs, the attorney in fact becomes accountable to the court appointee as well as the principal. The court appointed conservator or guardian can also terminate the durable power of attorney.
As long as he is legally competent, the principal retains the power to revoke the power of attorney. If the attorney does not act in accord with the wishes of a competent principal, the power of attorney can be revoked, terminating the authority of the attorney in fact. All that is needed for an effective revocation is for the principal to notify the attorney in fact that the durable power of attorney is revoked on a certain date and to demand the durable power of attorney assets held by the attorney in fact be returned to the principal by the date of revocation. The principal simply affixes a letter to the durable power of attorney document stating the durable power of attorney is revoked effective the certain date. If the power was recorded, the revocation must also be recorded to give constructive notice of the revocation to the world.
An attorney in fact can always resign. When the attorney in act resigns, he is replaced in the same manner as though he had died. Many durable power of attorney instruments name a successor attorney in fact to replace a dead or resigning attorney in fact. If the durable power of attorney does not provide for a successor attorney in fact, the durable power of attorney will terminate on the death or resignation of the attorney in fact. In a few states, most notably North Carolina, before an attorney in fact can resign, he must provide a full accounting of the durable power of attorney business during the time that he. If legally competent, the principal may waive the accounting.
Only a legally competent person can serve as an attorney in fact. If an attorney becomes incompetent all of his subsequent actions on behalf of the principal are voidable. An incompetent person cannot create a valid contract. Many durable power of attorney instruments have language that a successor attorney in fact takes over when the attorney in fact becomes unable to perform the duties of the attorney in fact. Even is the principal is unable to replace the attorney in fact because he, himself is incompetent, the attorney in fact may nevertheless be removed.
Durable powers of attorney for financial affairs forms can be purchased at office supply or stationary stores. Some states (such as California) publish statutory forms for durable powers of attorney for financial affairs. The use of these forms is usually not mandatory to create a valid durable power of attorney.
DURABLE POWER OF ATTORNEY FOR FINANCIAL AFFAIRS
KNOW ALL MEN BY THESE PRESENTS, that I, ___________________________
residing at ____________________________________________________________
do declare this to be a durable power of attorney.
This power of attorney shall not be affected by subsequent incapacity of the principal.
I hereby revoke all prior powers of attorney regardless of the type and to whom they may have been given.
I hereby nominate, constitute and appoint ____________________________________whose address and telephone number is: ___________________________________________as my true and lawful attorney in fact, for me and in my name, place and stead and for my use and benefit to exercise the following powers:
This durable power of attorney shall become effective:
( ) Immediately upon execution of this durable power of attorney.
( )Only after certification by two licensed physicians that I lack the mental capacity to make financial decisions for myself.
(1) Subject to any limitations in this document, I hereby grant to my agents full power and authority to act for me and in my name in any way that I myself could act with respect to the following matters to the extent that I am permitted to act through an agent:
(a) Real estate transactions.
(b) Tangible personal property transactions.
(c) Bond, share, and commodity transactions.
(d) Financial institution transactions.
(e) Business operating transactions.
(f) Insurance transactions.
(g) Retirement plan transactions.
(h) Estate transactions.
(i) Claims and litigations.
(j) Tax matters.
(k) Personal relationships and affairs.
(l) Benefits from military service.
(m) Records, reports and statements.
(n)I grant full and unqualified authority to my agents to delegate any and all of the foregoing powers to any person or persons whom my agents shall select.
(2) To ask, demand, sue for, recover, collect, and receive such sums of money, debts, dues, accounts, legacies, bequests, interest, dividends, annuities and demands whatsoever as are now or shall hereafter become due and owing payable or belonging to me and have, use, take all lawful ways and means in my name or otherwise for the recovery thereof by attachments, arrests, distress or otherwise and to compromise and agree to acquittances or other sufficient discharges for the same.
*** END OF SAMPLE VIEW OF THIS SECTION ***
DURABLE POWER OF ATTORNEY FOR HEALTH CARE
KNOW ALL MEN BY THESE PRESENTS, that I, ______________________________ residing at _______________________________________________________________do declare this to be a durable power of attorney.
This power of attorney shall not be affected by subsequent incapacity of the principal.
I hereby revoke all prior powers of attorney regardless of the type and to whom they may have been given.
I hereby nominate, constitute and appoint whose address and telephone number is: _________________________________________________________________________ as my true and lawful attorney in fact, for me and in my name, place and stead, and for my use and benefit, to exercise the following powers:
This durable power of attorney shall become effective:
( ) Immediately upon execution of this durable power of attorney.
