Planning Notes

The following infographic is a brief, non-comprehensive illustrated overview of asset protection.

This brief overview of some important considerations associated with the asset protection is by no means comprehensive. Always seek the advice of a competent professional when making important legal decisions.

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An Arizona living trust is a means of structuring the transfer of a decedent's assets upon his/her death in a manner that aims to avoid probate completely or minimize the size and complexity of a particular probate. This post is part of our continuing series addressing basic areas of the law.

Probate

Arizona probate is a judicial proceeding through which a decedent's will is validated, the decedent's creditors are paid, and the decedent's separate property assets are distributed to those specified in the decedent's will.

People often believe that probate is problematic and should be avoided because of high-profile cases in which litigation associated with probate was drawn-out and expensive. In many of those cases, however, had there been living trusts as opposed to wills, the litigation would not likely have been substantially less drawn-out or less expensive. Rather, the issues were often with the particular parties involved, as opposed to the probate process.

Although probate can be often be relatively simple, depending upon a person's particular circumstances, a living trust may be a better alternative.

Asset Ownership

In order to avoid probate, a person must transfer legal ownership of his/her assets to another legal entity. In the case a living trust, or more technically a revocable inter-vivos trust, the assets are said to be "held in trust" by a trustee for the benefit of a trust beneficiary or trust beneficiaries.

Settlor

The person who makes or settles a trust is called a trust settlor. Depending upon how the trust is structured, the settlor may reserve varying degrees of control over trust assets ranging from complete control and the right to revoke the trust (common in living trusts) to no ongoing control of the trust. Although some types of trusts can provide asset protection for trustees and/or beneficiaries, very few revocable living trusts (none in Arizona) provide asset protection for trust settlors.

Trustee

The person who holds legal title to assets owned by a trust is called the trustee. A trustee is a fiduciary and is held to the highest standard of care and good faith and is not permitted to use trust assets for his/her benefit and/or gain to the detriment of the trust beneficiary or beneficiaries.

Successor Trustee

In addition to appointing a trustee, who is often the trust settlor in cases of living trusts, a successor trustee is appointed to become the new trustee upon the death of the trustee. This helps to speed the distribution of trust assets if the settlor and trustee are the same person.

Beneficiary

The person or people for whose benefit trust assets are held by the trustee is/are called the trust beneficiary or beneficiaries and is/are often the heirs-at-law of the trust settlor. Depending upon the trust, the beneficiary or beneficiaries may be granted control over the trust ranging from near-complete control (if the beneficiary is also the trustee) to very little control (if the trust incorporates spendthrift provisions and trust beneficiaries cannot compel distributions of either trust income or principle).

Pour-Over Will

A pour-over will is often used to transfer the remainder of a person's estate to his/her trust after his/her death if not all assets are owned by the decedent's trust. Although pour-over wills are not exempt from probate, if the assets are less than values set by statute, an personal property affidavit may be used.

This brief overview of some important considerations associated with Arizona living trusts is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

A Miller trust can allow those that otherwise have too much income to become eligible for Medicaid.

What is Medicaid?

Medicaid is a federally-funded, but state-administered, program that pays the eligible health care expenses of low-income individuals and families who fit into an eligibility group that is recognized by federal and state law. In Arizona, Medicaid is administered by the Arizona Health Care Cost Containment System (AHCCCS). 

Medicaid Income Cap

Because Medicaid is administered by the various states, some eligibility rules vary from state to state. In particular, some states (including Arizona) set a maximum amount of monthly income that a person is permitted to receive and still be eligible for Medicaid benefits.

How Does a Miller Trust Work?

Medicaid places strict restrictions on the transfer of income or assets by the applicant/member for less than fair market value. If a member/applicant violates these restrictions, he/she will not be eligible for Medicaid for a period of time that varies from state to state (60 months in Arizona). However, Medicaid does permit an applicant/member to assign either all of his/her income to a Miller trust or the amount of his/her income that exceeds his/her state's Medicaid income cap.

If the member/applicant chooses to assign all of his/her income to the Miller trust, the trustee will distribute the associated Personal Needs Allowance to the member in addition to paying for the member's Share of Cost, if any, and other expenses.

