Published by the Virginia State Bar Trusts and Estates Section for its members

Volume 19, No.1

Letter -from the Chair The Board of Governors of the Trusts and Estates Section of the Virginia State Bar is pleased to bring to its members the Fall 2003 newsletter. This issue includes four articles that cover a variety of important topics in estate planning. The first article by Amy Pesesky provides useful information about planning for special needs beneficiaries. Amy offers helpful guidance in drafting a special needs trust, as well as considerations on when a special needs trust versus a broad discretionary trust may be appropriate. The article also addresses when a community trust may be beneficial in providing for a special needs beneficiary.

Fall 2003 state that has no estate taxes, if appropriate in the clients' situation, to help reduce estate taxes. If you are reading this newsletter and are not a member of the Trust and Estates Section, please join us. It is as simple as checking the Trusts and Estates Section box on your annual Virginia State Bar renewal form and paying the minimal additional fee. I hope that you find the articles in this newsletter informative. If you should have any questions or comments about this newsletter or the Trusts and Estates Section, please contact me or any of the other members of the Board of Governors. Our names, addresses and telephone numbers are listed at the end of this newsletter.

Phillip C. Stone, Jr., Chair

The second article by Victoria Roberson addresses the myriad of issues related to medical directives and the importance of fully advising clients on these issues and prQy_i_g!~g_Jh~JIlyvi~h tl1~ .);~s()tl:r~es '-l.Ya.il~Ql~ JQmake appropriate decisions. Victoria provides a sample medical directive form that is enhanced from the statutory form provided in the Virginia Code, as well as a list of available resources relating to medical directives and end of life decision making. The third article by Dana Fitzsimons offers important information about charitable giving using S corporation stock. Although it is possible for clients to make gifts of S corporation stock to charity outright or in certain types of trusts, extreme care should be taken so as not to violate the S corporation rules. Finally, the fourth article by Erin Sheehey Downs addresses the phase out of the state death tax credit and how lifetime transfers will result in lower Virginia estate taxes. In certain cases, Virginia clients may even want to consider changing domicile to another The Trusts and Estates Newsletter is published by the Virginia State Bar Section on Trusts and Estates for its members to provide information to attorneys practicing in these areas. Statements, expressions of opinion, or comments appearing herein are those of the editors or contributors and not necessarily those of the Virginia State Bar or the Section on Trusts and Estates.

PLANNING FOR SPECIAL NEEDS BENEFICIARIES by Amy G. Pesesky Professionals working in the estate planning area frequently encounter clients with family members who have special needs. At the initial stages of the planning process it is important for the advisor to get as much information as possible regarding the nature of the special needs beneficiary's disability. In particular, care should be taken to determine what pubic benefits (e.g., SSI, Medicaid, Section 8 housing and food stamps, to name a few), if any, the special needs beneficiary is receiving or may be entitled to receive in the future, so that the special needs beneficiary's share of an estate or trust does not mistakenly cause ineligibility. Similarly, special planning may be necessary to make sure beneficiaries with certain special needs do not have access to funds which enable certain unhealthy lifestyles (e.g., for drug or alcohol addicted beneficiaries). This article is a general discussion of several options available to the client who wants to make provisions for a special needs beneficiary and the possible effect on public benefits. It is not intended to be a comprehensive study of the eligibility rules which may apply to a special needs beneficiary's qualification for public benefits. Nor will this article address trusts established by disabled individuals with that individual's own funds for that individual's benefit. A Special Needs Trust can be utilized to provide for the special needs beneficiary in a manner that will not cause ineligibility for public benefits. The Special Needs Trust is a trust established by a grantor for the benefit of another individual who is or may become entitled to public benefits. This type of· trust is designed to supplement public benefits without causing the individual to be disqualified for public benefits.

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The term Special Needs Trust, as used in this article, refers to a trust which limits the trustee's discretion to make distributions to provide only for the "special needs". of the beneficiary. Special needs generally refer to the requisites for maintaining the beneficiary's happiness, welfare and development when, in the discretion of the trustee, such requisites are not being provided by any public agency, office, or department of any state or local government, or of the United States. The trust should contain terms defining the trust as a purely discretionary trust and not a basic support trust. That is, the Special Needs Trust should contain prohibitions of distributions for basic food, clothing and shelter. Special Needs Trusts usually contain provisions for the termination (and distribution to beneficiaries other than the special needs beneficiary) of the trust if the beneficiary's interest in the trust causes disqualification for public benefits. The trust may also give the trustee· the discretion to make distributions upon the beneficiary's death to pay some or all of the expenses of the beneficiary's last illness, funeral, burial and estate administration. Consideration should be given to the selection of remainder beneficiaries upon the death of the special needs beneficiary and the impact that might have under state law. For example, although not applicable in Virginia, the Rule in Shelley's Case can be in effect in other jurisdictions and may cause a trust to be treated as a resource of the special needs beneficiary. Prior to the establishment of a Special Needs Trust, it is important that the grantor be fully advised of the restrictive nature of a Special Needs Trust. If it is the grantor's strong desire

that trust assets not be utilized in a manner which may cause disqualification of the beneficiary for public benefits, the Special Needs Trust is the appropriate vehicle to accomplish that goal. An individually designed Special Needs Trust can be established and funded by the client's will, revocable trust or by an inter vivos irrevocable trust. However, care should be taken if the special needs beneficiary is the spouse of the grantor. For example, establishment of a Special Needs Trust for a spouse other than by a last will and testament may cause ineligibility for Medicaid. The Medicaid Manual is now available at www. dss.state.va.uslbenefit/medicaid manual.html and it is recommended reading for anyone preparing a Special Needs Trust. The Special Needs Trust can also be established by an individual during lifetime by gift or at death by bequest through any number of "community trust" entities. Many localities have established such trusts and will hold funds in a segregated manner to provide for a specific individual beneficiary.. These trusts may be ideal in certain circumstances. For example, in situations where resources are limited and the funds to be held are relatively modest in size, the use of a community trust may be advisable. In addition, community trusts may be advisable when there is no individual known to the grantor or testator who is suitable to serve as the trustee and the fund is not large enough to warrant the appointment of a corporate fiduciary.

receive funds that enhance their benefits. Some community trusts have Special Needs Trusts which are designed to meet the needs of any beneficiary with special needs and may serve a broader geographical region. The Commonwealth Community Trust, for example, was established in 1990 by a group of parents with disabled children. It is an I.R.C. Section 501 (c)(3) organization and ,is intended to be available to Virginia residents as an economical way to have trust funds administered for people with disabilities that will supplement the benefits offered by entitlement programs. The Commonwealth Community Trust administers a Special Needs Trust (funded by third parties), as well as a Pooled Disability Trust (self-funded by individuals with disabilities). The Trust Company of Virginia serves as Trustee and the trusts are administered by an Executive Director and a Board of Directors. The Board of Directors is comprised of volunteers, including estate planning professionals and individuals who have disabled children. The Master Trust Agreement of the Special Needs Trust of the Commonwealth Community Trust and other information regarding the trust can be found at www.commonwealthcommunitytrust.org. One of the drawbacks of the Special Needs Trusts (whether individually designed or established through a community trust) described above is that trust funds may only be used for supplemental or special needs. There may be situations in which the client prefers to provide for the special needs beneficiary in a more significant manner than permitted under the Special Needs Trusts discussed above. For example, a parent who pays the rent, food and clothing expenses for a child with special needs and who considers the child's current living arrangements to be ideal, may want such payments to continue after the parent's death even if the payments cause the beneficiary to be ineligible for certain entitlements. This is often the case with high net worth individuals who are providing significant support for an adult child with a disability. Such individuals may be more

Care should be taken to be sure the community trust selected meets all of the client's goals and that the client understands how the funds will be held and expended for the special' needs beneficiary. Some community funds have been established to assist individuals in a specific regional area and/or individuals with specific disabilities. For example, The Norfolk Community Trust was established in 1992 in association with the Norfolk Community Services Board as an instrument through which parents and guardians could ensure that their loved ones with mental illness and mental retardation would'

