LEGAL ISSUES FACING THE TERMINALLY ILL AND THEIR FAMILIES IN ARIZONA:

What You Need To Do While There’s Still Time

By Thomas J. Murphy

WILLS AND TRUSTS

Do You Need A Will? You should have a Will but, in many situations, having a will is not as critical as it once was. This is because, when someone dies, many of their assets will be transferred by other means. For instance, we frequently advise clients to create a “payable on death” designation (commonly referred to as a “POD” designation) on their bank or brokerage accounts. Or, you will normally have someone designated as a beneficiary on an insurance policy or retirement account. In Arizona, you can even have POD designations for your home and other real estate parcels.

These designations act as mini-wills. Whoever is named gets the funds, regardless of whether there is a will or who is named in the will. I discuss POD and other beneficiary designations in more detail on page *. The point here is that, for many people, a will is never needed or used. But, since you never know that for sure until well after your death, it is still better to have a will in case you do need it. And, for reasons I will mention later, it is very risky to not have a will if you are not married or have children from a prior marriage.

How Do I Know My Will Is Still Valid? First, make sure you have the complete and original copy of the will. Simply having a copy will not suffice since, in Arizona, it is presumed that you destroyed and revoked your will. Second, look at the signature page of the will. To be valid, it must be witnessed by two people who are not beneficiaries under the will and who do not otherwise have an interest in your estate. If there is only one witness, even if that witness is a notary public, the will is invalid and will not be honored.

There is no expiration date for wills, so that even a 25 or 50 year old will is still valid. And a will executed in another state is totally valid in Arizona as long as the will was properly executed under the laws of the state where it was signed. Different states have different laws, so determining this can be difficult. It is always best to have a qualified estate planning attorney make this determination for you.

But circumstances may have changed since you signed your will. You may have been married and/or divorced since then or you may have had children. A new will needs to reflect this.

Is It Too Late To Make A Will? As long as you have mental capacity, it is never too late to make a will. In other words. You can validly execute a will as long as you generally understand what it means to sign a will, that you know who your immediate family and friends are and that you can remember in a general way the property that you own. It is perfectly Ok if the person signing the will has become a little forgetful or if she is not a mentally sharp as she once was. As long as she generally understands what she is doing, that is enough.

Where Should I Keep My Will? Keep your will in a safe and secure location but in a place where your family will know where to find it. Do not leave it in a safe deposit box since the box can be difficult after your death. Be particularly careful if you have disinherited a family member or if one family member is getting more than another. These wills have a tendency to mysteriously disappear after your death. In such a situation, a good idea is to leave the original copy with the attorney who drafted it.

What Should I Do With My Prior Will? I recommend that you keep all prior wills and trusts so that you have a historical record of your intentions.

What Happens If I Do Not Have A Will? If you do not have a will, every state has laws that will determine who gets your property. Generally speaking, if you are married, your spouse will get your entire estate. If you are married with children from a prior marriage, the spouse gets one-half and the children collectively get one-half of your estate. If you are single with children, your children will receive your estate in equal shares. If you are single with no children, your parents will receive your entire estate. If both your parents have predeceased you, then your brothers and sisters will share equally.

For many people, this is the way they would want their estate to be distributed but this is not always so. For instance, charities are not included. Or if you are an unmarried or same-sex couple, your partner will receive nothing through this process. In these situations, having a will is critical.

Do I Need A Trust Rather Than A Will? Beginning in the 1980’s, the conventional wisdom has been that most people should have a revocable trust, also called a living trust. However, in the past several years, I have noticed a trend away from trusts. A well-drafted will together with the wise use of POD designations can accomplish many of the same objectives as can a trust and at a much lower cost.

A trust has several great features. First, it avoids the probate courts. This means your estate can be administered faster and cheaper. Your financial matters will remain private since there are no court accountings or hearings. Avoiding probate is especially important if you have real estate in more than one state since you will have to open a probate proceeding in every state where you own real estate.

Second, a trust can provide huge estate tax savings but only if you are married. Your net worth must exceed $1.5 million before you are subject to the estate tax (for the years 2004 and 2005). A properly-drafted trust allows both spouses to take advantage of this, so that the combined estate of a husband and wife must exceed $3 million ($1.5 million X 2) before the estate tax hits.

