Up until now, only bankruptcy courts have awarded inherited IRAs to creditors. (See our August and March, 2009 E-Updates reporting seven inherited IRA losses in eight Chapter 7 bankruptcy cases.) Now, however, for the first time, a civil court has awarded an inherited IRA to a judgment creditor. The Florida second district court of appeal's decision in Robertson v. Deeb, 2009 Fla. App. LEXIS 11322, was handed down on August 14, 2009.

The question before the court was whether the $75,372 IRA that Richard Robertson inherited from his father was exempt from garnishment by Kevin Deeb. Deeb garnished Robertson's inherited IRA after Robertson defaulted on a loan from Deeb. Though Florida statutes section 222.21(2)(a) exempts "any money or other assets payable to an owner, participant, or beneficiary from, or any interest of any owner, participant, or beneficiary in [an IRA] fund or account [...] from all claims of creditors of the owner, beneficiary, or participant", the court of appeal affirmed the trial court's opinion that this exemption had only the original IRA owner (i.e., Robertson's father in this case) in mind. Therefore, Deeb got Robertson's inherited IRA.

When it comes to protecting inherited IRAs in the civil courts, a spendthrift trust will not be enough. There is no simple exclusion for spendthrift trust assets in civil law as there is in bankruptcy law. In addition, unlike with Chapter 7 bankruptcy, judgment creditors get to "stick around" waiting for trust distributions to be made - distributions that they can take once made. Under Michigan law, judgment creditors can stick around for at least 10 years. MCL 600.5809(3). To counter this, a spendthrift trust that gives the trustee the discretion to hold back or "accumulate" distributions is needed. Fortunately, with careful drafting, such a trust can qualify for a stretch-out. Thus, when creditor protection for inherited IRAs is a concern - and it should be in light of these continuing court losses - careful trust planning to both preserve the IRA stretch-out and the IRA itself should be used.

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

In PLR 200927014, the IRS ruled that the transfer by two shareholders of their S corporation shares to their single member LLCs would not cause the S corporation to lose its S corporation status. The shares will be treated as owned by the transferring shareholders because the LLCs are disregarded entities for income tax purposes.

The shareholders will manage their LLCs and retain all rights to profits, losses, and distributions. The apparent purpose of the proposed transaction was to transfer some (but not all) management rights (of the LLCs) to a third party. It was not clear whether the third party was an individual or an entity. The third party was not a member of either LLC. It's not clear from the ruling whether the third party has control, but the tenor of the ruling is that the outcome was not dependent upon control, but solely the right to the economic interests in the LLC.

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

Do your estate planning documents include incentive trusts? Lots of folks thought these were the cat's meow to motivate Junior to be productive. Some incentive trusts distribute dollar-for-dollar to the beneficiary's earned income. Earn a dollar, get a dollar. This Forrest Gump trust planning, "Simple Is As Simple Does", was never the right approach. A common problem with incentive trusts is that if Junior became something less than desired he'd still get a big trust distribution, but if he joined the Peace Corp. he'd get a pittance. In a recession, Junior may have been industrious but lost his job anyhow. So, incentive trust fund kids are being hung out to dry, instead of their trusts helping them through the lean years. Not a great result.

Does it make any sense to limit distributions if the beneficiary lost her job because her employer declared bankruptcy? (What if she quit her job, not because she was retreating from the job, but because she was advancing her career in another direction?) The impact of the recession on a poorly drafted trust could be disastrous. If you set up an incentive trust, review it now with your advisers to see what can be done to infuse rationality into incentive provisions. Instead of memorializing incentive provisions in new trusts, explain wishes in nonbinding letters so they can be reconsidered in light of new circumstances.

For more information regarding this topic, please e-mail your requests to Randall A. Denha, or call Randy at (248) 457-7205.

IRS Notice 2006-95 provides that, if permanent life insurance policies issued since January 1, 1995 have their death benefits increased or reduced, the use of the 2001 CSO tables to determine reasonable mortality charges is required. Notice 2006-95 is effective for such policy changes made after December 1, 2008. Consequently, some insurers are no longer allowing the reduction of the death benefit (or face amount of coverage) on older policies on the grounds that a reduction of the death benefit would cause the policy to fail to qualify as life insurance under IRC Section 7702.

Older permanent policies (i.e., those that were issued when the 1980 CSO tables were in effect and after December 31, 1984) will be deemed to be reissued if there is either an increase or reduction in the death benefit. Consequently, the 2001 CSO tables will be applied to test whether the policy meets the definition of life insurance under IRC Section 7702. Unfortunately, many of these "older policies" will not meet the definition of life insurance. The consequence of failing to qualify as life insurance is that the policy would be treated, in essence, as a term life policy with a taxable side fund so that all of the increases in the cash value of the policy would be taxable. In order to avoid this outcome, some insurers are simply preventing the increase or reduction in coverage on their older policies. For those insurers that still allow reductions in these older policies, application of the 2001 CSO tables could result in the unintended taxation of the increase in the cash surrender value of such policies following such reduction.

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