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concerned that the adult child's lifestyle not be disrupted than they are that the child will not qualify for SSI or Medicaid. In theory, it is possible for a third-party to establish a discretionary trust for a special needs beneficiary (other than' himself) which is not a' special needs trust as long as the beneficiary does not have the legal right to compel distributions for his or her support and maintenance~ The plain language regarding the treatment of trusts as a resource under the Virginia Medicaid Manual leads one to believe that such trusts should not be treated as a resource. See Sections SI120.200, et. seq., Section MIllO.lOO, et. seq. and Ml120.202, et. seq. of the Virginia Medicaid Manual. However, state court decisions in this area have been less than consistent an'd the planner must use caution. The planner must consider the fact that (i) the Virginia Department of Social Services may take the position that these trusts are a resource, and (ii) that even if the trust may not cause ineligibility under Virginia Medicaid rules, it may cause disqualification from benefits under another state's law. Clients should be advised of the importance of reviewing their estate plans if they move to another jurisdiction. Some planners recommend adding a provision to the trust which permits the trustee to amend the trust to avoid such disqualification. Trust spendthrift language and provisions stating the grantor's, intention that the Trustee consider other means of support should be considered. For a comprehensive treatment of this topic, see Third Party and SelfCreated Trusts, A Lawyer's Comprehensive Reference, by Clifton B. Kruse, Jr. and published by the American Bar Association, Section of Real Property, Probate and Trust Law. The estate planning tools discussed above are not necessarily mutually exclusive. The client may, for example, decide to create two separate trusts for a special needs beneficiary, a Special Needs Trust and a trust which permits the trustee very broad discretion to make decisions regarding distributions and public benefits based upon the facts and circumstances at the time. The rules and regulations pertaining to qualification for public

benefits are constantly changing. Therefore, it is imperative that the estate planning advisor review eligibility requirements before proceeding with the establishment of Special Needs Trusts if the intention is to preserve public benefits which the special needs beneficiary is receiving. Some clients have a special needs beneficiary whose "disability" is the result of certain selfdestructive behavior. For example, the receipt of any significant amount of money by a beneficiary suffering from the disease of alcoholism and other addictive conditions will often enable the beneficiary to continue abusing alcohol or dlUgS. Although these are always sensitive issues, it is important to determine your clients' desires with regard to distributions to, or for the benefit of, such beneficiaries. Fortunately, there is unlimited flexibility through the use of trusts to protect and provide for such beneficiaries. Clients should be advised that such trusts may be tailored to fit any situation. Some special provisions to consider are withholding all distributions if drug or alcohol abuse continues, random drug testing, and matching distributions for earned income. Clients may be reluctant to include such provisions in the will or trust. As an alternative, a private conversation with or letter to the trustee discussing the nature of the beneficiary's problems and outlining the client's desires regarding distributions is recommended. Finally, it is imperative that the advisor obtain complete and accurate information regarding current benefits being received by the special needs beneficiary. After receipt of this information, the estate planner will be able to educate the client about the alternatives available in planning for special needs beneficiaries and the effect of various alternatives on public entitlements. Doing so will facilitate the decisionmaking process an~ result in a well thought out estate plan designed to provide maximum benefit to the special needs beneficiary. Amy G. Pesesky is a shareholder of the law firm Hofheimer Nusbaum, P. C. Amy received her law degree from Marshall-Wythe School of Law,

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College afWilliam and Mary'in May, 1990. She received her undergraduate degree in Business Management from St. Bonaventure University. Amy is a member of the Virginia State Bar, Virginia Bar Association, Norfolk and Portsmouth Bar Association, and a member of the American Bar Association, Section of Taxation. Amy is also the Vice Chairperson of the Board of Governors of the Trusts and' Estates Section of the Virginia State Bar. Amy lectures for Virginia Continuing Legal Education and is the author ofa chapter in the Estate Planning in Virginia Manual published by Virginia Continuing Legal Education. Amy has been practicing law for thirteen years, concentrating primarily in the areas ofestate taX planning, estate and trust taxation and administration and elder law.

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ADVANCE MEDICAL DIRECTIVES: KEEPING YOUR CLIENT IN THE DRIVER'S SEAT by Victoria J. Roberson Advance medical directives have become a staple element of any complete estate plan for most estate planning attorneys. The widely.accepted premise supporting the use of advance medical directives is that a completely competent and conscious. person should be able to make their own decisions concerning medical treatment, including the ability to refuse medical treatment in order to die with dignity. An advance medical directive allows an individual to express his or her desires about health-care decisions, and to designate an agent to speak for the individual, in the event the individual becomes incapacitated or terminally ill and unable to speak for himself or herself.

individual's "belief system, including religious orientation and cultural or ethnic background," while providing "care consistent with the general ethical principles of medical practice, including autonomy of lhe individual, nonmaleficence, beneficence, and justice.,,2 This is a tall order for even the best-intentioned agent. Therefore, clients should be encouraged to communicate to their designated agents as much information as possible concerning both the kinds of decisions they want made and the circumstances under which those decisions should be made. 3 The topics of incapacity, death, and dying are difficult for most people to discuss, however. In addition, verbal communication can be less than reliable due to human fallibility such as misinterpretation, forgetfulness, or the imposition of one's own values and viewpoints during any decision-making process, let alone the opportunity for fraud or abuse. For these and other reasons4 , a written advance directive made by the client is usually preferable.

The standard "form" advance medical directive does little to assist a named health care agent in ascertaining the client's individual thoughts or wishes. Zealous representation of the client may require that the estate planning practitioner do more to ensure that a client's wishes are understood and carried out. This article will summarize the current state of the law in Virginia concerning advance medical directives and related topics and offer suggestions for improving or expanding the use of advance medical directives in an estate planning practice.

Even if a client executes a written advance medical directive, the natural tendency of many clients is to keep the details of their estate planning documents private. In the case of advance medical directives, however, it is essential that clients disclose the existence of the document to their family and physicians. In addition to the written directive, clients should still talk with their appointed agent and family members so that they understand the client's wishes and the choices made in the advance directive.

Communication is Critical The Real Property, Probate and Trust Section of the American Bar Association recently published. a symposium of articles dealing with advance medical directives, including their common law history and origin. I The articles illustrate the inherent difficulty in discerning a person's wishes in the innumerable medical contexts that may arise. It suggests that when a patient's previously expressed desires are not known or may have changed since they were last expressed, the substituted decision-makers should consider the

The Attorney's Role Clearly, the lawyer's role in representing clients in connection with their advance medical directive extends beyond filling in a name and executing Page 6

the document. But, providing more assistance can be difficult for several reasons. The lawyer may lack the practical experience and medical background to effectively answer client questions on how the directive will be received or used. Sometimes the more clients discuss the advance medical directive and all its choices, the more confused they become and, ultimately, the less likely they are to execute a document at all. Furthermore, clients often find the estate planning discussion to be an overwhelming amount of information even without a detailed discussion of the advance medical directive. 5 Engaging in lengthy discussions with their attorney concerning the advance directive may also be cost-prohibitive to clients. Finally, even if the attorney has discussed the advance medical directive fully with the clients and drafted and executed a complete document, when actually faced with the decision of living with a diminished capacity or dying, the clients may change their minds.

directive is to be signed by the client and two witnesses. Any competent adult who has been diagnosed with a terminal condition may also make a valid oral advance directive if made in the presence of the attending physician and two witnesses. 9 It is important to communicate this latter point to the clients as their decisions about . treatment may change when faced with an actual illness. lo Section 54.1-2984 of the Code of Virginia sets out the suggested form of the advance medical directive. The statute contemplates not only withholding or withdrawing treatment, but also specifically requiring certain procedures or treatments, such as the administration of hydration and nutrition. I I Exhibit A of this article contains all the elements of the statutory form, with additional suggested options inserted as more fully discussed in the following paragraphs. 12 The form is a starting point for practitioners· and should be revised to facilitate individual attorney's preferences and practice.

Given these constraints, the attorney may have to limit himself or herself to preparing and executing the most complete advance medical directive possible, given the client's current circumstances and desires. 6 The attorney should also then provide the client with the information and resources to more fully educate themselves on the legal and medical aspects of the topic and to better communicate their philosophical, religious, and cultural needs to their appointed agent. Good representation begins with the written document itself.

Statutory Authority

The first augmentation to the statutory form involves defining under what conditions the client may want the living will portion of the advance medical directive invoked. In other words, under what circumstances does the client want treatment withheld or withdrawn? Relying on the phrase '·'terminal condition" is somewhat vague and does not necessarily include the condition of being in a persistent coma. Most clients agree that if there is no possibility of return to a cognitive life, they would want to refuse life sustaining treatment so this is a common addition to the statutory form. 13

Virginia's advance medical directive is a combination of a living will and health care power of attorney.7 Section 54.1-2983 of the Code of Virginia outlines the procedure by which a competent adult may make a written advance directive authorizing the providing, withholding, or withdrawal of life-prolonging procedures and appointing an agent to make health care decisions for the individual if he or she should be declared incapable of making an informed decision. 8 The statute provides that a written advance medical

Further definition may also be needed in the form to identify what kind of treatment the client considers "life sustaining" and wants to refuse. 14 The client may want to limit the refused treatment to respirators or feeding tubes, but may not consider cardiac resuscitation or experimental drugs as being "life-sustaining." As a patient's condition deteriorates, he or she may want to forego additional tests or surgery that he or she did not consider life sustaining earlier on. An option that clients may feel particularly strong

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member. The agent should be able to be a strong advocate for the client in the face of an . or re 1uctant doctor 19,or d·lsagreelng . uncooperative family members. The client should ask the intended agent if he or she is willing to serve before naming him or her and then notify him or her when the document is signed. The client should provide a copy of the executed. document to the agent that is stamped with the location of the originals, and be sure that the agent has access to that storage location. Most important, the agent should be someone who knows the client well and can be trusted to carry out the individual's wishes. A single agent should be named to avoid conflicts or disagreements between multiple agents, but a successor agent is recommended. If the client must name more than one person serving together, as in the case of someone with two children who does not want to differentiate between them, the appointment should speak to who has final control in the event of a disagreement.

about is the administration of nutrItion and hydration, so a specific paragraph addressing the issue should be included. I 5 These options defining the type of treatment to be refused should be discussed with clients, even though they may decide to leave such particulars to an appointed agent. Another situation that calls for special discussion is whether a female client of childbearing age would still want the treatment refused if she were pregnant, especially considering certain religions' positions on that issue. If a client decides not· to refuse treatment during the course of a pregnancy, she will also want to specify that her instructions on that issue control any conflict between her living will portion and instructions her agent may give. In any event, a provision stating how to resolve such conflicts should be added to the statutory form. 16 Finally, a common addition to the statutory form involves expanding the agent's authority to issue a "Do Not Resuscitate Order" and an "Emergency ·Medical Services Do Not Resuscitate Order."