Third, a trust can provide protection for the spouse or child who cannot handle their money or is disabled. I discuss this further on page *.

A properly drafted will can accomplish many of these objectives. But a terminally ill person should still consider creating a trust. Drafting a trust for a terminally ill person is equivalent to doing a probate proceeding while you are alive. Collecting and organizing your financial records is much less time-consuming if you do it now rather than having your family do it after you have passed away. It is much easier to transfer title to bank accounts and real estate while you are alive. And there may be tax advantages to doing this while you are alive that end with your death.

Creating a trust can only be done if you have mental capacity. (See page *.) Be aware that creating a trust will not protect your assets from creditors nor can it prevent a will contest.

Gifts and loans. A frequent source of family squabbles concerns money that has gone from parent to child. It is imperative that you establish whether the funds given to a child are a gift or simply a loan. If it is a gift, did you intend for it to be an advancement of that child’s inheritance? In other words, should the gift be offset against a later inheritance? If the funds are a loan, is the unpaid balance to be forgiven? If so, is the forgiven amount to be included in the beneficiary’s share of the estate? If the loan is not to be forgiven, what are the terms of the repayment. Make sure you have documentation to verify the gift or loan and keep it in a safe place since these may disappear after your death.

Whatever you do, do not try to hide this amount from the other children. They will invariably find out once they have reviewed your financial records after your death and, just as invariably, there will be an ugly confrontation. Deal with this while you can, even if the children will not find out about it until after your death.

Also consider if a large expense, such as paying for a college education or a wedding, has been undertaken for one child or grandchild but not another. You can always set aside money for the future education of a child or grandchild in your will.

Unequal or unusual bequests. Be prepared to justify it since this is another fertile source of family conflict once you are gone. Consider doing multiple wills or reaffirmation of trusts, done several weeks or months apart. This will discourage probate litigation since a disgruntled child will have to invalidate not just one will but several of them. Having multiple wills that have the same provisions also indicate that this is what you really wanted and was not the result of a single careless or thoughtless event.

These issues often occur with a terminally ill person who has had one particular child provide most of the caregiver services and who now wants to show appreciation for those efforts. It is crucial that the ill person, and especially the caregiver child, realize that they should not be surprised if the other children are not very appreciative of the child’s efforts. Children who are not around during your last illness frequently do not understand that amount of time and energy that it takes to care for you. They also do not realize how expensive a last illness can be. As a result, the caregiver child needs to be keeping receipts for expenses and maintaining logs reflecting the amount of time spent assisting you. This will be immensely helpful if someone later challenges the caregiver child.

If one child is being omitted for non-hostile reasons, give the testator an opportunity to explain or at least to indicate that this is not an adverse reflection on the beneficiary. You may have already given a child an ample amount of money and now think that the other children should get their share in your will. This is perfectly fine but you should say so in the will. If not, the child may interpret the omission as a bad reflection on him that he may carry with him for years to come.

On the other hand, a will is not the place to settle scores. If you are upset with a child and want to leave them out of your will, simply indicate that and leave it at that. You do not have to state why you are leaving him and, in my opinion, it is better that you don’t.

Testamentary capacity. Do you have the mental capacity to make a will? That is, do you understand the effect of a will or trust is? Do you know who your immediate family and close friends are? Do you, in a general way, know what property you own? If the answer is “yes” to all of these, then testamentary capacity exists. Be aware that the law is very clear that simply having diseases such as cancer, Alzheimer’s or Parkinson’s does not mean that the person incapacitated.

If capacity could later be raised as an issue, address it head-on. Do not fool around with this since it is the easiest way to challenge a will. Get opinions from treating physicians but be sure to provide physicians with proper terms and definitions (ie, use the term “capacity” and avoid the term “incompetence”). Consider videotaping the will signing during which you have a conversation where you explain your thoughts and reasons why you are doing this.

Coordinate terms of will with non-probate assets. This is absolutely critical, something of the highest importance. Ascertain the status of the beneficiary designations for retirement plans, life insurance, annuities, POD accounts as well as jointly titled accounts.

It is extremely important that this get done and done right because the distribution of these assets will occur outside of the will. In other words, the terms of the will do not control what happens to a life insurance policy or a jointly titled account.

