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Joel F. Dorroh, P.C. represents individuals persons and businesses in a wide variety of tax issues. This includes estate planning and business planning matters that are discussed in detail in other places on this web site. As stated in those areas, there is often a lot of overlap between probate law or corporate law and issues involving taxation. Since they are so intricately interconnected, they are not considered to be necessarily separate tax practices.

In addition to those services, we also provide strategic tax advice that is specifically designed to meet each of our client’s needs. This includes individual tax planning and tax litigation. We represent individuals and businesses with all types of taxing authorities, including the Internal Revenue Service, the Alabama Department of Revenue, the Alabama Department of Industrial Relations, and individual county or municipal taxing authorities. We provide both tax planning and assistance regarding income taxes on both the federal and state level, Alabama Business Privilege tax issues, sales and use tax, rental and lodging tax, and other tax matters.

In addition to helping individuals plan for an reduce these taxes, we also provide assistance in negotiating, appealing, and, if necessary, litigating all of these tax issues. We have a close connection with both the Internal Revenue Service agents and Alabama Department of Revenue agents in our area and have been successful in reducing and eliminating tax litigation issues that have arisen between our clients and these organizations. When the circumstance arises that our clients need assistance in the tax area, we are able to provide assistance in virtually all areas.

The way a FLP works is actually quite simple.  First, the person or couple establishes the FLP.  Second, the person or couple transfers property into the FLP.  Due to such factors as “lack of marketablity” or “minority interests” in the partnership shares, the value of the assets inside the partnership may be discounted as much as fifty percent (50%).  The individual or couple then transfers the FLP interest in the assets to other persons, such as their children, but at a discounted rate.  Therefore, in simple terms, a person having a farm worth $1 million could transfer almost the entire farm to their children , but for the purposes of the Internal Revenue Service, the Service would value the transfer at something substantially less than the $1 million, and possibly as low as $500,000 while maintaining control over the property.

 The Internal Revenue Code recognizes the validity of FLPs where certain requirements are met.  In the mid-1990s, the Internal Revenue Service finally acquiesced in the establishment of FLPs.  When they did, there was an explosion of FLPs created since this is one of the best, aggressive estate planning techniques left in the toolbox.

 One of the other strategic advantages of using a FLP is that it allows the older generation to continue to maintain control over the assets.  The FLP is managed by a general partner or partners.  In the establishment of the FLP, the person donating the property will normally be the general partner.  In so doing, even though most of the limited partnership interests in the FLP will eventually be transferred to other persons, such as children, by maintaining the general partnership interest unit, the person will always maintain control over how the assets are held, invested or managed.  This means that although the person has given up the value of the assets out of their estate, they are able to maintain full control over those assets.

Consider the following example:
A husband and wife own farm property with a fair market value of $3 million.  Their other assets total $2 million.  They have three children.  The business appraiser determines the value of the farm property inside the FLP they have created would be discounted by a conservative thirty percent (30%).  The couple transfers the property into the FLP and gives sixty percent of the FLP to their children as limited partners.  The parents retain the general partnership interest and a thirty-eight percent limited partnership interest.  More importantly, with the general partnership interest, the parents retain absolute management and control of the property.
$3,000,000 — net value of farm propertyx 70% — after application of the 30% discount————–$2,100,000x 60% — percentage gifted to children as FLP shares————–$1,200,000 — net gift to children for gift tax purposes (no gift tax payable)$1,800,000 –  actual value of farm property gifted to children

Estate result:
With no FLP: $5,000,000 — net value of estate at second spouse’s death- 1,799,000 — federal estate tax————–$3,201,000 — net to children
With FLP: $2,840,000 — net value of estate at second spouse’s death- 1,271,000 — federal estate tax————–$3,729,000 — net to children
Thus a $528,000 reduction in estate taxes achieved with an FLP in this scenario and yet the parents have never given up control of the property while they are living.

This was achieved assuming a very conservative discount of 30% and still using the applicable exclusion amount of $600,000.00.  With the new exclusion amount and with the realistic possibility of higher discounts, an even dramatic result can be achieved.

» Will (or possible a probate avoidance trust)
» Durable Power of Attorney
» Advance Directive for Health Care

If a person’s estate is greater than $500,000.00 serious consideration should be given to whether the person needs estate planning other than a simple will. These matters should definitely be discussed with an attorney to help consider factors such as the estate growth rate and what assets are going to be transferred at death. Once it is determined that a person needs estate planning, a model estate plan would consist of one of the following:

Testamentary Trust Method or Living Trust Method

» Will with testamentary bypass trust
» Durable Power of Attorney
» Advance Directive for Health Care
» Division of assets to take full advantage of the testamentary trust when the first person passes away
» Living (inter vivos) Bypass Trust
» Pour-over Will
» Durable Power of Attorney
» Advance Directive for Health Care
» Trust funding assistance

Additionally, estate planning is not a once-in-a-lifetime event. Even after an estate plan has been created that perfectly suits the person’s needs at that time, things quite often change. Often wealth is accumulated faster or slower than expected, new potential beneficiaries are born, previously designated potential beneficiaries pass away or it becomes undesirable to leave them as beneficiaries in their present form, divorces, and other events occur that often require us to re-examine an estate plan. It is highly recommended that a person have their estate plan re-evaluated every three to four years or after any significant event has occurred in the person’s life (such as a divorce, new child, child or spouse passing away). Quite often, no changes are necessary to the estate plan; however, it is always well worth the effort to make sure that the plan still fits a person’s needs.