Organ, Tissue, or Eye Donations

Selecting an Agent Equally as important as the living will portion of the advance directive is the appointment of a health care agent to make health care decisions for the client whenever he or she is "incapable of making an informed decision" about medical treatment. I? There are alternative procedures for employing substituted decision-makers,18 but these alternatives do not allow the client to name the person of his or her choosing. Furthermore, the potential for litigation or other court involvement increases, and if court involvement is required, the cost to the client increases significantly. Clients may need some direction as to the selection of an agent. The .agent must first meet the legal criteria for serving as an agent. He or she must be over 18 and should not be the client's medical or nursing care provider or the client's employee, unless he or she is also a family

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The attorney questionnaire, or discussion, should also ascertain if the client wishes to make any organ, tissue, or eye donations, or a gift of the client's entire body for research. Section 32.1-290 of the Code of Virginia specifically authorizes anatomical gift or organ donations by individuals. The individual must be competent and over 18 years of age (or under 18 with written consent of his or her parents).20 The gift may be made by 1) a written document of gift signed by the donor;21 2) designation on the driver's license or driving record;22 3) a will;23 or 4) an advance medical directive. A donor may amend or revoke an anatomical gift by (1) a signed written statement, (2) an oral statement made in the presence of two individuals, (3) any form of communication during a terminal illness or injury, (4) the delivery of a signed statement to a specified donee to whom a document of gift has been delivered, or (5) revocation in compliance with other applicable law,24 including revocation of the advance medical directive. If the gift is made under a will,

it may be amended or revoked in the same manner a will may be amended or revoked.

such donations. It also leaves a blank space for the individual's specific instructions concerning gifts or limits he or she may want to place on gifts. The practitioner may need to expand on the statutory form, however, to address the issues outlined above and to conform more closely to the client's intentions. 29

If an individual has not specified whether he or she wants to make anatomical gifts, Section 32.1290.1 of the Code of Virginia authorizes certain persons to make anatomical gifts of all or part of a decedent's body, unless the decedent had made an unrevoked refusal to make that anatomical gift. 25 Alternatively, the statute also allows an individual to appoint the person he or she would want to make anatomical. gifts for him or her and states that such agent may be appointed in a will or in an advance medical directive. 26 As is the case with agents named under the advance medical directive, clients should designate their own agent if the priority established in the statute is not appropriate in their case, such as persons who are estranged from their spouse or family members, clients with multiple persons in the same class who may not agree, or unmarried clients who want their partner to have priority over family members.

Prerequisites For Cremation Section 54.1-2818.1 of the Code of Virginia provides that no decedent's body shall be cremated without permission of the medical examiner and either (i) visual identification of the deceased by the next of kin or the deceased's representative who may be any person designated to make arrangements for the decedent's burial or the disposition of his or her remains pursuant to Section 54.1-2825 of the Code, or an agent named in an advance directive pursuant to Section 54.12984, or (ii) a 24 hour waiting period between the time of death and the cremation. The advance medical directive may therefore also identify who is to identify the body before cremation.

The clients may already have the designation as an organ donor on their driver's license27 , or. may carry an organ donor card in their wallet. 28 This decision should also be reflected on their written advance medical directive, however, in more detail. Several significant issues arise in this area. Clients may wish to affirmatively refuse making such gifts if they understand that someone else can make such gifts for them if they have remained silent on the issue. Some clients are donors, but specifically want to limit the gifts to organs or eyes, for example, and do not want a cadaver donated because it is recognizable. Clients may want to specify that gifts are to be made only for research, or only for the benefit of other living persons. Most importantly, the clients may want to specifically designate the recipient or donee of their gift if they have a family member or loved one who is in need of a transplant or other medical

Agent to Make Arrangements Disposition of Remains

for

An individual' may also designate the person who is to make arrangements for his or her burial or the disposition of his remains, including cremation remains, following his or her death. The designation must be in a notarized writing signed by the individual that has also been accepted in writing by the person so designated. 3o Again, for clients. for whom the "next of kin" is not a suitable arrangement, or in cases where there is the potential for disagreement in carrying out the client's wishes, a designation of who is to be in charge can be invaluable.

crISIS.

The statutory form of advance medical directive contains optional language concerning making· organ donations and naming an agent to authorize Page 9

If this designation is added to the body of the advance medical directive, the document will have to be notarized, and the agent so designated will have to sign the advance medical directive. While this presents some additional logistics to be worked out, it may be preferable to include it in the advance medical directive because clients tend

to think of the advance medical directive as addressing all end-of-life issues. It also ensures that the agent is now aware of the existence of the advance medical directive and presents an opportunity for the client to discuss it with his or her agent. Finally, notarizing the client's signature may prove to be valuable if the client is attempting to use the advance medical directive while traveling in another state which requires notarization. Some clients may prefer, however, to designate this agent in a separate writing, if at all.

Revoking Directive

the

Advance

the care they want at the end of their life. It is legally valid in 35 states and the District of Columbia. The document was designed by Jim Towey, founder of Aging with Dignity, a nonprofit organization that advocates for the needs of elders and their caregivers. The "five wishes" are: • • •

Medical

• •

An executed advance medical directive may be revoked by the client at any time by (1) a signed, dated writing; (2) physical cancellation or destruction of the advance directive by the client or by another person in the client's presence and at the client's direction; or (3) by an oral expression of intent to revoke. The revocation is effective when communicated to the client's attending physician. 31

Supplemental Communication Even the most complete advance medical directive cannot, and should not address, every possible situation. Rather, the designated agent needs the discretion and flexibility to make health care decisions in response to the client's changing At' this point, circumstances or condition. however, it is critical that the agent have as much direction as possible as to the clients' wishes, taking into consideration their medical, personal, emotional, spiritual, and cultural needs. While it is impractical for the attorney to become overly involved in this process, he or she should at least educate clients as to the existence of additional resources available to the clients to help them give more guidance to their agent. Any search of the internet will result in a myriad' of options, but there are two resources that are developing some widespread support. The first is known as Five Wishes. 32 Five Wishes is a questionnaire that assists people in making essential decisions about

Who do I want to make care decisions tor me when I can't? What kind of medical treatment do I want toward the end? What would help me feel comfortable while I am dying? How do I want people to treat me? What do I want my loved ones to know about me and my feelings after I'm gone?

The questionnaire provides various medical and treatment scenarios in greater detail and allows the clients to select from the various responses, or write in more wishes of their own. Another very good resource is the booklet prepared by the American Bar Association, Commission on Law and Aging. 33 This booklet includes assistance to the client in selecting an agent, identifying treatment preferences, personal priorities, spiritual values, organ donation, and burial or cremation instructions, as well as practical suggestions for the use and storage of the advance medical directive. There are conversation scripts that help facilitate discussions between the client and his or her agent, including a survey for the agent to test how well he or she understands the individual's wishes. Finally, the materials provide a guide to the agent outlining his or her duties and the steps to follow to make medical decisions for others. These types of materials can help ensure that the client has given adequate thought to the issues involved and adequate guidance to their substituted decision-makers. They can also help attorneys avoid a lengthy, inefficient, and expensive discussion with clients while still providing good service and representation.

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Conclusion

important, and often overlooked part of their estate planning project.

The perfunctory use of the statutory form of advance medical directive falls short of what can be considered zealous representation of the client, and may even rise to the level of malpractice. But it is not practical, profitable, or even feasible to assume the estate planning practitioner can anticipate or address every issue associated with an advance medical directive. The following steps may help attorneys ensure that their discussions with the clients and the resulting advance medical directive more closely address each client's individual needs:

Victoria J. Roberson, of Victoria J Roberson, PLC, is a sole practitioner in Midlothian, Virginia whose practice focuses on estate planning and estate administration. Ms. Roberson earned her B.A. in education from Westminster College in Pennsylvania and her JD. from Wake Forest University School ofLaw. She currently serves on the Board ofGovernors for the Virginia State Bar Trust and Estates Section and is a member of the Richmond Estate Planning Council.

