The U.S. Department of Health & Human Services (HHS) has announced the availability of $60 million in Affordable Care Act grants to states and communities to help individuals and their caregivers better understand and navigate their health and long-term care options. These grants will fund approaches that take into account the unique needs of seniors, Americans with disabilities and their caregivers. Some specific areas of focus include assisting older adults and individuals with disabilities live at home or in settings of their choosing with the right supports and assisting people transitioning from hospitals or nursing homes back into the community.

The application deadline is July 30, 2010. The grant application and instructions can be found at: www.aoa.gov/AoARoot/Grants/Funding/docs/2010/AoA_CMS_Affordable_Care_Act_June_2010.pdf

For more information regarding this topic, please e-mail your requests to Brenna D. Mansfield, or call Brenna at (248) 457-7227.

Mr. and Mrs. Thomas H. Holman, Jr. created the Holman Family Limited Partnership (HFLP) on November 3, 1999, and transferred 70,000 shares of Dell stock to the HFLP on that date. Five days later, they transferred LP interests to trusts for their four daughters. Similar gifts were made in 2000 and 2001. The Holmans filed gift tax returns and claimed combined discounts of 49.25% (for lack of control and lack of marketability).

The IRS contested the valuation discounts on several grounds, including IRC Section 2703(a). That Section provides that the value of the gift will be determined without regard to any restriction on the right to sell or use the gifted property. But exceptions are provided in IRC Section 2703(b) where the rights or restrictions (1) represent bona fide business arrangements; (2) are not used as a device to transfer property for less than adequate and full consideration; and (3) are comparable to similar arrangements entered into in arms-length transactions.

The partnership agreement had the normal prohibitions against transfer that are typically seen in family limited partnerships. However, the HFLP also had a buy-out clause for any prohibited transfer which allowed the Partnership to repurchase the transferred interests at their FMV. Moreover, the Partnership had the option to pay 10% down and the balance in five equal annual installments at the AFR.

The Tax Court held that HFLP was solely an entity to hold the Dell stock and, therefore, not a bona fide business. It also held that HFLP was merely a device to facilitate asset transfers to family members. Holman v. Commissioner, 130 T.C. No. 12 (2008). In a 2-1 decision, the 8th Circuit Court of Appeals upheld the Tax Court - holding that HFLP was not a bona fide business arrangement, but instead an estate planning device. Thomas H. Holman, Jr. v. Commissioner, No. 08-3774 (8th Circuit Court of Appeals, April 7, 2010).

Planning ahead, practitioners should look to the vigorous dissent of Judge Beam who cited the prevention of unauthorized transfers; the protection of assets from creditors and future ex-spouses; and the determination of who may be permitted to become a partner, as all legitimate non-tax reasons for the transfer restrictions. As Judge Beam wrote, the "underlying purposes of Section 2703 are not served where, as here, the bona fide business arrangement test is applied in a manner that discourages family partnerships from creating restrictions principally to achieve non-tax economic goals".

Holman is still a taxpayer victory, since gifts of LP interests holding one marketable stock obtained a 22.4% discount in the Tax Court. But if other Circuits (Michigan is in the Sixth Circuit) require an operating business to qualify under the IRC Section 2703 safe harbor, the transfer restrictions in most investment partnership agreements and LLC operating agreements will be disregarded for valuation purposes under IRC Section 2703. In the meantime, family partnership agreements and operating agreements should be drafted with less emphasis on favorable buy-out rights, and should expressly document the non-tax reasons (including those mentioned in Judge Beam's dissent) for establishing the entity.

For more information regarding this topic, please e-mail your requests to Julius Giarmarco, or call Julius at (248) 457-7200.

An income-only trust is an irrevocable trust created by a Medicaid applicant or the applicant's spouse. During the lifetime of the grantor, trust income is typically payable to the grantor or the grantor's spouse. Alternatively, trust income may be payable to other beneficiaries in the trustee's discretion. Trust principal is either retained in the trust or payable to beneficiaries other than the grantor or the grantor's spouse, in the trustee's discretion. At the death of the grantor, the trust may continue with income payable to the grantor's spouse and principal retained or paid to beneficiaries other than the grantor's spouse; or the trust may terminate and the trust assets distributed to or held in further trust for the benefit of the remainder beneficiaries.

