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Aging is often associated with social security and fixed incomes. However, as people live longer, the incidence of dementia or other mental disability becomes more of an estate planning problem. Often, the elderly have the foresight to appoint an attorney in fact under a power of attorney (POA) to act for them in financial and medical matters. In most of these cases, however, the attorney-in-fact is usually an adult child, which unfortunately sets up the ready-made problem of whether gift giving under a POA is appropriate, especially if one of the gift recipients is the adult child who holds the power of attorney.
In a “private letter ruling” issued by the IRS, the IRS allowed the annual gift tax exclusion amount ($15,000 for 2018) to be taken in a situation involving gift giving by an attorney-in-fact to herself and to her children. Such a series of gifts can reduce the size of the eventual taxable estate by the amount of the annual exclusion for each gift. To be entitled to the power to make tax-free gifts in this relatively common situation, however, the IRS appears to require the presence of additional circumstances that may not be common for many taxpayers.
A mother executed a durable power of attorney designating her spouse as agent and, in the alternative, her daughter. After the spouse died, the daughter, acting under the POA, created two trusts on her mother’s behalf: (1) a qualified personal residence trust that conveyed the residence to the daughter at the termination of the trust term and (2) a trust for the benefit of the daughter’s children. Both transfers were reported on gift tax returns and the applicable tax was paid.
In addition to specific authority to act in enumerated circumstances, such as to endorse checks, collect rents, and execute deeds, the POA granted “the authority generally to do, execute and perform any other act, deed, matter or thing whatsoever, that ought to be done, executed and performed, or that, in the opinion of the agent ought to be done, executed or performed in and about the premises, of every nature and kind whatsoever, as fully and effectually as the Decedent could do if personally present.”
The daughter had been named in her mother’s will as the sole beneficiary of the estate. The decedent had a history of making gifts, some of which were in excess of the annual exclusion amount. In fact, these gifts were in excess of any gift given through the daughter’s exercise of the power of attorney. The mother died with an estate much larger than the total value of all the gifts that had been made by her daughter.
The IRS’s analysis of whether the gifts were complete for tax purposes hinged upon its determination of whether a state court would likely determine whether the gifts made by the daughter on behalf of the decedent were authorized under the power of attorney. The IRS used the following criteria:
Is the power to make gifts specifically authorized under the power of attorney? If not, the taxpayer has a higher burden to prove that gifts are authorized.
Are the beneficiaries of any gift also the beneficiaries under the decedent’s will? The identity of such beneficiaries would point toward the decedent’s intent to authorize such gifts.
Does the person who executed the power of attorney have sufficient assets to take care of living expenses or would not otherwise become economically disadvantaged after the gifts are made?
Was there a previous gift-giving program in place prior to the exercise of the POA that indicates that the subsequent gifts were consistent with the history of gift giving? In the ruling under consideration, the gifts were consistent, since over the years the mother had made substantial gifts.
One way to avoid tax litigation may be to draft a power of attorney that sets out not only the specific power to make gifts, but also conveys the grantor’s intent that the attorney in fact should, if appropriate, continue a certain gift-giving plan. This would be particularly helpful when an estate is just within the taxable range (or it has the potential for doing so). Of course, the more common situation may be one in which the grantor is not as concerned (particularly when the power is granted) about maximizing estate and gift tax savings as the potential heirs, one of whom is given the power of attorney. Without the added history of gift giving and a large estate, this latter situation may continue to draw IRS scrutiny.
If you need any further explanation of how a properly-drafted power of attorney may save estate taxes, be sure to get in touch with your qualified tax professional.