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Understanding Illinois estate taxes

Federal estate taxes get all the press.  But don’t forget that Illinois has an estate tax too.

And, to be honest, the Illinois estate tax is one of the most misunderstood things in estate planning.  We frequently get questions about how it works…even from other Illinois estate planning attorneys.

Calculating Federal Estate Taxes

The federal estate tax is pretty straightforward.  You can gift or pass on up to the exemption amount (currently $5.12 million but scheduled to go down to $1 million in 2013) without paying any taxes.  If your estate is larger than the exemption amount, you pay taxes only on the excess.

Calculating federal estate taxes is a simple matter of subtracting the exemption amount ($5.12 million) and multiplying the remainder by the tax rate (currently 35%).

Calculating Illinois Estate Taxes

andWe prepared an Illinois estate tax chart to highlight how the exclusion works for different estate sizes.  A good picture can often make a point much more clearly than paragraphs of the best explanation.

The blue line shows the estate taxes due (these figures were obtained from the Illinois Attorney General estate tax calculator).  As you can see, no Illinois estate taxes are due until an estate exceeds $3.5 million (the amount of the 2012 Illinois estate tax exclusion).  But once an estate hits that mark, Illinois taxes shoot up like a rocket.  Then, around $4.8 million, the taxes level off.

The red line is a continuation of that part of the blue line above $4.8 million. It is there to show what the taxes would have been in the absence of the exclusion.  The straight line starting at zero and continuing on through the blue line tells us that the taxes at and above $4.8 million is a flat percentage of the entire estate, not just the amount of the estate over $3.5 million.

Illinois Estate Tax Example

Let’s see how that works in practice.  In 2011, the Illinois exclusion amount was $2 million.  In 2012, that amount was raised to $3.5 million.

So that means a person can pass on an additional $1.5 million to their heirs tax free in 2013, right?

Not necessarily!

It’s easiest to see by looking at an example.  We’ll use an estate size of $5 million because that is the amount of the federal exemption from 2011.

  • Illinois Estate taxes owed in 2011 (exclusion $2.0 million):  $352,158
  • Illinois Estate taxes owed in 2012 (exclusion $3.5 million):  $352,158

Yes, you read those numbers correctly!  The taxes owed on a $5 million estate are exactly the same regardless of whether the exclusion amount is $2.0 million or $3.5 million.

The convergence point seems to be around $4.8 million.  Below that amount, an estate will owe less taxes under the 2012 rules than under the 2011 rules.  But for any estates over that amount, the Illinois estate taxes didn’t change with the increase in the exclusion.

What It Means For You

If your estate is between $2 million and $3.5 million (or from $4 to 7 million for a couple with the proper estate planning to take advantage of both spouse’s exclusion amounts), you can rest easy.  The increase in the exclusion amount saved your future heirs lots of money in Illinois estate taxes.

But if your estate is above $4.8 million (or $9.6 million for a couple with the proper estate planning) the increase in the exclusion amount didn’t reduce your estate taxes by even a single penny.

The good news for everyone with an estate over (or even close to) $3.5 million (or $7 million for couples) is that estate tax reducing strategies are available.

The best medicine for treating estate taxes is a good strategy + time to make it work.

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Illinois shifts course on long-term care Medicaid rules again

We were all set to deliver part II of our series on the January 1, 2012 Illinois Medicaid rules changes for nursing homes.  But the Illinois legislature apparently wasn’t done overhauling the Medicaid system.  Last week, Governor Quinn signed Senate bill 2840, which became Public Act 97-0689. It’s been given a friendly name:  the Save Medicaid Access and Resources Together (SMART) Act.  But its impact is anything but friendly to Illinois seniors.

Unlike the January 1st rules changes, which were driven by federal laws, these new rules changes are almost entirely due to the well-known Illinois budget problems.  The new law cuts $1.6 billion from the Medicaid budget, primarily by modifying eligibility requirements and benefits.

The biggest change made by SMART is the elimination of Pooled Payback trusts (also called OBRA d(4)(c) special needs trusts) in Medicaid planning for those over the age of 65 (in other words, almost everyone who needs it).

Previously, a senior could place their assets into a pooled payback trust and qualify for Medicaid immediately.  In exchange, when the senior passed away, their trust would be required to reimburse the State of Illinois for whatever Medicaid had spent on the senior (the “payback” part of the trust name).