•

•

•

•

•

•

Revise the client questionnaire to ask more questions about the advance medical directive options and continue information gathering during the initial client visit. Begin with an advance medical form that that has been expanded from the statutory form to adequately address all of the clients' options for advance decisionmaking, including decisions regarding the refusal of treatment, appointment of agents, anatomical gifts, cremation, and burial instructions. Instruct clients as to the importance of communicating their desires by talking to their family, their physicians, and their agents and keeping their advance medical directive close at hand. Make available to the clients the applicable statutes concerning end of life decisions and statutes referenced within the advance medical directive itself. 34 Compile a list of resources for clients who want to learn more in order to make more informed decisions concerning their advance directive. 35 Provide clients with, or refer them to, an optional document that will more fully communicate their treatment decisions and wishes to their agents based on their moral, religious, cultural, or other concems.36

In these ways, attorneys can more effectively assist their clients in finalizing this most personal,

I Elizabeth G. Clark, Health Care Decision-Making for Others - No Easy Answers, 37 Real Prop. Prob & Tr. J. 537 (Fall 2002); Clifton B. Kruse, Jr., A Call for New Perspectives for Living Wills (You Might Like It Here)~ 37 Real Prop. Prob & Tr. J. 545 (Fall 2002); Louis J. Sirico, Jr., Life and Death: Stores of A Heart Transplant Patient, 37 Real Prop. Prob & Tr. J. 553 (Fall 2002). 2 See Clark, supra note 1, at 543. 31d, at 549. 4 See Gilmore, et. al. v. Finn (available at ).In this highly publicized case involving then Governor James Gilmore, the wife of John Finn sought to uphold the trial court's finding that her husband was in a persistent vegetative state, and that her decision to withdraw his feeding tube, as contemplated under Va. Code § 54.1-2986, was "a medically appropriate, ethical treatment decision that is not inconsistent with Hugh Finn's personal wishes or his personal religious beliefs." Mrs. Finn testified that her husband had on several occasions orally expressed his desire not to be kept alive by artificial means, including hydration and nutrition, if there were no reasonable possibility of returning to a cognitive life. Her husband had drafted, but not executed, an advance medical directive. Michelle Finn was eventually allowed to remove the feeding tube, but only after several lawsuits, much notoriety, and approximately $42,000.00 in legal fees. 5 See Kruse, supra note 1 at 551. "In a typical estate planning engagement, the discussion of testamentary disposition provisions, tax savings techniques, and selection of fiduciaries often tests the attention span limit. Many clients would resist expanding the engagement to include an extensive living will discussion and analysis." 6 Some practitioners take a much more active role in their client's advance medical directives when circumstances call for their involvement as Agent, and their expertise in the elder law area provides a better solution for the client. See, e.g., Andrew H. Hook, Health Care Decision-Making Services: A Panel Discussion on a Profitable Practice Area (2002).

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7 See Va. Code §§ 54.1-2981, et. seq. (Virginia Health Care Decisions Act) (2003). 8 Va. Code § 54.1-2983. 9/d. 10 See, e.g., Kruse, supra note 1; Sirico, supra note 1. 11 Va. Code § 54.1-2984 (i). 12 Special thanks to Andrew H. Hook, Esquire, Oast & Hook, P.C., P.O. Box 399, Portsmouth, VA 23705-0399, (757) 399-7506, for the suggested optional language contained in his outline. See supra note 6. 13 See Exhibit A, bolded language. 14ld 15 16

ld ld

17 "Incapable of making an infonned decision" within the context of the advance medical directive means unable to understand the nature, extent or probable consequences of a proposed medical decision or unable to make a rational evaluation of the risks and benefits of a proposed medical decision as compared with the risks and benefits of alternatives to that decision, or unable to communicate such understanding in any way. Va. Code §54.l-2984. See also Va. Code § 54.1-2982 for expanded definitions. 18 § 54.1-2986 of the Code of Virginia allows the following persons to authorize the withholding or withdrawal of treatment for patients incapable of making an informed decision if no advance medical directive was executed, or if the advance medical directive does not address the situation and does not appoint an agent, in the following priority: 1. Guardian or committee for the patient; 2. Spouse (except if a divorce action has been filed); 3. Adult child of the patient; 4. Parent of the patient; 5. An adult brother or sister of the patient; and 6. Any other relative of the patient in descending order of blood relationship. The Code also provides an alternative for judicial authorization of the provision, withholding, or withdrawal of medical treatment for incapacitated persons but requires clear and convincing evidence of the patient's inability to make an infonned decision and a showing that the suggested action is in the patient's best interest. See V a~ Code § 37.1134.21. 19 § 54.1-2990 of the Code of Virginia makes clear that physicians do not have to comply with the provisions of an advance directive or the instructions of an agent appointed therein if the physician determines such treatment to be medically or ethically inappropriate. If such a conflict arises and is unable to be resolved, the physician must make a reasonable effort to transfer the patient to another physician who will comply with the advance directive. See Va. Code§ 54.1-2987. 20 Individuals under 18 can refuse to make an anatomical gift without parental consent. 21 Va. Code § 32.1-290 B. A document of gift may designate a named individual or specific organ procurement program to receive the anatomical gift. Va Code § 32.1-290

C. The document of gift (or will or other written document making the gift) may be delivered to the donee but delivery is not' necessary to the validity of the gift. Va. Code § 32.1293. 22 Suspension, revocation, expiration or cancellation of a license does not automatically revoke the anatomical gift Va. Code § 32.1-290 B. 23 An anatomical gift made by will takes effect upon death, whether or not the will is probated. If the will is declared invalid for testamentary purposes, the validity of the anatomical gift remains valid. Va. Code § 32.1-290 D. 24 See Va. Code § 46.2-342 (Uniform Donor Document) and Va. Code § 54.1-2981 et. seq.(Health Care Decisions Act.). 25 Section 32.1-290.1 A of the Code of Virginia establishes the priority of individuals with the authority to make anatomical gifts on behalf of a decedent, as follows: 1. Spouse of the decedent; 2. Adult son or daughter of the decedent; 3. Either parent of the decedent; 4. Adult sibling of the decedent; 5. A grandparent of the decedent; 6. A guardian of the person of the decedent at the time of death. 26 Va. Code § 32.1-290.1 B. 27 The donor designation on a driver's license is controlling. No family member, guardian, or agent under an advance medical directive can refuse to honor or seek to avoid the donor designation on a license. Va. Code § 46.2-342 F. If the donor wishes to rescind his or her designation to be an organ donor, he or she must contact the Virginia Department of Motor Vehicles. Va. Code § 46.2-342 G. 28 The Coalition on Donations has in the past published a brochure entitled "Share Your Life... Share Your Decision" that answers many common questions about organ and tissue donation. The brochures are free and provide clients with a removable Uniform Donor Card to carry in their wallet or on their person. For more in fonnation, contact Coalition on Donations, 700 North 4th Street, Richmond, Virginia 23219, (804)782-4920; [email protected]. 29 See Exhibit A, Option concerning anatomical gifts and appointment of agent. 30 Va. Code § 54.1-2825. 31 Va. Code § 54.1-2985. 32 See or contact Aging With Dignity, P.O. Box 1661, Tallahassee, Florida 32302-1660, (888)594-7437. 33 See . Tools I10 created by American Bar Association, Commission on Law and Aging. 34 Including Va. Code §§ 54.1-2982 -54.1-2990; Va. Code §§ 32.1-289-32.1-293; Va. Code § 37.1-63 et. seq.; Va. Code § 37.1-134.6; Va. Code § 46.2-342; Va. Code § 54.12825. 35 See Charles P. Sabatino, Ten Legal Myths About Advanced Directives, 28 Clearinghouse Rev. 653, 655 (1994); Alan Lieberson, M.D., J.D., Advance Medical

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Directives (2003) (Resource for physicians and other medical administrators and personnel), Practice Management Information Corporation (1993). A docunlent created by the International Task Force on Euthanasia and Assisted Suicide known as the "Protective Medical Decisions Document" (PMDD) may be used as an addendum or alternative to the Advance Medical Directive. The PMDD defines and prohibits euthanasia for pati~ts who want to ensure their advance directive reflects a prolife/anti-euthanasia position. For copies, contact International Task Force on Euthanasia and Assisted Suicide, P.o. Box 760, Steubenville, OH 43952, (740) 2823810. See Exhibit B for a list of resources suitable for clients. 36 See Five Wishes Form, supra note 32; and ABA Booklet from Commission on Law and Aging, supra note 33.

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EXHIBIT A SUGGESTED FORM OF ADVANCE MEDICAL DIRECTIVE I, [CLIENT], of [CITY/COUNTY], Virginia, willfully and voluntarily make known my desire and do hereby declare: If at any time my attending physician (and a second qualified physician1 should determine that (1) I have a terminal condition and death is imminent, or (2) I am in a persistent coma from which there is no reasonable possibility of recovery to a cognitive life, where the application of life-prolonging procedures would serve only to artificially prolong the dying process, I direct that such procedures be withheld or withdrawn, and that I be permitted to die naturally with only the administration of medication or the performance of any medical procedure deemed necessary to provide me with comfort, care, or to alleviate . pain, even if such medication or procedure may hasten the moment of my death.

[OPTION: DEFINING TREATMENT TO BE REFUSED "Life-prolonging treatment" shall include, but shall not be limited to: (a) Cardiac resuscitation; (b) Mechanical respiration; (c) Blood or blood-products transfusion; (d) Any form of surgery or invasive diagnostic tests; (e) Kidney dialysis; (1) Antibiotics; and (g) Chemotherapy.]