( ) Only after certification by two licensed physicians that I lack the mental capacity to make health care and financial decisions for myself.
(1) To make health care decisions on my behalf. "Health care decisions" means decisions on my care, treatment and procedures to be used to maintain, diagnose and treat my physical condition. This durable power of attorney as it pertains to health caredecisions does not carry the power to authorize any of the following acts:
(a) Any commitment or placement in a mental health facility,
(b) Any convulsive treatment, or
(c) Any psychosurgery.
Furthermore, I hereby expressly authorize any physician, hospital, or other person or organization to release and disclose to my agent any information any of them may have concerning any treatment, diagnosis, recommendation or other fact, which they may have concerning my physical condition and any health care, counsel, treatment or assistance provided to me either before or after the execution of the power of attorney, any privilege hereby being expressly waived as to such disclosures. This waiver shall extend to communications to my agent only and shall not be deemed a general waiver of the privilege. My agent may, however, authorize release of such information to such third persons as my agent deems to be reasonable or necessary in the exercise of the powers granted in this instrument.
(3) Subject to any limitations in this document, my agent has the power and authority to do all of the following:
yes ( ) no ( ) (a) Authorize an autopsy.
yes ( ) no ( ) (b) Make a disposition of a part or parts of my body under the Uniform Anatomical Gift Act.
yes ( ) no ( ) (c) Direct disposition of my remains.
The attorney in fact under this durable power of attorney is specifically not given and does not have the authority or power to revoke, amend or alter any living will declaration or last will and testament that I have created or will create.
*** END OF SAMPLE VIEW OF THIS SECTION ***
DURABLE POWER OF ATTORNEY
FOR BOTH HEALTH CARE AND FINANCIAL AFFAIRS
KNOW ALL PEOPLE BY THESE PRESENTS, that I, ___________________________
residing at ______________________________________________________________, phone number ___________________________do declare this to be a Durable Power of Attorney.
This Durable Power of Attorney shall not be affected by subsequent incapacity of the principal.
This Durable Power of Attorney shall become effective:
( )Immediately upon the execution of this Durable Power of Attorney.
( )Only after certification by two licensed physicians that I have been determined to lack the capacity to make health care and financial decisions for myself.
I hereby revoke all prior powers of attorney regardless of the type or to whom they may have been given.
I hereby nominate, constitute and appoint , whose address and telephone number are: , as my true and lawful Attorney in Fact, for me and in my name, place and stead, and for my use and benefit, to exercise the following powers:
(1) To make health care decisions on my behalf. Health care decisions means decisions on my care, treatment, or procedures to be utilized in order to maintain, diagnose or treat my physical condition. This Durable Power of Attorney, as it relates to healthcare decisions, does not carry with it the power to authorize any of the following acts:
(A) Any commitment or placement in a mental health facility,
(B) Any convulsive treatment, or
(C) Any psychosurgery.
Furthermore, I hereby expressly authorize any physician, hospital, and any other person or organization, to release and disclose to my agent any information any of them may have concerning my physical condition and any health care, counsel, treatment, or assistance provided to me either before or after the execution of this power of attorney, any privilege hereby being expressly waived to such disclosures. This waiver shall extend to communications to my agent only and shall not be deemed a general waiver of the privilege. My agent may, however, authorize release of such information to such third persons as my agent deems to be reasonable or necessary in the exercise of the powers granted in this instrument.
(2) Subject to any limitations in this document, my agent has the power and authority to do all of the following:
yes ( ) no ( ) (a) Authorize an autopsy.
yes ( ) no ( ) (b) Make a disposition of a part or parts of my body under the Uniform Anatomical Gift Act.
yes ( ) no ( ) (c) Direct disposition of my remains.
(3) Subject to any limitations in this document, I hereby grant to my agent full power and authority to act for me in myname, in any way which I myself could act, with respect to the following matters as each of them to the extent that I am permitted to act through an agent:
(A) Real estate transactions,
(B) Tangible personal property transactions,
(C) Bond, share and commodity transactions,
(D) Financial institution transactions,
(E) Business operating transactions,
(F) Insurance transactions,
(G) Retirement plan transactions,
(H) Estate transactions,
(I) Claims and litigation,
(J) Tax matters,
(K) Personal relationships and affairs,
(L) Benefits from military service,
(M) Records, reports and statements,
(N)Full and unqualified authority to my agent to delegate any and all of the foregoing powers to any person or persons whom my agent shall delegate.