One significant benefit of the pooled payback trusts to seniors was that payback happened at the Medicaid rates (what the State of Illinois pays nursing homes), which usually offered a substantial discount over the nursing home’s private pay rates.

While we still have many tools in the Medicaid planning toolbox, the loss of the pooled payback trust is a major blow to Illinois seniors.

The law pinches the finances of seniors in other ways too:

  • Retroactive Eligibility.  A Medicaid application can request long term care coverage for the three months prior to the month of application. For example, an application file in June can request coverage for expenses in March, April, and May.  Previously, an applicant could get coverage for the entire month simply by meeting eligibility requirements at any time during the month (usually the last day of the month).  Under those rules, Medicaid would cover all expenses in March as long as the requirements were met by March 31st.  Under the new rules, the applicant will have to meet eligibility requirements at the time of receiving services.  This change makes it even more critical to consult with an elder law attorney as soon as you believe that a nursing home stay is likely.
  • Community Spouse Resource Allowance (CSRA).  The amount of a couple’s assets that the community spouse (the spouse not in the nursing home) can keep is reduced from $113,640 to $109,560.  The CSRA had risen automatically this year, but SMART rolled it back and fixed it permanently at the 2011 level.  Please note that certain assets are exempt and not included in the $109,560 limit.
  • Monthly Maintenance Allowance (MMA).  The amount of a couple’s income that the community spouse can keep is reduced from $2,841 to $2,739 per month (although that figure is subject to federal approval of the change).  If a couple earns more than $2,739 per month, most (or in many cases all) of the excess must be paid toward the nursing home spouse’s care.
  • Homestead in Trust.  The primary residence of a couple is normally an exempt asset, meaning the value of the home doesn’t count against the $109,560 CSRA limit.  SMART eliminates that exemption for homes owned in a trust (either a revocable living trust or a bank land trust). Traditionally, the State of Illinois has placed a lien on homes owned by a Medicaid recipient.  But having the house in trust complicates that. While this change does make planning the estate of a community spouse a little more complicated, it’s more of an administrative change than one that directly hurts Illinois seniors.
  • Spousal Refusal.  The law means that spouses will have to pool their resources to pay for one spouse’s care, regardless of whether they have been keeping their finances separate previously.

We’re still digesting the full impact of the SMART Act.  It weighs in at 450 pages (you can read it on the Illinois General Assembly website if you’re interested) and revamps the requirements for many of the Medicaid programs.

One thing SMART doesn’t change is that planning for possible long term care needs to be done early to be the most effective.  So if you, or someone you love, are concerned about the possibility of long term care (even if many years in the future), it is crucial to get educated and begin planning.

Many asset protection options take years to mature.  And it is essential to learn how to avoid the common mistakes in handling the finances of a spouse, sibling, or parent — mistakes that could cost them thousands of dollars in Medicaid penalties and countless sleepless nights.

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Long-Term Care Medicaid Changes for 2012 (Part I)

Most seniors who spend significant time (months or years) in a long-term care facility end up relying on Medicaid at some point during their stay. Nursing home costs can be a crushing burden, one that most seniors can’t shoulder alone for long.

Medicaid qualification has always been tough.  But seniors have usually been able to protect a few assets for their spouse or children, or to supplement their own care, on their way to getting Medicaid assistance.

Now, though, Illinois has implemented harsh new rules required by the Deficit Reduction Act of 2005 (DRA), a federal law that governs the state Medicaid programs.  These new rules apply to any Medicaid long-term care applications filed in Illinois after January 1, 2012.

If you’re close to retirement age, or have a parent or loved-one close to retirement age, knowing how these new rules work is critically important.

The changes are so big that we’ll need to cover them in several parts.  This first part deals with two concepts that our clients usually encounter first when researching Medicaid — “look back” and “penalty periods“.  The rules for both have changed dramatically.  And the changes could cost unprepared Illinois seniors tens of thousands of dollars in lost Medicaid long-term care benefits.

5-Year Disclosure Period (“Look Back”)

The old Medicaid rules required applications to be filed with three years of the applicant’s financial history, including bank records, tax returns, and information about sales or gifts of assets.  Anything that occurred more than three years prior to filing did not have to be disclosed for the most part.