If the member/applicant chooses to assign only the income that is in excess of his/her state's Medicaid income cap, the member/applicant will be responsible to pay his/her expenses, including share of cost, from the the funds not assigned to his/her Miller trust.

In either case, when the trust terminates, either because the member dies or the member no longer needs Medicaid benefits, the trustee must distribute to the state an amount equal to the total medical assistance paid on behalf of the member. After the state is reimbursed, any remaining funds will either be distributed to the member, if still alive, or the member's estate.

What About Assets?

Medicaid also imposes a limit on the value of non-countable resources that an applicant is permitted to own, $2,000 in 2011. However, Miller trusts are specifically forbidden from owning assets, so the applicant/member must reduce his/her assets in a manner that will not violate the transfer rules and cause ineligibility, e.g. annuities. This usually means spending down those assets before becoming eligible for Medicaid.

This brief overview of some important considerations associated with Miller trusts & qualified income trusts is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

To form an LLC in Arizona, two actions are required by The Arizona LLC Act: 1) file articles of organization with the Arizona Corporation Commission and 2) publish notice of the filing of the articles of organization. Filing of an affidavit of publication of the articles of organization with the Arizona Corporation Commission is optional.

However, those two (or three) steps are a bare minimum to form an LLC in Arizona; in order to provide for the internal governance of the LLC, an LLC operating agreement can be very useful.

1) File Articles of Organization

The Arizona LLC Act requires the Articles of Organization to contain: A) the name of the limited liability company, B) the name, street address in Arizona and signature of the agent for service of process, C) the address of the company's known place of business in Arizona, if different from the street address of the company's statutory agent, D) whether the LLC is member-managed or manger-managed, and E) the names of the managers, if member-managed, or the names of the members, if member managed. (ARS § 29-632) 

2) Publish Notice of Filing

The Arizona LLC Act requires: "Within sixty days after the commission approves the filing, there shall be published in a newspaper of general circulation in the county of the known place of business, for three consecutive publications, a notice of the filing of such articles of organization..." (ARS § 29-635)

3) File An Affidavit of Publication

Once the publication requirement has been fulfilled, "[a]n affidavit evidencing publication may be filed with the commission." (ARS § 29-635). This step is optional but encouraged in order to prove that the formation requirements were satisfied.

This brief overview of some important considerations associated with how to form an LLC in Arizona is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

Arizona beneficiary deeds and trusts are versatile and flexible methods of creating interests in property, however, the following discussion is limited to creating life estates in real property.

On occasion, a decedent may desire to permit another to use real property after the death of the decedent but only for as long as the other person is alive, thereby restricting the other person (life tenant) from directing the transfer of the property at the life tenant's death. Although there are a number of different methods to create a lifetime interest in real property at a person's death, two of the simplest and most flexible methods are beneficiary deeds and trusts.

Beneficiary Deed

A deed is the legal means of transferring real property from one owner to another. A deed generally becomes effective when it is executed, however, Arizona law provides for a special type of deed, called a beneficiary deed, that that will not become effective until the death of the grantor. Moreover, a beneficiary deed may convey either a fee simple absolute, i.e. an interest not subject to divestment, or a fee simple defeasible, i.e. an interest that is subject to divestment.

In order to create a life interest in real property at death via a beneficiary deed, the owner of real property executes the beneficiary deed currently, but it will not become effective until his/her death. If the grantor wishes to create a life estate, the deed specifies that a life tenant will posses a life estate in the property and that the property will be transferred to successor beneficiary upon the life tenant's death. After the death of the life tenant, the property will be conveyed to the second successor beneficiary. Because a beneficiary deed does not become effective until the grantor's death, it can be either directly revoked during the life of the grantor.

Trust

A trust is an centruries-old legal concept whereby a third party (trustee) holds property for the benefit of another (beneficiary) at the request of the property owner (grantor, settlor, or trustor). Specifically, a grantor transfers ownership of his/her property to the trustee for the benefit of the beneficiary or beneficiaries. The trustee is required to act as a fiduciary, i.e. cannot use the property for him/herself to the detriment of the beneficiary or beneficiaries, and is liable if he/she does not so act.