[OPTION: FOOD OR HYDRATION I specifically request that artificially provided fluids and nutrition, such as by feeding tube or intravenous infusion, shall be [provided to] OR [withheld or withdrawn from] me. OR

I specifically direct that the following procedures or treatments be provided to me:

---------------------, [OPTION: PREGNANCY If I have been determined to be pregnant, and notwithstanding the preceding paragraphs, I direct ·that all life-prolonging treatment be continued during the course ofmy pregnancy_} In the absence of my ability to give directions regarding the use of such life-prolonging procedures, it is my intention that this advance directive shall be honored by my family and physician as the final expression of my legal right to refuse medical or surgical treatment and accept the consequences of such refusal. I hereby appoint [PRIMARY AGENT], of [ADDRESS AND TELEPHONE NUMBER], as my agent to make health care decisions on my behalf as authorized in this document. If [PRIMARY AGENT] is not reasonably available or is unable or unwilling to act as my agent, then I appoint [SUCCESSOR AGENT], of [ADDRESS AND TELEPHONE NUMBER], to serve in that capacity. I hereby grant to my agent, nam,ed above, full power and authority to make health care decisions on my behalf as described below whenever I have been determined to be incapable of making an informed decision about providing, withholding or withdrawing medical treatment. The phrase nincapable of making an informed decision" means unable to understand the nature, extent and probable consequences of a proposed medical decision or unable to make a rational evaluation of the risks and benefits of a proposed medical decision as compared with the risks and benefits of alternatives to that decision, or unable to communicate such understanding in any way. My agentts authority hereunder is effective as long as I am incapable of making an informed decision.

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If there is ·a conflict between the directions contained in this instrument and the instructions given by my agent appointed herein, the instructions given by my agent shall control(.l.[, except as specifically provided with respect to pregnancy. J

medication in excess of recommended dosages in an amount sufficient to relieve pain, even. if such medication carries the risk of addiction or inadvertently hastens my death;

The determination that I am incapable of making an informed decision shall be made by my attending physician. and a second physician or licensed clinical psychologist after a personal examination of me and shall be certified in writing. ~uch certification shall be required before treatment is withheld or withdrawn, and before, or as .soon as reasonably practicabl~ after, treatment is pro.vided, and every 180 days thereafter while the treqtment continues. In exercising the power to make health care decisions on my behalf, my agent shall follow my desi:l~es and preferences as. stated in this document or as otherWise known to my agent. My agent shall be guided by my medical diagnosis and prognosis and any information provided by my physicians as to the intrusiveness, pain, risks, and side effects associated with treatment or nontreatment. My agent shall not authorize a course of treatment which he knows, or upon reasonable inquiry ought to know, is contrary to my religious beliefs or my basic values, whether expressed orally or in writing. If my agent cannot determine what treatment choice I would have made on my own behalf, then my agent shall make a choice for me based upon what he believes to be in my best interests. The powers of my agent shall include the following: A. To consent to or refuse or withdraw consent to any type of medical care, treatment, surgical procedure, diagnostic procedure, medication and the use of mechanical or other procedures that affect any bodily function, including, but not limited to, artificial respiration, artificially administered nutrition and hydration, and cardiopulmonary resuscitation. This authorization specifically includes the power to consent to the administration of dosages of pain-relieving

B. To direct and consent to the writing of a "No Code" or "Do Not Resuscitate Order" or . an "Emergency Medical Services Do Not Resuscitate Order" by any health care provider.

c.

To request, receive, and review any information, verbal or written, regarding my physical or mental health, including but not limited to, medical and hospital records, and to consent to the disclosure of this information; D. To employ and discharge my health care providers; E. To authorize my admission to or discharge (including transfer to another facility) from any hospital, hospice, nursing home, adult home or other medical care facility for services other than those for treatment of mental illness requiring admission procedures provided in Article 1 (§ 37.1-63 et seq.) of Chapter 2 of Title 37.1; and

F. To take any lawful actions that may be necessary to carry out these decisions, including the granting of releases of liability to medical providers. Further, my agent shall not be liable for the costs of treatment pursuant to my agent's authorization for such treatment, based solely on that authorization.

{OPTION: ANATOMICAL GIFT OR ORGAN, TISSUE OR EYE DONATION AND APPOINTMENT OF AN AGENT TO MAKE SUCH GIFTS.

Upon my death, I direct that no anatomical gift of any part of my body, including organs, tissue, or eye donations, be made. My agent shall have no authority to make such gifts pursuant to Section 32.1-290.1 of the Code of Virginia, or otherwise.

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OR

Upon my death, I direct that an anatomical gift of{all of my body or] certain organ, tissue or eye donations may be made pursuant to Article 2 (§ 32.1-289 etseq.) ofChapter 8 of Title 32.1 and in accordance with my directions, if any. I hereby appoint {AGENT, of (Address and Telephone Number)],OR {my agent named herein] as my agent to make any such anatomical gift or organ, tissue or eye donation following my death. Consistent with this intent and notwithstanding the preceding paragraphs, treatment that prolongs my dying may be very temporarily continued or modified so as to preserve and protect for transplant the useful portions of my body. I further direct the following

The declarant signed the foregoing advance directive in my presence. I am not the spouse or a blood relative of the declarant.

_ _ _ _ _ _ _ _ _ _ _~7

WITNESS my hand and official seal this __ day of _

{OPTION: APPOINTMENT OF AN AGENT TO IDENTIFY BODY FOR CREMATION

My agent shall be authorized to make a visual identification of my body prior to cremation if necessary pursuant to Section 54.1-2818.1 of the Code of Virginia.]

Witness

Witness

Address (City, State)

Address (City, State)

COMMONWEALTH OF VIRGINIA CITYICOUNTY OF - - - - - -

BEFORE ME, the undersigned authority, personally appeared (NAME OF CLIENT), personally known to me, or proved to me on the basis of satisfactory evidence, to be the person whose name is subscribed to the within instrument, and acknowledged that such person executed the same.

Notary Public My commission expires:

I have considered the possibility of limiting the effectiveness of this instrument to a fixed period of time from the date hereof and have decided, instead, that it shall remain in full force and effect for as long as I may live or until othenvise revoked by me in writing or by oral declaration in the presence of my physician. This advance directive shall not terminate in the event of my disability or mental or physical incapacity. By signing below, I indicate that I am emotionally and mentally competent to make this advance directive and that I understand the purpose and effect of this document.

Date

[CLIENT]

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_

EXHIBITB LIST OF AVAILABLE RESOURCES CONCERNING ADVANCE MEDICAL DIRECTIVES AND END OF LIFE DECISION MAKING I. Virginia Department for the Aging, 1600 Forest Avenue, Suite 102, Richmond, Virginia 23229, 1-800-552-3402; www.aging.state.va.us/advmedir.htm. 2 ·Virginia State Bar, 707 E. Main Street, Suite 1500, Richmond, Virginia, 23219-2800, (804) 775-0500, www.vsb.org/publications/senior/advance.pdf.

3. Five Wishes, Aging with Dignity, P.O. Box 1661, Tallahassee, Florida 32302-1660, 1-888594-7437, www.agingwithdignity.org. 4. American Bar Association, WVvw.abanet.org/aging/. Contains an excellent printable resource developed by the Commission on Law and Aging to provide directly to clients. 5. Partnership for Caring, www.partnershipforcaring.org. Includes '''Frequently Asked Questions" and state specific fonns. 6. American Association of Retired Persons, www.aarp.org/indexlhtml.

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LIFETIME CHARITABLE GIVING USING SCORPORATION STOCK: TRAPS, TRICKERY, AND TROUBLE AHEAD by

Dana G. Fitzsimons Jr. Introduction Despite the noticeably higher profile of many C corporations, most corporations doing business today are S corporations. For many clients, S corporation stock represents a large part of the client's net worth, making such stock a tempting candidate for charitable giving. For this reason, advisors should have an understanding and appreciation of the application of the Subchapter S rules in the context of charitable gift planning. This Article will review a handful of the many potential problems surrounding lifetime charitable planning involving gifts of S stock to "public charities." I As this Article will attempt to show, for the advisor seeking to further the client's charitable inclinations through gifts of S stock, there awaits a collection of traps, tricks, and trouble· to be carefully navigated. This Article will highlight some of the more common problem areas.

calculation of the number of shareholders of an S corporation can become complicated when trusts are involved. The Subchapter S rules also restrict who may be a shareholder of S stock. Individuals (other than nonresident aliens) can own S stock4, as' can estates and charitable organizations described in Code Section 50I(c)(3).5 Certain types of trusts (the most commonly used of which are considered in this Article) are allowed to hold S stock: grantor trusts6 , so-called "Mallinckrodt" Trusts7 8 certain testamentary trusts, voting trusts9 ,' qualified subchapter S trusts (QSSTs)lo, and electing small business trusts (ESBTs)ll. Great care should be taken to ensure that transfers of S stock to charity (or to charitable trusts) do not run afoul of the 75 shareholder limit or result in the transfer of S stock to an ineligible shareholder, either of which will "blow" the Selection.

Outright Gifts of S Stock to a Public Charity

Subchapter S The principal advantage of electing to do business as an S corporation is the opportunity to enjoy the limited liability of a regular, or C corporation, within the framework of a pass-through taxation regime. The principal disadvantage to S corporation status may be the technical complexity of the Subchapter S rules (Code Sections2 1361 et seq.). Of the many Subchapter S requirements that apply to businesses electing S corporation status, in the charitable planning context primary concern is with the rules restricting the number and types of shareholders that an S corporation may have. An S corporation may not have more than 75 shareholders at anyone time during any taxable year.3 As discussed throughout this Article, the

An outright gift of S stock to a public charity may be an attractive option because of its relative simplicity. A public charity is an eligible S shareholder, 12 and for purposes of the 75shareholder limit, a public charity is counted as one shareholder. Appreciated S stock can be an especially attractive subject of an outright gift to a public charity because generally the donor can take an income tax deduction based on the fair market value of the stock, and recognition of gain can be avoided on the appreciation of the stock over the donor's basis. Conversely, depreciated S stock is generally best not used for lifetime charitable giving, so as not to waste a potentially valuable

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capital loss deduction.

using a trust as a vehicle for a gift of S stock to charity_ As will be shown below, two common trust vehicles for charitable giving (charitable remainder trusts and charitable lead trusts) may not be viable or practical options where S stock is involved. ,

To qualify an outright lifetime gift of S stock for the income tax deduction, the donor must transfer his entire interest in the stock to avoid violating . 1 Interest . the partla rules. 13 For example, no deduction would be allowed if the donor retained the voting rights over the stock.

