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Legal Network News:
Keeping Your Incapacity Options Flexible
While Avoiding the Lurking Power of Appointment

by Peter S. Stern, Esq.

Gifting Powers

One of the hallmarks of good incapacity planning is to build in flexibility in estate planning and incapacity documents. Clients who want durable powers of attorney and trusts often desire the ability to change title to property, in order to create Medi-Cal eligibility, or to avoid Medi-Cal recovery, but they do not want to make those changes at the time they ask us to prepare their documents.

Powers of attorney can be used to amend and revoke trusts, and to make gifts, so long as the trust instrument and the power of attorney expressly permit such acts by an attorney in fact (Probate Code Sections 4264, 15401). An attorney in fact is, of course, a fiduciary, and is bound to act on behalf of the principal, and to manifest a duty of loyalty to the principal (Probate Code Sections 4266, 16002, 16004), which thus bars an attorney in fact from making gifts to him- or herself, unless the principal has specifically authorized self-dealing in the document.

A power of attorney that permits gifting is a potent document that can be abused. Most attorneys are aware of the dangers of broad gifting powers. But there are some circumstances where it is not possible to meet the objectives of the principal without providing for the power to make gifts.

A single person who wishes to qualify for Medi-Cal if her health deteriorates in the future might, for instance, wish to permit her attorney in fact to transfer nonexempt assets to certain individuals if she will require long term care and could be made eligible for Medi-Cal, once she had been properly placed in a Medi-Cal certified facility that proved to be suitable for her needs. If the principal retained capacity, she could of course carry out her own Medi-Cal planning. But if she suffered from the early stages of dementia at the time she had her documents prepared, she might well wish to provide for a time when she would no longer have capacity.

It might also be the case that she could qualify for Medi-Cal but would have a relatively small share of cost and would want to be sure that her exempt property could be protected from recovery in the future. In this case, she could provide in a power of attorney, in case she no longer has capacity in the future, for her attorney in fact to transfer her house to her trust beneficiaries, or to the devisees of her will.

In each of these examples, the principal's power of attorney could provide for the power to make gifts to a class of beneficiaries, or to individual beneficiaries. Sample gifting language follows this article.

Power of Appointment

But what if the principal has named as attorney in fact one of her beneficiaries? Most seniors do not have the luxury of having an unlimited number of persons from which to choose an agent, and in most cases, the principal chooses a child as agent. In some instances, the child is the sole beneficiary of the principal's estate. By providing the agent with the power to make a gift of the principal's property to the agent, the principal has created a power of appointment for the agent, under Internal Revenue Code Section 2041, which defines a general power of appointment (IRC Sec. 2041(b)(1)) as a power "exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate." Clearly, the power of the agent to exercise a gifting provision in favor of him- or herself would be a general power of appointment, and the consequence for the agent is that the property over which the agent has a power of appointment is includable in the agent's estate (section 2041(a)).

The creation of the gifting powers illustrated in the examples above would create powers of appointment in favor of the agents, and were the agent to predecease the principal, the full value of the property over which the agent had been given the power to gift to him - or herself would be subject to inclusion in the agent's taxable estate. In the case of a power over a residence in the California Bay Area, creation of a power of appointment could in and of itself create a taxable estate, where the agent had no property at all prior to receiving the power.

Avoiding Tax Problems

This problem has a number of solutions. The most obvious one is to name someone other than a beneficiary to have a special power under the power of attorney to make the gifts. Sample language appointing a special agent with power to make gifts follows this article. If, for example, a mother names her only child as her agent, and if the only child is to be the beneficiary of any future transfer of assets, then an adult grandchild could be named to hold power as special agent with power to make gifts. This solution is the preferred solution to avoiding the creation of a power of appointment.

In the alternative, one can seek shelter in IRC Reg. 20.2041-3(b), which holds that "a power exercisable only upon the occurrence during the [agent's] lifetime of an event or contingency that did not in fact take place or occur during such time is not a power in existence on the date of the [agent's] death." If the power to gift is couched in suitable conditions subsequent, and if the conditions have not occurred by the time of the death of the agent, the property over which the agent has power would not be includable in the agent's estate.

Samples of gifting language in powers of attorney:

A. My attorney in fact shall have the right to transfer ownership of assets held in my name only or held jointly in my name and the name of any other entity or person to my sons, if making such gifts would allow me to become eligible for support from California's Medi-Cal program, or any such successor program, or the Medicaid program of any other state, or to allow me to avoid recovery against my estate by any such program, if my name is removed from any assets held solely or in part by me, under the following conditions, all of which must be met. Until all these conditions are met, and until all documents referred to herein have been conveyed to my attorney, the power created under this Article 1.20 shall not be deemed to exist:

  1. I am a patient in long term care and my treating physician states in writing that I will remain a patient in long term care for at least four months, based on my medical condition as determined by that physician;

  2. My attorney in fact has advised in writing my attorney, ______ of the plan to make gifts to my family members, and of all other factors relating to my situation, and my attorney has approved of this plan in writing and has caused to be attached to this power of attorney a document to that effect.

I specifically authorize my attorney in fact to make gifts to himself, should either of my sons be serving as my attorney in fact.

B. 1.21. Gifts

My attorney in fact  shall have the right to transfer ownership of my home, located at ______ Pomona, California APN 8, to my daughter ______ under the following circumstances: If I am a patient in a skilled nursing facility and my physician states in writing that I am likely to have to stay in the facility three months or longer, and I am eligible for support from California's Medi-Cal program, or any such successor program. I convey this power to my attorney in fact specially appointed to exercise this power in order to fulfill my estate plan, which is to convey as much as possible of my assets to my daughter.

Sample language for appointment of special agent for gift making:

I, ______ of ______, County of Los Angeles, California, as principal, (the Principal) have this day appointed my daughter ______, of ______, California to serve as my attorney in fact for me and in my name, place and stead and for my use and benefit and to exercise the powers set forth in this document.  If she shall be unable or unwilling to serve or to continue to serve I appoint the following person to serve as substitute or successor attorney in fact:

1st alternate: My grandson ______of ______, California. My attorney in fact is to act in my capacity to do every act that I may legally do through an attorney in fact for my use and benefit.

I appoint ______ to carry out the powers specified in Article 1, paragraph 21 of this General Durable Power of Attorney.

Peter S. Stern, Esq., is a private practice attorney in Palo Alto.

From the December 2000 Legal Network News

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