Updating Your Durable Power of Attorney to Permit Gifts - It Really is Better to Give Than to Receive

April 3, 2009 | Stuart B. Dorsett

Recent changes in the law and the current downturn in the markets make this an opportune time to revisit Durable Powers of Attorney, particularly with respect to the authority granted to the Attorney-in-Fact to make gifts to family members.

What Is a Durable Power of Attorney?

A Durable Power of Attorney is a legal instrument by which an individual (known as the "Principal") grants another person (known as the "Attorney-in-Fact") the power to handle the Principal's personal and financial affairs. It is a "Durable" Power of Attorney because, unlike a standard Power of Attorney, it remains effective if the Principal becomes mentally incapacitated. A good Durable Power of Attorney is an important tool in planning for the possibility of incapacity, whether due to accident or illness, prior to death.

A Durable Power of Attorney typically is a "general" Power of Attorney, which gives the Attorney-in-Fact full authority to do anything on the Principal's behalf which the Principal could do personally. However, if the Power of Attorney does not expressly grant to the Attorney-in-Fact the authority to make gifts, the ability of the Attorney-in-Fact to make gifts is substantially limited by North Carolina statute. Generally speaking, only gifts to individuals to whom the Principal has a history of giving are permitted, and no gifts may be made to the Attorney-in-Fact. The statutory gifting authority, therefore, may severely limit the Attorney-in-Fact's ability to make gifts, particularly where the Attorney-in-Fact is a family member to whom gifts should be made. Therefore, a Durable Power of Attorney should expressly address the authority of the Attorney-in-Fact to make gifts, rather than simply rely on the statutory provisions.

What is the Benefit of the Power to Gift?

A threshold question, of course, is why gifts are advisable. There are at least three reasons why a Principal might want the Attorney-in-Fact to make gifts of the Principal's assets during lifetime:

Planning To Minimize Estate Taxes at Death. If an incompetent person has assets which exceed the available estate tax exemption, then lifetime gifts may be used to decrease the value of that individual's taxable estate and thereby avoid or minimize estate tax. The estate tax exemption is currently $3.5 million, but unless Congress changes the law, the exemption will decrease to $1 million in 2011. Thus, for an individual with assets in excess of $3.5 million (or possibly $1 million beginning in 2011), including gifting authority in the Durable Power of Attorney may enable the Attorney-in-Fact to minimize or eliminate estate tax through lifetime gifts.

One of the most important gifting tools is the gift tax annual exclusion which allows an individual to give up to $13,000 per year to each recipient without incurring gift tax. An individual also may make medical and tuition gifts without incurring gift tax, if such gifts are made directly to the medical provider or educational institution. In addition, federal law provides a cumulative lifetime gift tax exemption of $1,000,000. Utilizing some or all of these exemptions is an important part of an estate plan for anyone with a significant estate. Gifting has been made easier by the elimination, as of January 1, 2009, of the North Carolina gift tax, which previously had a lifetime exemption of only $100,000. Accordingly, gifts now may be made which utilize the federal lifetime gift tax exemption without incurring North Carolina gift tax.

For an individual whose estate may exceed the available estate tax exemption, lifetime gifts offer several advantages. First, annual exclusion gifts and medical and tuition gifts reduce the individual's taxable estate without incurring gift tax and without reducing the individual's available estate tax exemption. While use of the separate federal lifetime gift tax exemption results in a corresponding reduction of the available estate tax exemption, such gifts remove future appreciation in the value of the gift from the donor's taxable estate, and the gifts often may be structured to discount the gifted assets' value for gift tax purposes, thereby "leveraging" the value of the gift tax exemption.

In light of the repeal of the North Carolina gift tax, lifetime gifts offer another significant advantage over transfers at death. Even if the value of lifetime gifts exceed the $1,000,000 federal gift tax exemption, such gifts are subject only to the federal gift tax which has a top marginal rate of 45%. In contrast, if the value of the assets passing at death exceeds the available estate tax exemption, then such assets are subject to both federal estate tax and North Carolina estate tax. The North Carolina estate tax can increase the effective marginal estate tax bracket from 45% to as high as 54%. Therefore, lifetime gifts may reduce the taxes imposed on the transfer of assets by up to 9%.

It is, of course, uncertain whether an individual's Attorney-in-Fact will ever need to make gifts in order to achieve these estate planning objectives, because it is impossible to forecast the ultimate size of the Principal's estate or the future status of federal and North Carolina gift and estate tax laws. However, by ensuring that the Attorney-in-Fact has broad authority to make gifts, the Principal provides the flexibility to respond to the circumstances at the time of incapacity.
Avoiding a "Step-Down" in Basis. Under current law, when an asset passes from a decedent to heirs or beneficiaries, the asset receives a new basis for capital gains purposes, equal to the fair market value of the asset at the time of death. This adjusted basis often is referred to as a "step-up basis" because, historically, we have experienced rising markets and increased values. In other words, the adjusted basis typically has eliminated unrealized capital gains as of the decedent's date of death.

However, the basis for a decedent's asset will be adjusted downward if the asset's value is less at the time of death than the decedent's cost basis in the asset. Thus, if an individual purchases a share of stock in ABC Corporation for $50, but at the time of death, the share has a market value of only $25, then the heir or beneficiary receive that share of stock with a tax basis of $25 and loses the opportunity to take a capital loss upon a sale of that stock. Given the severe downturn in the securities and real estate markets, the potential for a "step-down basis" is significant.

