On February 26, 2009, President Obama sent to Capitol Hill an outline of his budget proposal. The proposed budget suggests making permanent the 2009 rules for estate taxes - $3.5 million exemption (per decedent), with a 45% top tax rate. In addition, the $3.5 million exemption amount would be indexed for inflation. While Congress is certain to put its own "stamp" on estate taxes, it appears to us that two things are likely: There will be no estate tax repeal; and the estate tax exemption will not be reduced from its current level.

We will be closely watching the legislative process and will report back to you if and when a new tax bill is finalized.

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

Section 529 plans (also called "Qualified Tuition Programs" or QTPs) are a popular way for parents and grandparents to save for a child's or grandchild's college education. The donor can make an after-tax contribution to a 529 plan and the earnings, if used for college, are free of federal income tax (and usually state income tax, too).

What if there are no earnings? The following list summarizes the rules concerning 529 plan losses.

• Losses Can Be Claimed. If a nonqualified distribution is taken from an account that has a loss, the distributee can claim the loss as a miscellaneous itemized deduction. I.R.S. Publication 970 (2008) states:
  
  "If you have a loss on your investment in a QTP account, you may be able to take the loss on your income tax return. You can take the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. Your basis is the total amount of contributions to that QTP account. You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23, subject to the 2%-of-adjusted-gross-income limit."
  
  
• Aggregation of Accounts Within a State. Because of an aggregation rule, "all amounts from that account" will not have been distributed until all accounts for that particular beneficiary under that particular state's program have been distributed.



• Aggregation of Distributions. All distributions during the year must be aggregated in determining losses. Publication 970 (2008) states:
  
  "If you have distributions from more than one QTP account during a year, you must combine the information (amount of distributions, basis, etc.) from all such accounts in order to determine your taxable earnings for the year. By doing this, the loss from one QTP account reduces the distributed earnings (if any) from any other QTP accounts."



• Miscellaneous Itemized Deduction. The loss is a miscellaneous itemized deduction, not a capital loss. A taxpayer who does not itemize will receive no benefit from the loss. A taxpayer who does itemize will benefit only if total miscellaneous itemized deductions exceed 2% of adjusted gross income.



• AMT. Miscellaneous itemized deductions are not deductible for alternative minimum tax purposes. Therefore, a 529 plan loss could cause a taxpayer to incur AMT. A taxpayer who is already subject to AMT would not be able to use a 529 plan loss.



• Recontributions. If a nonqualified distribution is made, any recontribution to a 529 plan would be considered a new gift.

For more information regarding this topic, please e-mail your requests to Salvatore J. LaMendola, or call Sal at (248) 457-7204.

A stock life insurance company submitted a request for a private letter ruling to the IRS regarding the income tax consequences of benefits paid under one of its permanent life insurance contracts. The insurer represented that it issues individual non-participating, flexible premium adjustable life policies designed to qualify as life insurance contracts under IRC Section 7702. The insurer permits the purchase of a rider to such policies which allows the owner to make an election to accelerate the receipt of all, or a portion of, the death benefit if the insured becomes critically ill. The rider outlines several "qualified covered conditions" which trigger the ability of the policy owner to receive the benefit payments during his/her lifetime.

Upon the payment of benefits following a physician's diagnosis that the insured falls within one of the qualifying covered conditions, benefit payments may be received until the death benefit is reduced to zero. In the event that the death benefit payable is reduced to zero, the policy would terminate.

The insurer represented to the IRS that the rider does not provide any cash value or loan value. The policies and the subsequent rider are purchased with after-tax monies so that none of the premiums are deductible by the policy owner.

Based upon the representations made by the insurer, the IRS ruled in PLR 200903001 that the rider benefits payable to the policy owner would be fully excludable from the owner's gross income under IRC Section 104 (a)(3). The IRS has ruled that the recipient is essentially receiving non-income taxable life insurance proceeds prior to the insured's death. These benefits would not be taxable, since IRC Section 104(a)(3) provides that gross income does not include amounts received through accident or health insurance for personal injuries or sickness, other than amounts contributed on a pre-tax basis.

For more information regarding this topic, please e-mail your requests to Thomas P. Cavanaugh, or call Tom at (248) 457-7218.

When is an IRA (traditional or Roth) not an IRA? Apparently, after the owner dies. This has been a winning argument for creditors in six of the last seven bankruptcy cases on the matter.

From 1999 until as recently as January, 2008, bankruptcy courts in Alabama, California, Illinois, Oklahoma, Texas, and Wisconsin have all decided against IRA beneficiaries claiming exemptions for their inherited IRAs. The lone state to buck the trend has been Idaho. This, despite state law in each state explicitly protecting IRAs. How, then, the one-for-seven record? Looking at the pre-death and post-death differences (such as the post-death minimum distribution rules, the pre-death pre-59 ½ withdrawal penalty, and the post-death prohibition against additional contributions), the courts have decided that inherited IRAs are not the same kind of IRA that their state legislatures had in mind for protection.

It is important to note that all of these cases applied the state exemptions rather than the federal exemptions which also protect IRAs. Therefore, there may be some hope for the debtors in the Texas and Wisconsin cases since, of the seven, these states are the only two that are not "opt out" states (states which prohibit use of the federal exemptions). Thus, if certain other conditions are met, the Texas and Wisconsin debtors may be able to try again under the federal exemptions. Would they fare any better? If the same reasoning is used, probably not. This would be especially unfortunate for the Wisconsin debtor. The IRA that his 73 year old mother left to him was worth $283,893.

What to do? If asset protection planning for IRA beneficiaries is an important consideration, arrange to make reliance on any exemption, state or federal, unnecessary by either using a trusteed IRA or by naming as beneficiary a spendthrift trust. (A debtor's beneficial interest in a trust that contains a valid spendthrift provision is excluded from the bankruptcy estate.) Since trusteed IRAs are not very common and are hard to amend, the spendthrift trust option will usually be preferable. Such a trust should not be a conduit trust since creditors will be able to reach the amounts required to be distributed. It should, nonetheless, qualify as a "see-through" trust to allow for a stretch-out. If drafted properly, results better than the current record should obtain.

For more information regarding this topic, please e-mail your requests to Salvatore J. LaMendola, or call Sal at (248) 457-7204.

	Annual	Semi-Annual	Quarterly	Monthly
Short Term AFRs (Term 3 Years or Less)	0.83%	0.83%	0.83%	0.83%
Mid Term AFRs (Term More Than 3 Years and 9 Years or Less)	2.15%	2.14%	2.13%	2.13%
Long Term AFRs (Term More Than 9 Years)	3.67%	3.64%	3.62%	3.61%
Section 7520 Rate	2.6%