Estate tax allocations. If the value of your estate at the date of your death is more than $1.5 million, there will be an estate tax on your estate. This tax is applied to everything you own above the $1.5 million figure. And the tax rate begins at a 45% rate, so the amount of tax can pile up very quickly.

The big question is: Who will pay the estate tax? Most wills simply allocate this to the residue of the probate estate but this can be a disaster if title to most of your assets is passing outside of probate (ie, through POD designations, joint title, etc.)

It is best to pro-rate the tax over all of all of your assets. In other words, a child getting 25% of your estate pays 25% of the tax. But, if this is what you want ( and virtually all of my clients do), then you need to say so in the will.

Income tax allocation. If you are consulting with an attorney or financial advisor, make sure you ask them about “income with respect to a decedent”. Some of your assets, such as retirement plans or commissions earned but not yet paid, is money that has not yet been taxed. This is called “income with respect to a decedent” or simply “IRD”. Usually, money that is inherited passes to the beneficiary tax-free. However, the beneficiaries who inherit these IRD funds will be subject to income taxes when received and they will not get a stepped-up basis in those assets. (See page * that discusses what “stepped-up basis” means.)

This can mean a huge difference in the net amount that the beneficiary will receive. Because of the tax issue, a $1million insurance policy is not the same as a $1million 401(k) plan.

Make sure to ask your attorney or financial advisor to explain what IRD is. I have found that this is a good way to determine who knows what they are talking about. If your attorney or financial advisor does not know much about IRD, then you definitely need to look for another attorney or advisor. Dealing with issues relating to your estate is not a place for amateurs or part-timers.

Protecting Beneficiaries from Themselves, Their Creditors, Ex-Spouses, Etc.

Special care needs to taken for spouses, children or other beneficiaries who have a demonstrated inability to manage their money. Within a will or trust, you can establish what is commonly called a “spendthrift trust”. This is money that is set aside for a particular person but it is not simply handed over to them when you are gone. This is money that is managed by someone of your choosing who then uses it for the benefit of the beneficiary. Common examples are for education or a down payment on a home.

But, if the trust is properly established, the beneficiary’s creditors cannot reach the trust funds. This money is protected not only from creditors, but also from ex-spouses (or soon-to-be ex-spouses or other in-laws you don’t trust) and future lawsuits.

These trusts are particularly important if minor children are involved. Establishing this type of trust avoids having an 18 year old beneficiary immediately receiving their entire inheritance all at once. Instead, this money is set aside for education and other worthwhile endeavors such as substance abuse counseling if such a problem exists.

The most important consideration when establishing this trust is choosing the trustee, who is the person who will oversee the management of the assets. Simply put, the trustee must be someone you trust. A trustee does not have to be financially astute since I always insist that a professional financial advisor be retained to make investment decisions. Rather, the trustee must be someone who is familiar with your values and what you would like to see done with the money. And the trustee has to be someone who can say “no” to the beneficiary.

Disabled children. A very technically difficult aspect of planning concerns leaving an inheritance to a disabled child, especially if that child is receiving public benefits. As any parent or grandparent of a disabled child knows, many public benefit programs are “means-tested”. If a person is on a means-tested program, such as Supplemental Security Income (“SSI”) or Arizona Health Care Cost Containment System (“AHCCCS”), that person generally cannot have more than $2,000.00 in assets. If such a person receives, say, $100,000.00 as an inheritance, that person’s benefits will immediately cease. A potentially devastating situation and not what you wanted. Until 1993, your most likely choice would have been to simply disinherit the child and hope that the other children or beneficiaries took adequate care of that child even though they were under no legal obligation to do so.

This has now changed and a carefully drafted trust can allow for an unlimited amount of funds to be set aside for a disabled person without jeopardizing the person’s public benefits. But be forewarned -- it has been my experience that very few attorneys or advisors understand the complicated laws and regulations that govern this area. This, most definitely, is not an area for amateurs. Make sure you retain someone who is experienced in the area of what is called “special needs trusts”.

Pets. Ascertain what happens to any pet that you may have. Who will take care of the pet if you are no longer able to do so? Who will receive the pet upon your death? Should money be given to that person to care for your pet? And if you want to leave a substantial amount to provide for the pet, what happens to those funds if there are funds left over after the pet has passed away?

Payment of travel expenses. State in your will whether your estate will pay for travel plans for family and friends to attend the funeral. Consider specifying whose expenses will be paid, whether a cap on expenses should be established and whether these costs will be netted against a beneficiary’s share.