In contrast, a lifetime gift provides the recipient with a "carry-over basis," meaning that the gift recipient has a tax basis in the gifted asset equal to the donor's cost basis. Thus, using the above example, if the individual owning the share of stock in ABC Corporation gave that share of stock to a child immediately before the individual's death, rather than leaving the stock to the child through a Will, the child would have a tax basis in the stock of $50, not $25. Therefore, if the child subsequently sold that stock for $25, the child would be able to claim a $25 capital loss.

Accordingly, even if an individual has an estate which falls well below the available estate tax exemption, lifetime gifts may serve an important tax purpose. If an individual with a shortened life expectancy has an asset which has declined in value below its tax basis, a lifetime gift of that asset may provide the individual's beneficiary with capital gains tax benefits.
Planning for Long-Term Care. As life expectancies have lengthened, the risk that an individual will need long-term nursing home care has increased. For example, some studies suggest that individuals who live beyond age 85 have a 50% probability of developing some form of dementia, which may require nursing home care. The cost of such care is not covered by private health care insurance or Medicare. Accordingly, unless an individual has a separate insurance policy specifically providing for long-term care expenses, the cost of nursing home care must be paid either from the individual's assets or by Medicaid.

Medicaid coverage is available only for individuals who have limited financial resources (typically, no more than $2,000 of "countable assets"). However, individuals whose assets exceed that threshold nonetheless may be able to qualify for Medicaid coverage through certain planning techniques, some of which require lifetime gifts. If that individual's Durable Power of Attorney does not confer gifting authority on the Attorney-in-Fact, the ability to engage in these planning techniques may be lost.

Expanding the Power to Act

It is natural for even Principals who understand that gifting authority is an important component of a Durable Power of Attorney to want to limit the power of the Attorney-in-Fact. For example, Principals typically will want the Attorney-in-Fact to be able to make gifts only to the Principal's children. However, the Principal should consider a carefully thought-out expansion of the power to gift.

Expanding the Number of Potential Gift Recipients. The Principal should consider expanding the class of beneficiaries entitled to receive gifts to include not just the Principal's children, but also other lineal descendants (grandchildren and great-grandchildren) and the spouses of the children and other descendants, in order to increase the number of individuals to whom annual exclusion gifts and medical and tuition gifts may be made. Including a broad range of potential beneficiaries does not require the Attorney-in-Fact to make gifts to each and every one of those beneficiaries, but it provides the Attorney-in-Fact with the authority to make such gifts if advisable under the circumstances. As an example, if the gifting authority is limited to children, the Attorney-in-Fact for an incapacited Principal who has two children may make annual exclusion gifts totaling only $26,000. However, if those two children each have two children who, in turn, have an aggregate of five children of their own, and if each of the children and grandchildren are married, then the class of potential gift recipients has increased from two to 17, meaning that the Attorney-in-Fact could make annual exclusion gifts totaling $221,000.
Expanding the Types of Gifts. Many Durable Powers of Attorney limit gifting authority to annual exclusion gifts, which effectively limits gifts to $13,000 per recipient. While annual exclusion gifts are often the most important gifting tool, it may be advantageous to make medical and tuition gifts in order to utilize the $1,000,000 lifetime gift tax exemption, and even to make taxable gifts in order to avoid the North Carolina estate tax at death. Thus, limiting the Attorney-in-Fact's gifting authority to annual exclusion gifts may unwisely limit the Attorney-in-Fact's ability to make other and larger gifts to achieve important estate tax or income tax goals. Accordingly, Principals may wish to authorize gifts without any limitation on the type or size of those gifts.
Equalization of Gifts. Frequently, a Principal's estate plan calls for an equal division of assets among the Principal's children at the individual's death. However, in order to maximize the utility of annual exclusion gifts and medical and tuition gifts, it may be desirable to make gifts to as many family members as possible, and those gifts may result in inequality among family groups.

For example, if a parent has two children, and child A has one child and child B has three children, then if annual exclusion gifts are made to all of the children and grandchildren, the family of child B has received, in the aggregate, twice as much as the family of child A. If this inequality is inconsistent with the parent's desires, this issue may be addressed in one of two ways. First, the parent's Will could include a "gift equalization clause" which equalizes the families' shares at the parent's death after taking into account the amount of lifetime gifts made. Alternatively (or in addition), the parent's Durable Power of Attorney could require that any gifts made by the Attorney-in-Fact be equalized among the several family groups unless all of the family members agree to unequal gifts. Including these provisions in the Will and the Durable Power of Attorney will help to maintain the integrity of the parent's overall estate plan.

Conclusion

Durable Powers of Attorney sometimes are viewed as "standard" documents which require little thought or customization. However, they are not "one size fits all" instruments, and an individual should put at least as much thought into the design of a Durable Power of Attorney as a Will. In particular, the authority of the attorney-in-fact to make gifts needs to be given careful thought. In the estate planning context, it often is better to give than to receive, but only if such gifts further a carefully considered estate plan.

For further information regarding the issues described above, please contact Stuart B. Dorsett.

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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.