Applications filed on January 1, 2012 or later must include five years of financial history.  That’s a big change (66% more), and when combined with the penalty period changes below, it makes planning for Medicaid much more complicated than under the old rules.

Penalty Periods

The primary purpose behind reviewing five years of financial history is to determine whether the applicant made any disallowed transfers.   Gifts, of course, are considered transfers.  But so are many other things that people often do, such as reimbursing family members for groceries or paying them for helping around the house.

When disallowed transfers are found, a penalty period is imposed.  While under a penalty, a senior is denied Medicaid benefits — even though they might otherwise qualify.  The senior must find another way to pay for the care until the penalty is over.  That can be difficult when the assets gifted or transfered can’t be recovered.

The new Medicaid rules made significant changes to the way penalty periods are calculated and applied.

Transfers Accumulated

The old rules treated every month with a disallowed transfer independently.  So the penalty for a $6,000 transfer in January was separate from the penalty for a $500 transfer in February.  This generally worked out in favor of the senior because of how the other penalty rules worked.  Small transfers spread among many months often didn’t even create a penalty at all.

Under the new rules, all disallowed transfers from the past five years are added together to calculate the penalty.  So very small transfers (even just a few hundred dollars) — if they are made regularly — can result in a huge penalty when added together.

No Rounding of Penalties

The length of the penalty period for a disallowed transfer is equal to the value of the transfer divided by the monthly private pay rate for the nursing home the senior resides in at the time of the application.  For example, a $9,000 transfer with a private pay rate of $5,000 results in a 1.8 month penalty.

The one month penalty is pretty easy to understand.  But happens to that fractional 0.8 months?

Penalties under the old Medicaid rules were calculated in whole months.  And fractional months weren’t rounded using the rules we were all taught in grammar school (round up 0.5 and above and round down anything lower).  Instead, fractions were simply dropped.  So a 1.8 month (or 1.9 month) penalty was applied as a 1.0 month penalty.

This obviously left open up all sorts of doors for creative asset protection.  But those doors have now been closed.

Fractions are no longer rounded down.  Penalties are calculated and applied to the half of a day.  A penalty of 1.8 months will be applied as a 1 month and 24 day penalty.

Penalty Periods Applied After Qualification

Applications under the old rules were often simplified by the fact that penalties were applied in the month of the transfer.

Imagine that a $15,000 transfer was made 24 months before applying and that the nursing home private pay rate is $5,000 per month.

  • Under the old rules, a three month penalty would have been applied beginning in the month of the transfer.  That means the penalty ended 21 months ago — in other words, long before Medicaid coverage was actually needed!
  • Under the new rules, the penalty starts only after the senior applies for Medicaid and meets all of the other qualification requirements.

As you can see, even fairly large transfers made many months (or years) before applying weren’t likely to cause problems under the old Medicaid rules.

Combining the Penalty Period Rules — An Example

Taken individually, the changes to penalty periods sound quite harsh.  But you really need to see an example to fully understand just how much the new rules will affect seniors.

Mary has been in good health and financially secure for years.  And she has been generous with her money.  Every year at Christmas, Mary gives $100 to each of her seven grandchildren.  A couple of years ago, Mary also gave $4,500 to her daughter, Susan, to help Susan through a period of prolonged unemployment.

Recently, though, Mary’s health has declined and she is now residing in a nursing home that costs $5,000 per month.  The rest of Mary’s assets have been spent, and she is now looking to Medicaid for her long-term care needs.

Everything Mary did is what many other grandparents would do — and have done — in the same situations.  But the Department of Healthcare and Family Services won’t look at what Mary did in the same light.

Under the new Medicaid rules, Mary made $700 worth of disallowed transfers each year (the Christmas gifts) plus a single disallowed transfer of $4,500 (the gift to Susan).  Adding up five years worth of transfers (remember, there is now a five year look back period) brings the total to $8,000.

The Department of Healthcare and Family Services will apply a 1.6 month penalty to Mary ($8,000 in transfers divided by the $5,000 private pay rate).  Mary’s nursing home will be looking to someone else to pay for Mary’s care during the penalty period.