Shipping costs. If an out-of-state beneficiary will be receiving large items of personal property, such as furniture, your will should state who will pay the shipping costs – your estate or the beneficiary?

Charitable bequests. I find that terminally ill clients are much more charitably inclined than most of my clients. Many make bequests to their hospice or their church. Be sure to address this in your will. If your estate will exceed $1.5 million, gifts to charity will diminish the size of any estate tax that may be owed by your estate

Power of appointments. Ascertain if you have been granted any powers of appointment in someone else’s will that are exercisable by you. In other words, some wills provide that, rather than making a bequest to a particular person or group, a person is appointed to decide at some later point who will receive the property. If you have been appointed by a deceased spouse, friend or family member to do this, then you need to make this decision by stating it in your will (even though the bequest comes from another person’s will). This power to decide is called a power of appointment.

Powers of attorney(“POAs”)

Financial POAs. Probably the most important documents that you will sign are powers of attorney. These authorize the appointed person, called an “agent”, to act on your behalf. A POA can be as broad or as narrow as you like. For financial matters, I usually draft a very broad POA since you can never be sure exactly what you may need it for.

A POA does not give the agent any ownership rights to your property. You are not giving up any of your rights. A POA simply allows the agent to act on your behalf. The flip side of this is that your agent is never personally liable when they are acting on your behalf. However, the agent must make it clear that they are acting on your behalf. For instance, always make sure that, when signing a document, the agent signs something like “John Doe, POA for Sam Smith”.

A few other warnings need to be made here. First, in 1998, Arizona adopted some new and very unique laws on POAs. These laws require that you be very specific is stating what your agent can do. In other words, the simple one-page POA that states that the agent can do anything that you yourself can do is no longer valid. You need to be specific. This is especially so if the agent may profit or benefit form what she is doing. For instance, the POA may allow for the agent to make gifts to herself and other family members or to reimburse herself for expenses she has incurred on your behalf. For this to be valid, the POA must expressly state that this is permissible.

Because of this, do not assume that you can simply download a POA form from the Internet or buy a POA form from a book or stationary store. Virtually everyone that I have seen is invalid under Arizona law. Please note that this problem even exists with the POA form that is available from the website of the Arizona Attorney General.

Another warning concerns your choice of agent who will act via the POA. Make sure it is someone who is absolutely above reproach since a dishonest person can empty your bank accounts and do huge damage when using the POA. For this reason, I usually will only name the spouse.

Finally, you need to know that your POA is only effective while you are alive. When you die, the POA dies with you. After your death, the Personal Representative named in your Will will handle many or all of the financial affairs of your estate.

Healthcare POAs. Another POA deals with your health care. Specifically, who will make medical decisions for you when you are no longer able to do so. Most people name their spouse. If there is no spouse, then the children are usually named. This can be done in a couple of ways. Most of my clients will nominate all of their children with a majority of the children agreeing on any decision. If there are only two children, then we either require that, no matter what, both children must agree or we appoint a tie-breaker, such as a brother or sister, to a cast the deciding vote.

Make sure your Healthcare POA is HIPAA-compliant. If the HCPOA was executed prior to the implementation of HIPAA on April 14, 2003, a new HCPOA should be executed since some health care providers and insurers will not honor pre-April 2003 HCPOAs.

“Stand-alone” medical records releases. The healthcare POA grants decision-making authority to another person. But you will typically want other family members and friends to have access to doctors and their staffs during a hospitalization but who are not acting in a decision-making capacity. As a result, my clients use a “stand-alone” medical records release. The release is limited to visitation and to speaking with the medical staff. It does not authorize access to medical records. The release will list family members and friends. It should also include the attorney and members of the law firm, accountant, financial advisor, business partners or associates and the employees of the client’s church or synagogue.

Hospital visitation rights. This can be a problem if you are not married and your partner is not particularly well-liked by your family. This is a frequent occurrence with gay and lesbian couples. Make sure your desires regarding visitation are addressed in writing, usually within your healthcare POA.

OTHER THINGS YOU NEED TO DO

Encourage communications within family. Inform family members about the terminal illness. Withholding this information from estranged family members only adds fuel to a potential fire.