In order to create a life interest in real property at death via trust, the owner of real property transfers the property to a trust for which he/she would be both the trustee and beneficiary, the life tenant would be the successor trustee and contingent beneficiary, and a second successor trustee and second contingent beneficiary would also be specified. Such a trust may be either revocable (the grantor can revoke the trust prior to death) or irrevocable.

This brief overview of some important considerations associated with life interests in real property, revocable trusts, and beneficiary deeds is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

On 14 April 2011, President Obama signed The Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, which repealed substantially broader Internal Revenue Service (IRS) Form 1099 reporting requirements scheduled to become effective beginning in 2012 because of The Patient Protection and Affordable Care Act (PPACA) and scheduled to become effective beginning in 2011 because ofThe Small Business Jobs Act of 2011.

What is Form 1099-MISC?

Some payments totaling $600 or more for goods and services that are made in the course of a taxpayer's trade or business are required to be reported to the IRS using Form 1099-MISC. Payments not made in the course of a trade or business need not be reported.

The Patient Protection and Affordable Care Act (PPACA)

Prior the PPACA, it was necessary to issue Form 1099-MISC to independent contractors, e.g. sole proprietorships & partnerships, for goods and services they provide. Beginning in 2012, the PPACA required that Form 1099-MISC be issued to all vendors and service providers, including corporations, to whom payments totaling $600 or more were paid during a tax year.

The Small Business Jobs Act of 2010

Beginning in 2011, The Small Business Jobs Act of 2010 required owners of real estate used as rental property to also report payments totaling $600 or more for expenses associated with their rental properties.

What's Changed, Err, Not Changed?

The legislation enacted on 14 April 2011 returns the Form1099-MISC requirements to their pre-PPACA and pre-Small Business Jobs Act of 2010 states as if the neither law had been enacted.

This brief overview of some important considerations associated with IRS Form 1099 reporting requirements is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

In contrast to corporations, in which a creditor who obtains a judgment in court (judgment creditor) can execute on shares of a shareholder, most states provide that judgment creditors of owners of interests in some types of legal entities are limited to obtaining a charging order. A charging order is a court-ordered remedy that only entitles the holder of the order to temporarily receive distributions from an entity in which a judgment debtor has an interest until the judgment has been satisfied. Holders of charging orders are not entitled to participate in management of the entity or compel distribution.

Entities

The most common types of entities that limit creditors to obtaining charging orders are the limited liability company (LLC) and limited partnership (LP). However, other entities may also limit creditors to obtaining charging orders, including the limited liability partnership (LLP) and limited liability limited partnership (LLLP).

Rationale for Charging Orders

Unlike corporations, in which the shareholders generally possess the right to elect the board of directors, but do not have the right to manage the corporation (unless it is a statutory close corporation), interest holders in some partnerships or partnership-like entities, e.g. member-managed LLCs, possess the right to actually manage the entity. Legislatures have been reticent to force those non-debtor members into an involuntary partnership-like relationship with judgment creditors.

Distribution Provisions

Although a charging order may seem like an effective remedy for creditors, what happens if the entity simply doesn't make distributions? Some partnership agreements and LLC operating agreements provide that distributions will be made entirely in the discretion of the general partner or manager, thereby providing no means through which creditors can compel distributions. This means that a charging order may be significantly less effective and valuable than may appear on its face.

Foreclosure, Taxes, & Phantom Income

Although charging orders are often viewed as a creditor's exclusive remedy against partnership and partnership-like interests, courts in some states have permitted creditors to foreclose on such interests. However, Arizona limits creditor remedies against both LPs (ARS § 29-341) and LLCs (ARS § 29-655) to charging orders as "the exclusive remedy."

Charging orders are one feature of LLCs
Learn More »In those states that do allow foreclosure, either tacitly or affirmatively, it does come with a very significant potential cost: income taxes.It is unclear whether the Internal Revenue Service (IRS) or state taxing authorities will require the holder of a charging order, to whom distributions have not been made, to pay taxes on the holder's share of an entity's taxable income or so-called phantom income, but the possibility cannot be ignored (Revenue Ruling 77-137). However, it is very likely that IRS and state taxing authorities will require a judgment creditor who forecloses upon a partnership or partnership-like interest to pay taxes in such circumstances because the creditor is the owner of the interest.