What it All Means for Your Family

The new Medicaid rules have been described by some as “harsh”.  But that may be an understatement.  Completely ordinary behavior will now be penalized.  As a result, it is imperative that Illinois seniors suffering from declining health get counsel from an elder law attorney to make sure that they aren’t damaging their Medicaid eligibility.

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Looking back at 2011: all the rest

In Part 2 of our year-end review, we discussed the new Power of Attorney statute.  Next up are some changes affecting couples.

Tenancy by the Entirety

The first major change of 2011 provided new options to married couples in how they own their home.  Tenancy by the entirety was a special protection available for the marital residence.

Normally, a person’s house is completely exposed to their creditors apart from a $15,000 homestead exemption.  But married couples can own their primary residence (and only their primary residence) in tenancy by the entirety.

Tenancy by the entirety works the same as joint tenancy, meaning that when one spouse dies the other spouse inherits the entire property.  But it also adds some major creditor protection.  A home held in tenancy by the entirety can’t be lost to creditors of only one spouse.

Of course, creditors try to find a reason (any reason!) to drag the other spouse into the picture.  Even so, it’s a very strong protection.

Prior to 2011, tenancy by the entirety was only available to married couples who owned their homes directly or via a land trust.  Owning a home directly exposes the home to probate.  Land trusts were a common solution to the probate problem, but that usually meant paying annual fees to a bank to maintain the land trust.

Starting January 1, 2011, tenancy by the entirety protection became available to couples who want to own their home in a traditional revocable living trust.  It’s not automatic and it does not apply to people who transferred their home into their trust prior to January 1, 2011.  The trust and the deed need to be drafted with tenancy by the entirety in mind.

The new statute provides a useful alternative for married couples who want to: (1) hold their home in tenancy by the entirety; (2) keep their estates out of probate; and (3) avoid paying a bank for an expensive land trust.

Civil Union Act

On June 1, 2011, the Illinois Religious Freedom Protection and Civil Union Act went into effect.  That law made Illinois just the sixth state in the nation to recognize civil unions for same-sex couples. Civil union partners have the right to be treated as a spouse under the Probate Act.  They can also hold their primary residence in tenancy by the entirety (previously granted only to married couples—singles and same-sex couples were out of luck!).

While the Civil Union Act provides certain safeguards, its benefits don’t extend to every aspect of estate planning.  And at best, it means that same-sex couples get the same bad “default” Illinois estate plan as traditional married couples.  So it is important for same-sex couples to have a comprehensive estate plan that addresses their property and health care.

To 2012…and Beyond!

Those are the major stories from 2011.  There’s more to come for 2012, and we’ll be sharing it with you as it happens.  We look forward to a great year of serving you!

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Looking back at 2011: new powers of attorney

In Part 1 of our year-end review, we discussed the reemergence of the Illinois estate tax.  Next up are the changes to powers of attorney.

A new version of the Illinois Power of Attorney Act went into effect July 1, 2011.  The law changed the rules and statutory form for the Power of Attorney for Property and the Power of Attorney for Health Care.

No doubt, you are probably thinking, “what happens to the powers of attorney I signed 1 (or 2, 5, 10) years ago?”  Don’t worry.  If you have existing powers of attorney, you are not required to rush out tomorrow and sign new ones.

Of course, if they’re more than a few years old, you may still want to get them updated.  Banks sometimes question outdated powers of attorney (those more than 3 years old).  And if you’re over the age of 55, you’ll definitely want to consider a power of attorney with long-term care and elder law provisions (the statutory form which most people have does not address these issues).

While there are many technical changes to the Power of Attorney for Property, the most noticeable change is the ability to name multiple people to act as your agents simultaneously under a Power of Attorney for Property.  Your panel of agents can then act on your behalf by majority vote if you become incapacitated.

The new Power of Attorney for Health Care also provides broader access by your agents to your health care information if they need to act under the power of attorney.  These changes were made necessary by the HIPAA privacy rules that were published in August, 2002.  If you have a separate HIPAA authorization as part of your estate plan (and you do if we drafted your plan), you may not need to update your Power of Attorney for Health Care.

From a legal standpoint, I would describe the changes as a “solid upgrade”.  Something to be aware of, but not likely creating any need for action on your part—unless you were sorely lacking in the power of attorney department to begin with!

In Part 2, we’ll fill you in on the rest of the changes from 2011 and look ahead at what to expect in 2012.

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