Trusts as Permitted S Shareholders

A "qualified appraisal" is required to substantiate the value of gifts of S stock over $10,000 (along A with additional reporting requirements).14 qualified appraisal must be prepared by a qualified appraiser, who holds himself out as an appraiser and is qualified to appraise the type of assets being valued, and who is not the donor, the The charity, or a related party to either. 15 appraisal must be dated no earlier than sixty days before the date of the gift and no later than the date (including extensions) by which the donor 16 must file his income tax return reporting the gift. Assuming the S stock is long-term capital gain property (i.e., held by the donor for more than one year), the donor may generally deduct the full market value of the appreciated S stoCk. 17 Gain is not generally recognized on the transfer of appreciated S stock to a qualified charity. 18

The most commonly used trusts permitted to hold S stock are trusts structured as grantor trusts and trusts making one of two elections: the election to be treated as a qualified subchapter S trust (QSST) or the election to be treated as an electing small business trust (ESBT).

Grantor Trusts Generally, a grantor trust is a trust where the grantor includes all of the trust's items of income, deductions, and losses for income tax purposes. Such a trust, where the grantor is treated under Code Sections 671-679 as the owner of the trust for income tax purposes, and the grantor is a U.S. citizen or resident, is eligible to hold S stock.24 For purposes of the 75-shareholder limit, the grantor is treated as the shareholder. 25

While there is _an unlimited gift tax charitable deduction for the value of the S stock,19 the income tax deduction on gifts to charity is limited to a percentage of the taxpayer's "contribution base" (usually adjusted gross income).2o Generally, the deduction for an outright gift21 of long-term capital gain property, including S stock, to a public charity is limited to 300/0 of the donor's contribution base. 22 If an individual's charitable contributions for any year exceed the 30%- limit the excess may be carried forward for up to five 23 years until fully used.

There are significant disadvantages to transferring S stock to a grantor trust. The grantor will be taxed currently on all of the trust- income attributable to the S stock held in the trust , regardless of whether such income is actually distributed. Additionally, the grantor must have sufficient income to take advantage of any charitable deductions. Great care should be taken when setting up a grantor trust to ensure that the gift into trust is a completed gift, to avoid inclusion of the trust assets in the grantor's estate under Code Section 2036, and to avoid violating the private foundation rules that may apply to the trust.

Even with the limits, outright transfers to qualifying public charities can yield favorable income tax results while reducing the donor's estate for transfer tax purposes and satisfying the donor's charitable objectives. For those clients unwilling to make - an outright disposition, consideration might be given to the availability of

A QSST is a trust that satisfies the QSST requirements, which require generally that: (I) the trust may have only one income beneficiary at a time, (2) the trust must distribute all of its income annually, and (3) principal distributions made during the life of the income- beneficiary can only

QSSTs

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counted twice in applying the 75-shareholder limit. Where any potential current beneficiary of the trust is not an eligible S shareholder, the trust is not eligible to be an ESBT.

be made to the income beneficiary, and if the trust terminates during the income beneficiary's life, the trust must distribute its assets to the income beneficiary. The QSST election must be made separately for the stock of each S corporation held in the trust (as opposed to an ESBT, where one election is made for all S stock in the trust). A QSST is an eligible S shareholder,26 provided the trust satisfies the definitional requirements·of a QSST and the beneficiary makes the necessary election. For purposes of applying the 75-shareholder limit, the income beneficiary making the QSST election 27 is treated as the shareholder during his life.

ESBTs An ESBT election is often preferred over a QSST election for its flexibility because, unlike a QSST, an ESBT can have multiple beneficiaries, accumulate income, and sprinkle income and principal among the beneficiaries.

A trust 'may qualify to make an ESBT election where the trust does not have beneficiaries other than individuals, estates, certain charities, or certain governmental entities. A public charity can be a beneficiary of an ESBT.28 Additionally, in order to qualify as an ESBT no interest in the trust can have been acquired by purchase,29 and the trustee must make a timely ESBT election. 3D Once made, the ESBT election applies to all of the S stock in the trust, and the election is generally irrevocable.3] An ESBT electing trust is an eligible S shareholder. 32 For purposes of the 75-shareholder limit, each potential current beneficiary of the trust is treated as a shareholder. A potential current beneficiary is any person who, at any time, is entitled to, or may, receive a distribution .oftrust income or principal, but doesn't include a future 33 If at any time there is no potential interest. current beneficiary, the trust is treated as the shareholder.34 If a potential current beneficiary (or the beneficiary's spouse) owns S stock directly, the potential current beneficiary is not

The S corporation jeopardizes its S election where the ESBT election is made and one of the potential current beneficiaries of the trust is not an eligible· S shareholder. Accordingly, it is important to evaluate the eligibility of every potential current beneficiary of the trust before making the ESBT election. The class of persons and entities that are eligible beneficiaries of an ESBT include some entities that are not permissible S shareholders (and vice versa).35 It is therefore important to assess each beneficiary of the trust under both the ESBT and S rules before making the irrevocable ESBT election and inadvertently blowing the corporation's S status or violating the ESBT rules. As discussed below, both the QSST and ESBT elections can be problematic when made for the most common forms of charitable trusts.

Charitable Remainder Trusts Simply put, if you are considering funding a charitable remainder trust with S stock, don't! In a charitable remainder trust, the trust instrument provides for either fixed payments or a percentage of the value of the trust as revalued annually to one or more beneficiaries (commonly a spouse or other family members) for a term of 20 years or less or for the lives of the beneficiaries. 36 The remainder interest passes to a charity at the termination of the income interest. In a 1992 private letter ruling, the Service concluded that neither a charitable remainder annuity trust nor a charitable remainder unitrust could qualify as a Qualified SubchaEter S Trust (QSST) under Code Section 1361(d). 7 This ruling makes clear that transferring S stock to a charitable remainder trust will blow the corporation's S election. Charitable remainder trusts are also ineligible to make an ESBT election. 38

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CLAT (usually to a family member) may violate the QSST requirement that the trust assets be distributed to the current income beneficiary if the trust terminates "during the life" of the income beneficiary.42

Charitable Lead Trusts A charitable lead trust is a split-interest trust under which an annuity or unitrust interest is payable to charitable beneficiaries for a certain term, and upon expiration of that term the remainder interest is payable to noncharitable beneficiaries or reverts to the donor. 39 In a charitable lead annuity trust ("eLATn), the charity receives a fixed sum annually for a term of years, or for the lives of named persons, of either a fixed dollar amount or a percentage of the initial fair market value of the amount transferred to the trust. In a charitable lead unitrust (HCLDT"), the charity receives annually a fixed percentage of the fair market value of the trust, as revalued annually, for a term of years, or for the lives of named persons.. The potentially high cost of annually appraising S stock in a CLUT makes the eLAT typically the more attractive option. 4o Additionally, the CLAT's use of an annuity may offer greater leverage for transfer tax purposes when the Code Section 7520 rates are low. The most common form of CLAT is the qualifying non-grantor trust (to shift the items of income and deductions from the grantor to the trust). In this type· of arrangement the income interest is given to a qualified charitable organization in the form of a guaranteed annuity. The grantor does not receive an income tax charitable deduction, rather, the CLAT is entitled to a charitable deduction for amounts of its gross income paid to charity each year. 4 I The qualifying non-grantor CLAT is used generally to remove future appreciation of -the trust corpus from the grantor's estate and to leverage transfer tax exclusions and exemptions.

Accordingly, in order to hold S stock the trustee of· the non-grantor CLAT must qualify to and make an ESBT election (which, as discussed, below, may result in the loss of the trust's charitable deduction under Code Section 642(c)).43

ESBT Electing CLAT In 2002 the Treasury Department and the IRS issued final ESBT regulations under Code Sections 1361 and 641, which, in addition to addressing numerous other issues clarified how charitable contributions from an ESBT would be treated. 44 The Code and Regulations set up an elaborate taxation scheme for ESBTs, a full discussion of which is beyond the scope of this Article. Basically, for purposes of reporting and computing the ESBT's income taxes, the ESBT is segregated into an "S portion" (consisting of S stock) and a "non-S portion," and the regulations allocate items of income and deductions among the portions. The final regulations create disincentives for charitable contributions by an ESBT.

A split-interest trust with a charitable lead beneficiary (keeping in mind that charitable remainder trusts cannot hold S stock without blowing the S election) is not eligible to make a QSST election because: (1) the charitable lead trust's charitable income beneficiary does not have a "measuring life" as required by the QSST rules and (2) the distribution of the remainder in a

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Where an S corporation in which an ESBT holds shares makes a charitable donation, the regulations limit the deduction available to the ESBT by subjecting the deduction to the limitations of I.R.C. Section 681, regarding unrelated business income, which can be a significant limitation..45 Where the ESBT makes a direct contribution to a charity (such as the annuity payment under a CLAT) of assets other than S stock, the contribution is only deductible to the extent it is paid from the gross income of the non-S portion (which would not include income earned with respect to the S stock).

