Prior to the enactment of the Michigan Trust Code, there was no Michigan law providing a date by which a challenge to a revocable trust had to be brought. This was in contrast to wills, where a formal proceeding to admit a will to probate could bring certainty to the validity of the will.

MCL §700.7604, which is effective on April 1, 2010, along with the rest of the Michigan Trust Code, provides alternative periods of time to bring claims to challenge the validity of a revocable trust. The length of the statute of limitations period will depend on whether notice is given. If the statutory requirements are satisfied, a person receiving proper notice has six months to commence a judicial proceeding to contest the validity of a trust that was revocable at the settlor's death. If the requisite notice has not been provided, then it is two years after the settlor's death.

What if a person has no interest in the trust at the time of the settlor's death? The Trustee can still send the requisite notice to that person in order to begin the six month statute of limitations. For example, assume that a settlor, prior to his death, amended his trust to eliminate a beneficiary. Even though that person no longer has any interest in the administration of the amended trust, it may be prudent to provide that person with notice in case the amended trust is held to be invalid. The six month statute of limitations period would not begin to run against that eliminated beneficiary unless he/she was provided with the statutory notice. Thus, trustees will need to carefully consider the benefit of providing notice to persons or charities who have been eliminated as beneficiaries by amendments to the trust.

For more information regarding this topic, please e-mail your requests to Julie L. Cavanaugh, or call Julie at (248) 457-7228.

Inherited IRAs are now 2-9 in the courts. On January 11, 2010, in the Nessa decision, the Minnesota bankruptcy court held that the federal exemption for IRAs protects inherited IRAs. (See our February, 2010 E-Update for more.) This was the second win, and the first time that the federal statute was put to the test. However, the ninth loss came on March 5, 2010, less than two months later, in Texas. In In Re Chilton, a Texas bankruptcy court has held that a $170,000 inherited IRA was not protected under the same federal statute. Unlike the Nessa court's opinion, the Chilton court's opinion was quite thorough. In fact, creditors' attorneys will benefit from it.

Which court is interpreting the statute correctly? We will have to wait and see. However, one thing is certain for now. Since retirement plan trusts are always excluded from the bankruptcy estate, the question of whether an exemption (federal or state) applies or not never comes up. To prevent your client's retirement plans from becoming the next loss (see our updated summary on page 2 here), be sure to recommend a retirement plan trust as beneficiary.

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

In 1986, Carolyn McGowen purchased for $500,000 a single-premium variable life insurance policy on her own life. Carolyn remained the owner and possessed the right to cancel the insurance policy and receive its net cash surrender value. The net cash surrender value is the cash value less any policy debt, which would include all outstanding loans plus accrued interest. The policy permitted Carolyn to borrow money at a 5.25% annual interest rate. Any loans against the policy are non-recourse to Carolyn and the insurance policy itself was the sole collateral for which the insurance company could seek payment of the amount Carolyn might borrow.

From the date the policy was issued until March 30, 2004, the policy loans and accrued interest exceeded $1 million. On March 30, 2004, after numerous written warnings, the insurer cancelled the life insurance policy. Additionally, it issued and sent to Carolyn IRS Form 1099-R reporting a gain of $565,224.11. ($1,065,224.11 cash value of the policy on the date of cancellation minus the $500,000 investment in the contract).

Following Carolyn's refusal to report this income on her 1040 and pay the correlative tax, the IRS issued a notice of deficiency. Litigation in the tax court ensued. There is no dispute that Carolyn received income. The question is whether or not the income is to be: (1) characterized as income received from a life insurance policy; or (2) characterized as income received from a discharge of indebtedness.

Carolyn argued that she received income from discharge of indebtedness. In other words, she did not deny that there was income, but rather the income she received (due to the discharge of indebtedness) was not taxable because her use of those funds fell within one of the permitted exceptions outlined in IRC Section 108 (g). Although the Court in Bill S. McGowen v Commissioner, T. C. Memo 2009-285 didn't outline the use of the policy loans taken by Carolyn, apparently the loans were used for farm related expenses and which fell within one of the exceptions.

The Court did not agree with Carolyn's argument and held that she is treated as having received income from a life insurance contract. Plainly, Carolyn never received any direct distributions from her life insurance policy, but the Tax Court held that she must recognize this indirect distribution of income under IRC Section 72 (e).

The point to be taken from this case is that taxpayers who borrow from their life insurance policy and allow the carrier to cancel it because the loans and accrued interest exceed the cash surrender value should expect to report as ordinary income the amount of the policy's cash surrender value in excess of their investment in the contract. Here, since the policy was cancelled and not sold, there was no reduction in Carolyn's $500,000 basis for the cost of insurance. Had the policy been sold pursuant to IRS Notice 2009- 13, her basis in the contract would have been reduced for the cost of insurance.

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

Significant changes occur for many parents when a special needs child turns 18. Upon reaching the age of majority, the child becomes an "adult" in the eyes of the law and the parent loses the legal authority to make decisions for their child and automatic access to information about the child. If the child has sufficient mental capacity, he or she should execute a general durable power of attorney appointing a parent or other representative to assist with financial decisions when needed or appropriate. Similarly, the child should execute a patient advocate designation appointing a third party as his or her agent for medical decisions. If the child is not legally competent to execute powers of attorney, a guardianship (for health care decisions) or conservatorship (for financial decisions) may be necessary.

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