The extension of the look-back period for reporting all asset transfers made on or after the Deficit Reduction Act (DRA) enactment date to the 60 months immediately prior to the Medicaid application, combined with the change of beginning date of the penalty period, treats the transfer of assets to an income-only trust in the same manner as outright transfers to individuals, at least for purposes of the Medicaid penalty period for uncompensated transfers. In other words, clients who make transfers are now subject to waiting 60 months for Medicaid eligibility whether the transfers are to a trust or outright to an individual. Understanding the treatment of trusts in determining the Medicaid eligibility is essential to evaluating whether an income-only trust is an appropriate asset protection option for a particular client.

The trust rules, which were unchanged by the DRA, are applied to determine (1) whether any of the trust assets are available to the Medicaid applicant, and (2) whether a divestment (i.e., an uncompensated transfer of assets) has been made. Any portion of the assets of such a trust, whether principal or income, which could be paid to the Medicaid applicant under any circumstances, is considered an available or "countable" resource to the Medicaid applicant. Actual payments from the trust to or for the benefit of the applicant are considered income of the applicant. Any portion of the assets of such a trust that cannot be paid to the Medicaid applicant under any circumstances, whether principal or income, is deemed to be a divestment as of the date of the establishment of the trust, subject to a penalty period of Medicaid ineligibility.

The principal of an income-only trust, which by its terms should pay only income to the Medicaid applicant and/or the applicant's spouse, and cannot distribute principal to the Medicaid applicant or the applicant's spouse, will not be deemed an available resource for Medicaid eligibility purposes. The principal either remains in the trust until the death of the applicant and/or the applicant's spouse or may be paid to a beneficiary other than the applicant or the applicant's spouse. The funding of an income-only trust is deemed an uncompensated transfer for Medicaid purposes and will result in a period of ineligibility, if the Medicaid application is filed within the 5-year look-back period.

Clients who want to plan for future long-term care costs, even though they may not presently have serious health issues, typically have concerns about the loss of control that accompanies an outright transfer of their assets to their children. An income-only trust can address the concerns of those clients by allowing the client to retain some control over the disposition of assets at death. An income-only trust also provides protection from creditor claims of the trust beneficiaries, except to the extent of the grantor's retained interest; whereas an outright transfer of assets to the grantor's children subjects those assets to the children's creditors.

Since the enactment of the DRA, an income-only trust is a powerful long-term care and asset protection planning opportunity when used properly in certain circumstances. Unlike outright gifts, the income-only trust can establish Medicaid eligibility while permitting the grantor more control over the distribution of the assets and protecting the grantor's assets from certain creditors' claims.

In addition to the Medicaid planning benefits, income-only trusts offer a number of tax benefits, which will be discussed in greater detail in our upcoming Summer 2010 Quarterly Newsletter.

For more information regarding this topic, please e-mail your requests to Brenna D. Mansfield, or call Brenna at (248) 457-7227.

In Pierre v. Commissioner, T.C. Memo. 2010-106 (5/13/10), Mrs. Pierre transferred $4.25 million of municipal bonds to a single-member family LLC. Twelve days after funding the LLC, Mrs. Pierre gifted 9.5% of her membership interests to each of two trusts - one she created for the benefit of her son, and the other for the benefit of her granddaughter. Simultaneously, she sold 40.5% of her membership interests in the LLC to each trust for secured promissory notes. Mrs. Pierre's appraiser valued the membership interests at a combined discount of 36.55% for lack of control (10%) and lack of marketability (30%). [A 10% lack of control and 30% lack of marketability discount would produce a combined discount of 37%. Perhaps the difference between 37% and 36.55% was due to some mistake in valuing the underlying assets.]

In its ruling, the Tax Court concluded the step transaction doctrine applied to the simultaneous gift and sale of membership interests in the LLC. The Tax Court found that "...nothing of tax-independent significance occurred in the moments between the gift transactions and the sale transactions". In other words, according to the Tax Court, a "single transaction" as to each trust occurred. Therefore, the Tax Court determined that two (2) 50% membership interests were transferred. It's interesting that the Tax Court appears to have disregarded the step transaction issue between the funding of the LLC, and the LLC transfers 12 days later.

Next, the Tax Court determined the value of the 50% membership interests. Mrs. Pierre's valuation expert at trial testified that there would be a lower lack of control discount (i.e., 8% rather than 10%), and a 30% lack of marketability discount. Given that the IRS failed to produce any valuation evidence, the Tax Court agreed with Mrs. Pierre's expert and allowed a combined discount of 36.5%! Thus, the Taxpayer was able to justify significant discounts for transfers of 50% membership interests in a single-member LLC holding only marketable securities.

For more information regarding this topic, please e-mail your requests to Julius Giarmarco, or call Julius at (248) 457-7200.