A transfer of S stock to, charity to satisfy the annuity payment in-kind would not be deductible by the non-S portion because the S stock is allocated to the S portion, and the transfer would therefore not be out of the gross income of the non-S portion. To complete the rather punitive regime under the regulations, a transfer of S stock to charity is also not deductible by the S portion of the ESBT.46 Because in order to protect the corporation's S election a non-grantor CLAT must make an ESBT election (and subject itself to the oppressive regulations), the significant tax disadvantages of using a eLAT to hold S stock must be carefully considered.

Conclusion A trusted colleague may have summed it up best: when asked for guidance on approaching lifetime charitable giviIlg using S stock, she told me it should be a short article-just advise clients to "pick another asset." In addition to the complexity, in her experience, many charities are not interested in S stock gifts because of the unrelated business taxable income (UBTI) problems for the charity under Code Section 512. While this Article mentions only some of the most basic potential problem areas, closer examination of the relevant Code and Regulations will undoubtedly reveal additional issues to be mindful of. In light of this, the prospect of funding a lifetime charitable gift with S stock seems to be an unattractive proposition. That being said, if you're faced with a charitably inclined client with only S stock to carry that inclination to fruition, strap yourself in, because it's going to be a rough ride.

Dana G. Fitzsimons Jr. is an associate with the law firm of McGuire Woods LLP in Richmond, Virginia. Mr. Fitzsimons earned his Bachelor of Music degree from Ithaca College, and his JD. from William and Mary. Mr. Fitzsimons would like to thank W Birch Douglass, III and Michele A. W McKinnon at McGuire Woods lor their

invaluable assistance with the preparation ofthis Article. 1 "Public charities" are traditionally those § 501 (c)(3) organizations described in Code §§ 170 (b)(l)(A)(i) - (vi) and 509(a)( 1), and typically include churches, educational institutions, and organizations providing medical care or education. The myriad of additional issues that arise when the intended charitable donee is an entity other than a public charity, such as a private foundation, are beyond the scope of this Article. Testamentary charitable planning is also beyond the scope of this Article. 2 Citations to Code Sections are to the Internal Revenue Code of 1986, as amended. 3 I.R.C. § 1361(b)(lXA). 4 I.R.C. § 1361 (b)(I)(B). 5 I.R.C. § 1361(b)(1)(B). A concern that should be addressed by a charity considering holding S stock is that the items of income, loss, deduction, or credit of the S corporation that flow through to the charity and the gain and loss on the sale of S stock are treated as unrelated business taxable income (UBTI) to the charity. I.R.C. Section 512(e)( 1). For an excellent consideration of this and other concerns about donations of S stock from the donor's and the charity's perspectives, see Laura H. Peebles, Charitable Gifts of S Corporation Stock: Problems & Opportunities, The Journal of Gift Planning (2 nd Quarter 2002). While repetitive citations are omitted, Ms. Peebles' excellent article was a valuable and frequently referenced source in preparing this Article, and I highly recommend that anyone considering charitable planning with S stock refer to her article for a more detailed discussion of the subject matter. 6 1.R.c. § 136I(c)(2)(A)(i). 7 I.R.C. § 1361 (c)(2)(A)(i); I.R.C. § 678. 8 1.R.C. §,1361(c)(2)(A)(iii). 9I.R.C. § 1361(c)(2)(A)(iv). I°I.R.C. § 1361(d). II I.R.C. § 1361(c)(2)(A)(v). 12 I.R.C. § 1361(b)(1)(B). 13 See I.R.C. § 251,1 and accompanying regulations. 14 Treas. Reg. § 1.170A-13(c)(2)(i) and (ii). 15 Treas. Reg. § l.l70A-13(c)(5). 16 Treas. Reg. § 1.170A-13(c)(3). 17 I.R.C. § 170(e)(I). Certain limitations apply where the donated securities are short-term capital gain property. 18 This may not be the case where the transfer to charity was for partial consideration, or where the charity sells the stock shortly after receipt pursuant to a pre-arranged agreement. 19 I.R.C. § 2522. 20 I.R.C. § 170(b). 21 Gifts other than an outright gift may be subject to additional limitations and requirements. See, e.g. I.R.C. § 170(b)( 1)(A). 22 I.R.C. § J70(b)(1)(B). The donor may be able to deduct up to 50% of his contribution base if he elects to limit the deduction to his basis in the property. 23 I.R.C. § 170(d)(1)(A).

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I.R.C. § 1361(c)(2)(A)(i). I.R.C. § 1361(c)(2)(B)(i). 26 1.R .C. § 1361(d)(l). 27 Treas. Reg. § l.l361-1(j)(7)(i). The regulations also detail the application of the 7 5-shareh~lder limit after the death of the income beneficiary. See Treas. Reg. §·1.1361I G)(7)(ii). 28 Treas. Reg. § l.l361-1(m)(1)(i). 29 Treas. Reg. § l.1361-1(m)(1)(iii) (although the trust itself may purchase S·stock) 30 Treas. Reg. § l.l361-1(m)(2)(i) 31 The ESBT election may be revoked with the consent of the Commissioner obtained through a request for a private letter ruling. See Treas. Reg. § 1.1361-1(m)(6). 32 I.R~C. § 1361(c)(2)(A)(v). 33 Treas. Reg. § 1.1361-1(m)(4). The 75-sharehoJder limit should be carefully considered where there is a CLAT with several charitable beneficiaries or a class designation. If a class is used, the class may be so broad as to violate the 75shareholder limit. One possibility may be to name a community foundation as the sole charitable income beneficiary, and through the use of a donor-advised fund the charitable gift might be spread amongst several charitable beneficiaries without running afoul of the 75-shareholder limit. 34 I.R.C. § 1361 (c)(2)(B)(v). 35 For example, an l.R.C. § 170(c)(5) cemetery company is a permissible ESBT beneficiary, but is not an eligible S shareholder. Also, a qualified pension trust is a permissible S shareholder, I.R.C. § 1361(c)(6), but is not a pennitted ESBT beneficiary because it is not listed in I.R.C. § 170(c). A trust may have a sixty-day period to cure some defects in the beneficiaries that arise. See tR.C. § 1361(e)(2). 36 See generally Code § 664. 37 PLR 8922014. 38 I.R.C. § 1361 (e)(I)(B)(iii). 39 For an excellent discussion of additional considerations in using CLATs, including CLATs structured as grantor trusts, see Adam J. Wiensch, Esq., Funding Charitable Lead Trusts with S Corporation Stock, Tax Management Estates, Gifts and Trusts Journal, p. 108 (2002). Mr. Wiensch also considers the continuing usefulness of charitable lead trusts under the new taxation regime contemplated by the recent estate tax repeal legislation. While repetitive citations are omitted, Mr. Wiensch's excellent article was a valuable and frequently referenced source in preparing this Article, and I highly recommend that anyone considering planning involving charitable lead trusts and S stock refer to his article for a more detailed discussion ofthe subject matter. 40 Charitable lead trusts are subject to many of the private foundation rules in tR.e. §§ 4940-4948, 507, and 508. The requirements and prohibitions of these sections are not considered in this Article but must be carefully reviewed before drafting or administering a charitable lead trust. 41 Code § 642(c). 42 I.R.C. § 1361(d)(3)(A). 24

25

The trustee should carefully weigh fiduciary considerations when considering whether to make an ESBT election. 44 TD 8994. For an excellent review of the Final Regulations in their historical context, see Jerald David August, et. al., Clarifications Made By ESBT Final Regulations Demonstrate the Need for More Statutory Changes, Journal of Taxation (August 2002). 45 Treas. Reg. § 1.641 (c)-1 (d)(2). 46 Treas. Reg. § 1.641(c)-1, Example 4. 43

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LIFETIME TRANSFERS RESULT IN VIRGINIA ESTATE TAX SAVINGS DUE TO PHASE OUT OF STATE DEATH TAX CREDIT by Erin Sheehey Downs The decoupling of the Virginia estate tax from the federal state death tax credit as a result of the Economic Growth Tax Relief and Reconciliation Act of 2001 ("EGTRRA") provides a significant opportunity for tax savings through lifetime giving. The tax savings is the result of simple mathematics. The state death tax credit, upon which the Virginia estate tax is based, applies only to the taxable estate and does not apply to adjusted taxable gifts. Therefore, lifetime transfers that are completed gifts will not be subject to Virginia estate taxes. This tax savings opportunity should not be overlooked, especially for the terminally ill client who will not be able to benefit from future tax reform or repeal. This article explains and illustrates the reduction of overall estate taxes through lifetime· gifts.