(4) To ask, demand, sue for, recover, collect, and receive such sums of money, debts, dues accounts, legacies, bequests, interest, dividends, annuities, and demands whatsoever as are now or shall hereafter become due, owing payable or belonging to me and have, use and take all lawful ways and means in my name or otherwise, and to compromise and agree for the acquittance or other sufficient discharge of the same.
(5) For me in my name, to make, seal, and deliver, to bargain, contract, agree for, purchase, receive, and take lands, tenements, hereditaments and accept the possession of all lands, and deeds of assurances, in the law therefor, and to lease, let, demise, bargain, sell, remise, release, convey, mortgage, and hypothecate lands, tenements and hereditaments upon such covenants as they shall think fit.
(6) To sign, endorse, execute, acknowledge, deliver, receive,and possess such applications, contracts, agreements, options, covenants, deeds, conveyances, trust deeds, security agreements, bills of sale, leases, mortgages, assignments, insurance policies, bills of lading, warehouse receipts, documents of title, bills, bonds, debentures, checks, drafts, bills of exchange, notes, stock certificates, proxies, warrants, commercial paper, receipts, withdrawal receipts and deposit instruments relating to accounts or deposits in or certificates of deposits of banks, savings and loans or other such institutions or associations, proof of loss, evidences of debts, releases and satisfaction of mortgages, judgments, liens, security agreements, and other debts and obligations, and such other instruments in writing of whatever kind and nature as may be necessary or proper in the exercise of the rights and powers herein granted.
(7) Also to bargain and agree for, buy, sell, mortgage, hypothecate, and in any and every way and manner deal in and with goods, wares and merchandise, choices in action, and to make, do and transact all business of whatever nature and kind.
(8) Also for me and in my name, and as my act and deed, to sign, seal, execute, deliver, and acknowledge such deeds, leases, mortgages, hypothecations, bottomries, charter parties, bills of lading, bills, notes, receipts, evidences of debt, releases and satisfaction of mortgages, judgments and other debts, and other such instruments in writing of whatever kind and nature as may be necessary and proper.
(9) To have access at any time or times to any safe depositbox rented by me, wheresoever located and to remove all or any part of the contents thereof, and to surrender or relinquish said safe deposit box, and any institution in which such safe deposit box is located shall not incur any liability to me or to my estate as a result of permitting my agent to exercise this power.
(10) I hereby expressly authorize any attorney of mine, past or present, to release and disclose to my agent any information any of them may have concerning my legal affairs or other facts, which they may have concerning my personal affairs and any legal service, counsel or assistance provided to me either before or after the execution of this power of attorney, any privilege hereby being expressly waived as to such disclosures. This waiver shall extend to communications to my agent only and shall not be deemed to authorize a release of information to third parties and shall not be deemed a general waiver of the privilege. My agent may, however, authorize release of such information to such third persons as my agent deems to be reasonable or necessary in the exercise of the powers granted in this instrument.
*** END OF SAMPLE VIEW OF CHAPTER ***
Age Discrimination 112
Americans with Disabilities Act 128
Changing a Will 292
Civil Rights Act of 1991 119
Common Law States 286
Consideration in Making a Will 277
Disinheriting a Child 294
Dismissal for Alcoholism 115
Durable Power of Attorney 318
DPA for Financial Affairs 324 DPA for Health Care 340
DPA for both Financial Affairs and Health Care 349
Statutory Enactments 323
Uniform Durable Power of Attorney Act 318
Uniform Probate Code 321 Effect of a Testator's Divorce on a Will 296
Estate and Inheritance Taxes 290
Estate Planning 246
Family Allowances 302
Federal Estate and Gift Taxes 251
Unlimited Marital Deduction 251
Unified Credit for Gifts or Estates 252
Annual Exclusion for Gifts 253
Gift Tax on Creation of Trust 253
Gift Tax Considerations 287
Grantor's Revocation of the Trust 262
Guarding Against Employment Problems 104
At-Will Employment 114
Equal Pay For Equal Work 115
Mandatory Drug Testing 106
Non-Discriminatory Questions 118
Handicap Discrimination 125
Impermissible Questions to a Handicapped Job 130