Generally, the proceeds of a life insurance policy are included for federal estate tax purposes in the estate of a decedent who is the owner/insured of the policy.  This is true even if the proceeds are paid to a designated beneficiary other than the decedent’s estate.  Therefore, even if a person’s life insurance designates his or her spouse or children as the beneficiary of a life insurance policy, the full value of the life insurance policy is includable in the person’s estate when they pass away as far as the Internal Revenue Service is concerned.  Therefore, it is very advantageous to transfer any life insurance policy in a manner so that it is not includable in the person’s estate.  Many people do not want to transfer the ownership of their policies to their spouse because it will defeat many of the purposes of estate planning and do not wish to transfer ownership to their children for a number of reasons including lack of control over the policies.

This is where an irrevocable life insurance trust (“ILIT”) comes in.  An ILIT may be used to hold the “incidents of ownership” of a life insurance policy and thus remove it from the insured’s taxable estate.  Generally, a policy owned by the insured is transferred into an ILIT.  If the insurance policy is a new policy taken out through the trust, the proceeds from the policy will be immediately excluded from the person’s estate.  If the life insurance policy is an existing policy that is transferred into the ILIT, the Internal Revenue Code requires that the insured survive for three years after the transfer for the proceeds to be excluded from his or her estate.

The settlor/insured may pay the premiums of life insurance policies in the ILIT by making gifts to the trust or beneficiaries using “Crummey” provisions.  Such gifts qualify for the $10,000.00 per year per donee annual gift tax exclusion.  The settlor/insured may not be the trustee of the ILIT.  At the settlor’s death, the life insurance proceeds will be paid into trust and administered according to the trust provisions established by the settlor for the benefit, for example, of the settlor’s spouse or children.

As is generally the case with life insurance policies, there will be no income tax payable on the insurance proceeds distributed at the settlor’s death.  Therefore, the use of an ILIT allows for substantial sums of money that would ordinarily create estate tax problems to transfer to a spouse or child estate tax free and income tax free.

If a person passes away with a will, the will must be “probated” in order for the person’s property to be transferred to his or her beneficiaries.  This process begins by petitioning the probate court to issue Letters Testamentary to the person designated as the executor or personal representative in the will.  Usually, the other heirs must be contacted and either sign waivers of notice or there must be a hearing scheduled to allow for any will contest.  Once the will has been entered into probate court and Letters Testamentary issued to the executor, the executor then has the power to collect all assets belonging to the deceased person.  He must then pay any liabilities or expenses owed by the deceased person.  The remainder of the property left over after paying any expenses of the estate are then divided according to the terms of the person’s will.
During the probate process, the estate must be open for a period of six months, during which publication of the estate must be run in the newspaper once a week for three consecutive weeks.  This allows any person having a claim against the deceased person’s estate to enter such claim with the court.  Most estates are capable of being closed out shortly after the six-month claims period.  However, some estates are more complicated and may take longer to close.
If a person passes away without a will, he or she is said to have died “intestate.”  An intestate estate must be administered according to the laws of the State of Alabama.  The deceased person does not have any control over how the property is to be distributed.  Rather, it is distributed strictly as defined in the Alabama Probate Code.  In the case of an intestacy, anyone may apply for Letters of Administration on the estate of deceased person; however, certain persons are given preferential treatment in being appointed as administrator, such as the spouse and children.  Typically, if a person has a will they exempt their executor from having to file a bond with the probate court.  In the case of an intestacy, a bond must be filed in the amount of double the value of the estate.  Finally, wills typically give the executor the authority to do certain acts such as sell or consolidate property inside the estate.  This is not the case with an administration.  In the case of an intestacy administration, the administrator must apply to the probate court and get an official order to sell or exchange any of the property on behalf of the estate.
Due to the time delays, probate expense, and other problems associated with probate, some people choose to try to avoid probate through the use living trusts.  There is an entire article on Living Trusts to avoid probate in this section.