The Decoupling of the Virginia Estate Tax from the Federal Estate Tax System Current Virginia law provides that the amount of the Virginia estate tax shall be no less than the amount of the federal death tax credit as it existed in 1978. 1 The EGTRRA decreases and then eliminates the allowable credit for state death taxes over a four year period.2 In 2002, the credit was reduced by 25%. This reduction is 50% in 2003 and increases to 75% in 2004. In 2005, the credit is eliminated and replaced with a deduction for state estate or inheritance taxes paid. 3 The deduction continues until the scheduled repeal of the federal estate tax in 201 0. On April 3, 2003, the Virginia Assembly sustained Governor Warner's veto of legislation that would have "coupled" the Virginia estate tax to the federal estate tax system. If that legislation had passed, Virginia's estate tax would have been exactly equal to the amount of the federal death

tax credit, so as the credit decreased and then disappeared as a result of the 2001 Tax Act, Virginia's estate tax would have also decreased and then disappeared. Instead, the Virginia estate tax remains at 100% of the computed state death tax credit.

Tax Savings Through Lifetime Transfers The additional estate taxes resulting from the decreasing federal credit and the anchored Virginia estate tax can be saved if the client makes lifetime gifts because the state death tax credit, upon which the Virginia estate tax is based, applies only to the taxable estate and not to adjusted taxable gifts. This strategy is successful in Virginia because there is no state gift tax and no The gift in contemplation of death rules. following example illustrates the mathematics that result in the tax savings. Assume that Client is not married. Her total current assets are $5,000,000. The beneficiaries of her estate are her children. If Client makes gifts of $3,000,000 and dies in 2003, the gifts result in estate savings of $146,000. If her death occurs in 2004, the tax savings increase to $219,000. Assuming the same facts, except that Client's current assets are $25,000,000 and the amount of her lifetime gifts is $12,500,000, the estate tax savings are $1,000,000 if she dies in 2003 and The tax $1,500,000 if she dies in 2004. calculation for 2003, as well as the percentage savings for 2003-2009, are shown in Exhibit A. Note that lifetime gifts result in an increase in the federal estate and gift tax liability. It is the reduction in the Virginia estate tax that causes the total tax savings. Since the federal taxes are

Page 24

increased, the gifts are not a red flag for an IRS audit. The risk· of audit by the Virginia Department of Taxation is typically less than the risk of a federal audit. Even if there is an audit, there is no exposure if the gifts are in fact completed before the client dies.

client dies and the basis of the appreciated property is stepped up to fair market value, the appreciated property can be sold with little or no tax cost to payoff the loan.

Of course, one disadvantage of making lifetime gifts and incurring a current federal gift tax liability is that if the federal estate tax is repealed, federal gift taxes have been paid unnecessarily. This lifetime gifting strategy is therefore recommended for amounts in excess of the $1,000,000 gift tax exemption amount only when it is apparent that the client will not survive estate tax repeal or reform.

A number of states have a tax that is tied to the federal death tax credit. When the state death tax credit is eliminated in 2005, these states will no longer have an estate tax. A change in domicile for a Virginia resident to one of these other states will result in significant estate tax savings for the client. Many wealthy Virginians already have residences in other states and spend a significant amount of time residing in those other homes. Those clients should give serious consideration to a possible change in domicile.

Change in Domicile to Save Taxes

A gift of the $1,000,000 federal estate tax exemption amount will not result in a current gift tax liability. Such a gift will result in estate tax savings, the amount of which depends on the value of the client's estate. Ifa client's estate will be taxed in the top marginal Virginia estate tax bracket, applicable to taxable estates in excess of $10,100,000, a gift of $1,000,000 will result in Virginia estate tax savings of $80,000 if the client dies in 2003 and $120,000 of savings if the client dies in 2004.

Planning for Gifts During Incapacity It is advisable to ensure that an agent or trustee has the authority to make these gifts in the event that the client becomes incapacitated prior to death. Then, if the client becomes ill and it is apparent that he will not recover, gifting can be accomplished and tax savings realized.

Gifting for Clients with Appreciated Assets Highly appreciated assets should not be used to fund the gifts, if possible. The donee will have a carryover basis in appreciated property, and will incur capital gains taxes when the gifted property is sold. The client could borrow the cash to make the gifts, pledging an investment portfolio or other appreciated property as collateral. Then when the

Conclusion Every Virginia estate planning attorney should plan for the possibility of lifetime gifts in order to minimize estate taxes. As illustrated above, the tax savings can be substantial. Unlike other estate planning strategies, there is little audit risk to this lifetime giving strategy. So long as the gifts are complete before the client's death, the tax savings are realized. Future legislation in Virginia may In the also provide some estate tax relief. meantime, Virginians should keep all of their options open, including a possible change in domicile.

Erin Sheehey Downs is a shareholder with the law firm of Jones, King & Downs, P. C. in Bristol, Virginia. Ms. Downs received her B.S. and J.D. degrees from William and Mary ·in 1984 and 1987 respectively. Prior to joining her firm, Ms. Downs was associated with the firm of Christian & Barton in Richmond and served as Trust Counsel for erestar Bank. She focuses her practice on estate planning, trust and estate administration and fiduciary litigation. Ms. Downs gratefully acknowledges the efforts ofher partner, Nell King Bieger,for her prior work on this issue and for h~r editing contributions.

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Va. Code § 58.1-901. I.R.C. § 201 1(b)(2). 3 I.R.C. §§ 2011 (t), 2058. 1

2

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EXHIBIT A ILLUSTRATION OF IMPACT OF LIFETIME GIFTS ON TOTAL ESTATE TAXES IN VIRGINIA - 2003

$25 Million Estate

$5 Million Estate

No Gifts 25,000,000

5,000,000 0 5,000,000

Gifts 5,000,ODO -3,000,000 -925,000 925,000 2,000,000 3,000,000 5,000,000

25,000,000 0 25,000,000

Gifts 25,000,000 -12,500,000 -5,580,000 5,580,000 12,500,000 12,500,000 25,000,000

5,000,000 -60,000 4,940,000

2,000,000 -60,000 1,940,000

25,000,000 -60,000 24,940,000

12,500,000 -60,000 12,440,000

391,600

99,600

3,466,800

1,466,800

Gross Federal Estate Tax Unified Credit State Tax Credit- 50% Federal Gift Tax Paid

2,250,800 -345,800 -195,800

2,250,800 -345,800 -49,800 -925,000

12,050,800 -345,800 -1,733,400

12,050,800 -345,800 -733,400 -5,580,000

Net Federal Estate Tax

1,709,200

930,200

9,971,600

5,391,600

Federal Gift Tax Federal Estate Tax Virginia Estate Tax Total Tax

1,709,200 391,600 2,100,800

925,000 930,200 99,600 1,954,800

9,971,600 3,466,800 13,438,400

5,580,000 5,391,600 1,466,800 12,438,400

Total Current Assets Proposed tfDeathbed Gifts Gift Tax Payable - Sch K I Gift Tax Payable - Sch G2 Federal Taxable Estate Adjusted Taxable Gifts Federal Tax Base

No Gifts 5,000,000

tf

Federal Taxable Estate Adjustment Virginia Tax Base Virginia Estate Tax

146,000 4.87% 7.300/0 5.160/0 5.260/0 5.350/0

Net tax savings Savings as % ofgift - 2003 Savings as % of gift - 2004 Savings as % of gift - 2005 Savings as % of gift - 2006 Savings as % of gift - 2007 - 2009

1,000,000 8.00% 12.00% 8.48% 8.64% 8.80%

I Unpaid gift taxes on gifts made by a decedent before death are deductible on the Federal Estate Tax Return as a debt ofthe decedent. Treas. Reg. § 20.2053-6(d). 2 Gift taxes paid on any gift made within three (3) years before the donor's death increase the donor/decedent's gross estate for federal estate tax purposes; I.R.C. §2035(b).

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VIRGINIA STATE BAR TRUSTS AND ESTATES ·SECTION 2003-2004 BOARD OF GOVERNORS Phillip C. Stone, Jr. Chair P.O. Box 640 Harrisonburg, VA 22803 (540)432-0157 [email protected] Amy G. Pesesky Vice Chair Hotheimer Nusbaum, P.C. 999 Waterside Drive, Suite 1700 Norfolk, VA 23510 (757) 629-0615 [email protected] Mark G. Ferguson Immediate Past Chair Walton & Adams, P.C. 1925 Isaac Newton Square, Suite 250 Reston, VA 20190 (703) 790-8000 [email protected]

Donna E. Fincher Newsletter Editor Vaughan, Fincher & Sotelo, PC 1650 Tysons Boulevard, Suite 700 McLean, VA 22102 (703) 506-1810 [email protected] Victoria J. Roberson Asst. Newsletter Editor 13702 Village Mill Drive, Suite 100 Midlothian, VA 23114 (804) 423-5700 [email protected] Broaddus C. Fitzpatrick Coleman & Massey, P.C. P.O. Box 1489 Roanoke, VA 24007-1489 (540) 343-5100 [email protected] Andrew H. Hook Oast & Hook, P.C. 521 Middle Street Mall Portsmouth, VA 23704 (757) 399-7506 [email protected]

William A. Truban, Jr. Owen and Truban, PLC 103 N. Braddock Street Winchester, VA 22601 (540) 678-0995 [email protected] John H. Turner, III Virginia Estate Plans, PLC 840 I Patterson Avenue, Suite G-l 00 Richmond, VA 23229 (804) 565-2300 [email protected] Lewis W. Webb, III Kaufman & Canoles, P.C. P.O. Box 3037 Norfolk, VA 23514-3037 (757) 624-3247 [email protected] Thomas D. Yates Yates, Campbell & Yates 4155 Chain Bridge Road Fairfax, VA 22030 (703) 273-4230 [email protected]

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