Keep receipts. A terminal illness can be very expensive, especially where insurance coverage or public programs are insufficient or non-existent. Other family members often do not realize this. If a child has been the primary caregiver, this is a particularly fertile source of family discord. Without documentation, the caregiver child is very susceptible to post-mortem attacks by other family members.

Your medical expenses can also qualify as an itemized deduction on your income tax return but you must keep receipts to verify these expenses. The Internal Revenue Code has a very broad definition of medical expenses. Most any legitimate expense incurred for treatment of your illness or injury will qualify, such as doctor’s fees, lab fees, insurance co-pays, premiums for health or long-term care insurance, prescription medicines, prosthetic devices, special equipment, special foods or dietary supplements and medical supplies. A significant portion of nursing home costs are deductible. It also includes transportation and lodging costs incurred primarily for medical care as well as improvements or additions to your home that serve a medical purpose.

To take advantage of this deduction on your federal tax return, you can only deduct that portion that exceeds 7.5% of your gross income. However, all of your medical expenses are deductible on your Arizona tax return as an itemized deduction.

Marriage or divorce. If you have a significant companion of the opposite sex, the issue of marriage should be discussed. It has been my experience that senior couples often do not marry because of a perceived threat to their public benefits. With death in the foreseeable future, this perceived threat greatly diminishes and many advantages of marriage become much more apparent. If you have an exposure to the estate tax because your net worth exceeds $1.5 million, the unlimited deduction for property left to spouses can save enormous amounts of taxes. But you must be married to take advantage of this tax break.

If you are concerned about the well-being of your companion, the status as surviving spouse brings with it many benefits. Under the probate code, a surviving spouse is automatically entitled to up to $37,000.00, before any beneficiary gets paid. A surviving spouse is entitled to a large portion of your retirement plan and has special, unsurpassed flexibility in taking distributions from those plans, such as a 401(k) plan. Marriage will also allow for gift-splitting, meaning that you can double the tax-free annual exclusion gifting of $11,000.00 per beneficiary, per year.

Be advised that a marriage shortly before death will not have any impact on your new spouse’s Social Security benefits since you must be married for nine months before your new spouse can claim survivor benefits.

On the other hand, a divorce will eliminate many of these spousal rights. But, again, you must be actually divorced art the time of your death. Living apart or having a pending divorce at the time of death does not count.

Residences for unmarried couples. If you own a home with someone you are not married to, you must address what will happen to the title to your home. If both of you own the home, look to see if title has been taken as joint tenants with rights of survival (“JTROS”) or as tenants in common (“TinC”). If it is JTROS, then the surviving person gets the entire title to the home. This may or may not be what you want. If it is TinC, your estate remains one-half owner of the property. This can cause serious problems for the survivor.

If your partner is not on the title, then you need to determine what will happen to the house. If you are not going to bequeath the home to your partner but still want to allow for your partner to remain in the home, numerous issues arise. Who will pay for any mortgage, property taxes, insurance, maintenance, repairs and improvements? What happens if the partner does not make these payments? If the property is later sold, does your partner get a share of the sale proceeds? What happens when your partner dies?

Establish domicile. Determining domicile can have wide-ranging impact since the law in the state of domicile will govern many aspects of your estate. This will effect rules such as how much a surviving spouse is entitled to or determining which state can impose taxes, such as inheritance, income or intangible personal property taxes. To establish an Arizona domicile as firmly as possible, you should:

file income tax returns with an Arizona address,

have bank and brokerage account statements (and corresponding form 1099’s) sent to an Arizona address

join local community and religious organizations and obtain documentation reflecting this.

Safe deposit box. Inventory the box and create a list of items that are inside it. If you want to retain the box after the inventory, have another name added to the box for ease of entry after your death. Otherwise, it may be difficult to gain entry to it after your death. And make sure the key to the box can be located.

Medicare hospice. While the care and concern exhibited by hospice organizations have been the primary reason for participating in the program, there are two important financial advantages of hospice. One is that Medicare hospice will pay for all drugs and biologicals “used primarily for the relief of pain and symptom control related to the individual’s terminal illness”. The other is that, like all Medicare services, there is no post-death estate recovery as there is with AHCCCS/ALTCS.

Viatical settlements and accelerated death benefits. If your terminal illness is expected to run many months and you are running low on cash, you may want to consider a viatical settlement or accelerated death benefit.