1.The gift must be permanent and without strings.  This means that if you transfer your house or money to a child with the expectation that the child will take care of you and then later the child declines to do so or decides to literally “kick you out of the house,” they can and there is little or nothing that you can do about it.
2.If transferring your house, you lose your homestead exemption and your federal and state income tax deduction for real estate taxes.
3.You have given away your children’s ability to claim a “step-up”in basis in the property after your death, which could result in your children paying much more in Capital Gains income tax on the sale of your house.
4.If transferring your house, you lose your ability to claim your $500,000/$250,000 Capital Gains Exclusion.
5.You have exposed your assets to the claims of creditors of your kids.
6.You have exposed your assets to the possibility that half of the value of your assets will fall into the hands of your daughter-in-law or son in-law if they divorce your child.
All of these situations can be costly and some can be down right devastating.  Therefore, it is hard to ever recommend that giving all of your assets away to qualify for Medicaid is a good idea.  Nevertheless, we are asked everyday to do exactly that.  So with that in mind, the remainder of this article is dedicated to explaining how to transfer assets prior to needing to qualify for Medicaid assistance.
Nursing home care costs approximately $3,500 per month, so private payment can deplete a family’s finances very rapidly.  Therefore persons trying to qualify often want to transfer assets out of their name to qualify.  However, the “powers that be” were smart enough to realize that if some protections were not put in place, everyone would wait until the day before they needed Medicaid and then give everything away so as to immediately qualify.  This led to the enactment of two very important rules relating to Medicaid planning: the “Three-year lookback rule” and the “Medicaid penalty period.”
It seems almost everybody knows that there is some kind of three-year period related to gifts and Medicaid eligibility. It also seems like almost everybody is confused about the exact relationship. Federal and state law require you to disclose on your Medicaid application every gift you’ve made during specified time periods preceding the date you want Medicaid benefits to start. These time periods are called lookback periods. The lookback period for outright gifts is 36 months (3 years), however this period is 60 months (5 years) for gifts made in trust.
The general rule can be summed up as “Lookback and Count Forward.”  For example, if you gave away something in May, 1999, then this gift would not have to be disclosed if you applied for Medicaid today.  Additionally, if you gave something away today, it would be three years from today before you would not have to disclose this gift when applying for Medicaid.
This leads into the second rule which is commonly referred to as the Medicaid penalty.  Realizing that some people would give things away but need to qualify for Medicaid prior to the three-year period expiring, the Medicaid laws provide a formula for knowing when a person would be eligible.
A Medicaid transfer penalty is a period of restricted eligibility. During that period of time, the person who made the transfer is not eligible for Medicaid benefits covering nursing home care.  A Medicaid penalty period is produced by an uncompensated asset transfer. “Uncompensated transfer” means, basically, that you made a gift. The term “asset” includes your house, cash, bank accounts, stock, personal assets and basically any other thing of value you own. You can make a gift of some or all of the value of an asset. For example, you could give someone your house for free or you could sell it to them for less than fair market value. Some things that you may not think of as transfers by you, will be treated as transfers and, if made within a look-back period, will affect your eligibility for Medicaid.  These include:

1.Any transfer made by your spouse before you are awarded Medicaid is treated the same as if it were made by you.
2.Transfers made on behalf of either of you by a conservator, under power of attorney, etc., are treated as if made by you.
3.Withdrawals by a joint account-holder from a joint bank accounts.
4.Putting the title to your house into joint names with someone else.
5. Disclaimer of an inheritance is a transfer.
 However, a gift in a will is not considered a transfer. Regardless of the actual intentions, the presumed purpose of any transfer by the Medicaid administration is that it was for Medicaid qualification.
The “penalty period” is equal to the amount of care (usually expressed as a period of time) that Medicaid could have purchased with the assets transferred. In other words, if all of the assets transferred had been sold for cash and used to pay for nursing home care, how long would the money last.  There are several steps to the calculation. First, you determine the length of the penalty period. Second, you determine when the penalty period starts.
The length of the penalty period is determined by dividing the total uncompensated value of the asset transferred by the applicable Medicaid regional rate (approximately $3,500 for Tuscaloosa County, Alabama). For example, a $50,000 gift divided by $3,500 produces a 14.3 month penalty period during which no Medicaid benefits are available.
The penalty period starts in the month after you made the gift. For example, if you gave away $50,000 on June 30, 2002, the 14.3 month penalty period would start on July 1, 2002 and end during September, 2003. During that period, Medicaid and the nursing home would expect the person to private pay for the nursing home care during that period.
Depending on when you made the gift, how big it was and when you want Medicaid to start, the penalty period may or may not affect your Medicaid eligibility. For example, if you want Medicaid to start on August 1, 2002, and you gave away $50,000 on July 31, 1999, there would be no penalty period because the gift was outside the 3 year lookback; therefore the person would immediately qualify. However, if the gift was on June 30, 2001, it would be within the lookback period and you would not be eligible for Medicaid benefits until sometime after September 1, 2002, because of the 14.3 month penalty period that started on July 1, 2001.
It is also important to remember that the penalty period is unlimited. In other words, even though the look-back period is only 36 months for transfers to individuals, a transfer penalty can be unlimited. For example, if a person transfers $500,000 to his son on January 1, 2001 and then on February 1, 2002, that person enters a nursing home and applies for Medicaid, then Medicaid will look-back 36 months. During that 36 month time period, the person made the $500,000 transfer. That transfer results in a penalty. Assuming a  $3,500 applicable Medicaid regional rate, the penalty would be 142.9 months ($500,000/$3,500=142.85 months). This means that it would be roughly 12 years before the person would be eligible! You must be careful.
Two final thoughts that often come up in the discussions of Medicaid planning:

1.A lot of times instead of “giving” assets away, the better plan is to use assets to take care of other matters that does not impact the person’s ability to qualify for Medicaid such as paying off unsecured debts (e.g. credit cards) and/or pre-paying for non-countable assets such as funeral expenses or life insurance that does not accumulate cash value.
2.Do not confuse gifts for Medicaid purposes with the Federal Gift Tax laws.  Nothing prevents a person from giving away more than $10,000 (now the amount is actually $11,000) per person per year as some people believe.  For Medicaid spend-downs gifts of any amount can be given away subject to the lookback and penalty provisions discussed above.  However, if a person gives away more than $11,000 per person per year, then that person MUST file a Form 709 with the Internal Revenue Service stating the amount given away and possibly subjecting the gift to a Gift Tax.
Finally, this article does not represent an endorsement of any particular course of action. Decisions about whether to do Medicaid planning are VERY IMPORTANT and should only be entered into with a full understanding of the potential negative consequences.  Before any actions are taken, you should consult an attorney.

Another area in which corporations are significant are tax planning.  There are several tax advantages that can be achieved through various corporations.  One of the most significant is through the use of a “Small Business Corporation.”  A Small Business Corporation (S-Corp) can be used to significantly minimize employment taxes that would otherwise be charged to sole proprietors or general partnerships.  A person who is a sole proprietor or a partner in a general partnership is required to pay a self-employment tax rate of 15.3%.  This is on top of any individual income tax this person may pay.  Through an S-Corp, the shareholders are only required to pay self-employment taxes on money paid to them as compensation for services (their salary) not on all of the profits of the corporation.  Therefore, by strategic use of establishing S-Corps and determining appropriate levels of compensation, significant employment taxes may be saved.  Quite often this savings alone is more than enough to offset any cost of establishing a corporation and any additional tax returns it may have to generate.
¼br /> Other reasons for forming corporations include:

» The ability to issue stock to key employees in order to keep them in the business
» The ability to issue stock to outside investors in order to raise capital for funding without having to borrow money and pay interest
» Other tax advantages such as tax splitting
» Centralized management
» To aid or assist in the transfer of a small business ownership from one generation to the next
» To provide a formal structure between partners in a partnership
» For the establishment of certain types of qualified retirement accounts such as 401(k) plans
» To aid others in how they view the business entity (lending institutions often request that their borrowers form corporations)
Corporations are formed by the filing of Articles of Incorporation with the local Judge of Probate and with the Secretary of State.  Once established, the corporation will also need to establish bylaws and have a meeting to establish its initial set of minutes.

While most of the ideas of forming a corporation are positive, there are a few down sides to forming corporations.  First, there will be some initial setup costs for attorneys fees to establish the corporation.  Second, the corporation will need to file a tax return each year and may result in slightly increased accounting fees.  However, a corporation would require an additional return be prepared, but since all of the information regarding the business is now filed on the corporate tax return and not on the individual’s tax return Schedule C, the increase in costs for the corporate tax return is often offset in part by the reduction in the cost of preparing the individual tax return.  Lastly, financial records must be kept for the corporation and minutes of an annual director’s meeting must be prepared.  However, as noted above, usually there is enough tax savings generated by the formation of the corporation to more than offset the additional costs and requirements of the corporation.

When talking about the difference between corporations and LLCs, we are usually talking about the difference between and S-Corporation and an LLC. Since C-Corporations, S-Corporations and LLCs all provide for limited liability, the major distinction between the three is how they are taxed. A C-Corporation is taxed usually at the entity level; whereas, S-Corporations and LLCs are usually taxed at the individual owner level. Therefore, when discussing a business entity choice between an LLC and a corporation, we are really discussing the choice between an LLC and an S-Corporation. If a C-Corporation better fits a business situation, it is usually preferable to any form of LLC that involves an entity level tax.

First, the area of business entity choice is a specific area where the aid of an attorney is essential. Attorney expertise and experience in these areas is essential in helping a person decide which business entity choice is right for them. However, as a way of helping of the person see some of the advantages and disadvantages to each type of business entity, the following may be used to help decide which business entity would be preferable.