Permissible Questions for Handicapped Job
State Acts 131
Steps for Incorporation 41
Choose a Corporate Name 43
Issue Stock 44
Prepare and File Articles 46
Invalidating a Will 277
Issuance of Stock 41
Joint Tenancy and Gifts 305
Joint Wills 291
Judicial Review of a Trust Administration 266
Legal Competence to Make a Will 275
Letters of Probate 285
Ambulance Payments 199
Assignment of Medicare Payment 205
Catastrophic Illness and Nursing Home Care 200
Filing a Medicare Claim 209
Kidney Disease 198
Medically Necessary Treatment 208
Part A Benefits 192
Part B Benefits 195
Purchasing Supplemental Insurance 201
Skilled Nursing Facility Benefits 207
What Part B Does Not Cover 197
Nursing Home Benefit under SSI 187
Nursing Home Care 235
Care in a Nursing Home under Medicaid 207
Cost of Nursing Homes 239
Nursing Home Insurance 240
Pre-existing Conditions 242
Requirement for Prior Hospitalization 242
Nursing Homes 237
Patients Rights 245
Addition of New Partners 12
Assignability of the Partnership Interest 14
Authority to Act for Partnership 8
Comparison with a Subchapter S Corporation 19
Considerations Before Deciding to Form a Partnership 9
Expulsion of a Partner 14
Federal Identification Number 21
Federal Unemployment Tax 24
Fictitious Name 21
Fiduciary Duties of Partners 9
Limited Liability Partnerships 25 Partners' Liability for Partnership Debts 6,7
Partnership Property 12
Profits and Losses 11
Rights of the Partners 10
State Taxes 25
Tax Effect of Contributing Property to a Partnership 13
Tax Returns 23,25
Tax Treatment 4,38
Tax Treatment of Contributed Property 19
Tax Withholding 22
Termination of a Partnership 15
Uniform Partnership Act 3
Pretermitted Heirs 295
After-discovered Property 304
Ancillary Probates 297
Community Property 258
Competence to Make a Will 275
Considerations in Making a Will 277
Creditor Claims 300
Definition of Probate 270
Final Judgment of Distribution 304
Husband's Curtesy Rights 286
Invalidating a Will 277
Last Will and Testament 271
Letters of Probate 285
Personal Representative 282
Probate Court 270
Stepped-up Basis on Property Received from a Decedent 280
Time it Takes to Probate an Estate 303
Wife's Dower Rights 285
Revocable Trusts 250
S Corporations 46
Basis of Stock 60
Federal Law 50
Fringe Benefits 60
Method of Making the S Status Election 52
Disadvantage When Shareholder's Home State Has No Income Tax 57
State Tax Treatment of a Federal S Corporation 51,59
Termination and Revocation of S Status 54
Tax Returns for S Corporations 55
Tax Treatment 50
Sexual Harassment 116
Simultaneous Death 302
Social Security Administration 135
Taxes over the Years 135, 162
Toll-free Number 161
Verifying a Worker's Social Security Records 158
Social Security Benefits
Appealing a SSA Denial of Benefits 151
Application for Benefits 148
Benefits Cannot Be Attached by Creditors 158
Calculations of Benefits 138
Covered Employment 139
Decision on the Application 150
Disability Benefits 145
Family Benefits 165
Insured Status 141
Number of Quarters Need for Coverage 140
Parents' Eligibility for Survivor's Benefits 148
Proof of Support 150
Receipt of Benefits While Working 154
Retirement Benefits 143
Surviving Spouse Benefits 146,166
Table of Retirement Benefits 163
Types of Benefits 137
Social Security Disability Insurance (SSDI) 211
Application for Disability Benefits 224
Definition of Disability 214
Determination of Disability 216
Disability Benefits Are Not Attachable by Creditors 231
Disability of a Surviving Spouse or a Surviving
Divorced Spouse 221
Eligibility for SSDI Benefits 221
Evidence in Support of a Disability Claim 223
Medical Evaluations 230
Monthly Benefits 234
Receipt of Benefits During the Appeal 228
Recovery of Overpayments 228
Table of Benefits 232
Termination of the Disability 229
Supplemental Security Income (SSI) 170
Application for SSI Benefits 170
Attachment of Benefits 182
Benefits Affected by an Applicant's Domicile 185
Determination of Need 172
Earnings by an Applicant 178
Payments of SSI Benefits 184
Presumptive Disability 184
Termination of Disability Benefits 186
Treatment of In-kind Income in Determining Eligibility 181
Tax Withholding 22
Annual Exclusion for Gifts 253
Attachment of Trust Assets for Trustor's and
Beneficiary's Debt 264
Basic Types of (Revocable) 250
Joint Trust 254
A-B Trust 254
QTIP Trust 256
Generation-skipping Trust 257
Charitable Remainder Trust 263
Creation and Operation of a Trust 258
Effect of a Trust on Dower and Curtesy Laws 265
Federal Estate Tax Return 261
Grantor's Revocation of the Trust 262
Income Tax Treatment of a Revocable Trust 266
Termination of a Trust 262
When a Will Should Be Changed 293
Will Contests 298
Worker's Compensation 117