Many life insurance policies offer an accelerated death benefit for a terminally ill person whose physician has certified that the person has a condition reasonably expected to result in death within 24 months of the certification. If your policy does not offer such a benefit, you can usually obtain a rider to the policy that will provide for this.

A viatical settlement is the sale of a life insurance policy to a company that must be specially licensed to do so. There are about 100 of these companies nationwide.

The proceeds from either of these are tax-free to you. However, you will normally receive much more under an accelerated death benefit than under a viatical settlement.

This type of procedure is not allowed for annuities although most annuities now offer a nursing home waiver that allows for penalty-free withdrawals if they are needed for payment of nursing home costs.

TAX ISSUES AND STRATEGIES

Gifting. The terminally ill should think twice about gifting property while they are alive. From a tax standpoint, it is always better to inherit property rather than to receive it as a gift. The reason for this concerns how the IRS will determine the amount of gain when the property is later sold. If you give property to your children, they are assigned the cost of the asset when you purchased it. This may be very low compared to the current fair market value. If your children inherit the property, they are assigned the fair market value of the asset at the time of your death. This can result is huge tax savings. In tax lingo, this is referred to as the “stepped-up basis”.

The bottom line is: do not gift highly appreciated property.

If you still decide to do some gifting, the gifting is tax-free as long as it does not exceed $11,000 per person, per year. With a spouse joining in the gifting, each of you can do an $11,000 gift, thereby doubling the amount you can gift. In addition to this, you can gift unlimited amounts for tuition and medical expenses for anyone.

If you want to give away some items of personal property, make sure you have physically delivered the property to the person receiving it. This means you can no longer use the item or pay the insurance on it. A legally valid gift requires that you give up all aspects of use and enjoyment of the item given away.

Charitable gifting. This will not only get the asset out of your estate for estate tax purposes, but you can also get an income tax deduction for the year you make the gift. Make sure you have the correct and exact name of the charity. This can be easily done by asking the charity for a copy of a “501(c)(3)” letter. Or look for the name of the charity in IRS Publication 78.

Sell property with capital loss. It is usually not advisable to gift property that has lost money since the person receiving the asset will be assigned the lower fair market value as his cost. Instead, sell the asset for a capital loss, gift the proceeds and use the capital loss as an income tax deduction of up to $3,000 or the amount of capital gain that you may have, whichever is greater.

Collect and organize your important documents. Gather up all stock certificates, bonds, insurance policies, automobile titles, birth certificate, passport, income tax returns, bank statements, cancelled checks bonds and documentation for other investments, such as limited partnership interests or oil and mineral rights. If these records cannot be found, your estate may never be able to prove ownership to these items. Put them in a secure place where they will not mysteriously disappear. Retrieve cash that has been left in odd places throughout your home and deposit it in a bank or brokerage account.

Videotape or photograph the contents of your home. It is amazing how many things will disappear within days of your death. Photograph or videotape each room of your home. This includes dresser drawers, the inside of closets and your garage. Pay particular attention to jewelry and various collections, such as artwork, antiques, firearms, books, silverware, flatware, photographs and family memorabilia.

Income in respect to a decedent. Consider withdrawing a substantial of funds from a retirement plan or zeroing out other IRD assets (eg, deferred compensation, accounts receivable, accrued interest or rent, installment notes) since a terminally ill person may be in a much lower income tax bracket than the beneficiaries. Or make a specific bequest of the IRD asset to charity, allowing all of the money to pass tax-free to the charity.

Conservation easements. Charitable deductions are authorized for the gifts of perpetual real estate easements that are made for historic or conservation purposes. You still have rights to the land subject to the easement and you can own adjoining land. The term “conservation” includes land areas for “public recreation” and “open space including farmland and forest land where such preservation is for the scenic enjoyment of the general public”. The practical effect of this is you and the general public get to enjoy the use of the land while the value of the property gets greatly reduced for estate tax purposes.

Family limited partnerships. The creation of FLPs done near death or while seriously ill have undergone extreme IRS scrutiny in recent years. At this writing, the outcome is not clear but some fairly definitive answers may not be too far away.

WILLS AND TRUSTS

Powers of attorney(“POAs”)

RELATED DOCUMENTS

OTHER THINGS YOU NEED TO DO

TAX ISSUES AND STRATEGIES