Because of the above-described limitations of a charging order or successful foreclosure of an interest in a limited partnership, a limited liability company, and similar entities that are taxed as partnerships, creditors may be less inclined to pursue those interests or more willing to settle their claims than if they had access to the assets held in these entities.

This brief overview of some important considerations associated with charging orders and asset protection is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

Two bills, Senate Bill 1499 (SB 1499) and House Bill 2424 (HB 2424), have recently been introduced into the Arizona Legislature to reform Arizona's probate, conservatorship, and guardianship laws under the Arizona Probate Code, primarily by modifying the Arizona statutes applicable to Persons Under Disability And Their Property (A.R.S. § 14-5101 to 15-5501). In addition to these modifications, HB 2424 also proposes to create a Probate Advocacy Panel to oversee Arizona's probate courts.

Senate Bill 1499

SB 1499 proposes to:

• Require guardians and conservators to submit estimates of costs to probate courts;
• Require probate courts to oversee and approve expenditures in excess of those estimates;
• Permit probate courts to require a party challenging guardian or conservator actions to reimburse the other party if the court determines that an action was not filed in good faith, was not grounded in fact or based on law, or had another improper purpose.

House Bill 2424

HB 2424 proposes to:

• Establish a Probate Advocacy Panel to oversee Arizona's probate courts;
• Require guardians and conservators to account for expenditures on a monthly basis;
• Require the Arizona Supreme Court to establish a schedule of fees permitted to be charged by fiduciaries acting in furtherance of a conservatorship or guardianship;

Although HB 2424 doesn't expressly apply to conservatorships, the text of the bill appears to be intended to apply to both guardianships and conservatorships.

As of this writing, neither bill has been passed by either chamber of the legislature and only time will tell whether these specific reforms, or some derivative(s) thereof, become law.

This brief overview of some important considerations associated with Arizona Probate, Guardianship, & Conservatorship Law Reform, SB 1499, and HB 2424 is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.

Minority discounts are a generally accepted practice used in determining the fair market value of non-controlling, minority interests in corporations. Such discounts are also often deemed valid by the Internal Revenue Service (IRS) when calculating the federal estate and/or federal gift taxes that are associated with interfamilial transfers of interests within a corporation.

Revenue Ruling 93-12

In a significant departure from its previous position, the IRS issued Revenue Ruling 93-12 in 1993 holding that a minority discount is permissible for the gift of a minority interest in an enterprise entirely controlled by the donor or the deceased donor's family. Previously the IRS aggregated the interests of family members in determining whether a minority control discount was valid.

At issue was the validity of minority control valuation discounts taken when a donee who owned 100% of the outstanding shares of a corporation, having one class of stock, simultaneously gave all of his interest, in equal amounts, to his five (5) children. In specific the IRS stated, "[i]f a donor transfers shares in a corporation to each of the donor's children, the factor of corporate control in the family is not considered in valuing each transferred interest."

Private Letter Ruling 9449001

The IRS further acknowledged the position above in a private letter ruling stating that the fair market value standard is used in determining the valuation of gifts, i.e. price at which a willing buyer and willing seller, neither being under any compulsion and both having knowledge of the relevant facts, would exchange property.

Economic Substance

In certain circumstances, and in spite of the aforementioned rulings, the IRS has argued that minority control discounts in closely-held corporations are invalid if a corporation or partnership was created principally to produce such discounts. In particular, the IRS has claimed that these transactions lack "economic substance," i.e. there were no substantial changes in the relationships and rights of the parties involved, rather, changes in form.

For example, three years prior to Revenue Ruling 93-12, the tax court disregarded a minority control discount in Estate of Murphy (60 TCM 645). In Murphy, a woman with terminal cancer transferred 2% of her interest in a corporation to her children thereby decreasing her interest just below 50% and she subsequently died 18 days later. The tax court reasoned that no substantial change in the parties positions had occurred despite such a significant change in form.

Conclusion

Although the IRS has effectively prohibited the use of minority control discounts in certain limited situations, such discounts are, more often than not, an approved strategy to reduce federal gift taxes directly and federal estate taxes indirectly.

This brief overview of some important considerations associated with minority control discounts and gift taxation is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.