Recent Tax and Estate Planning Developments

This case serves as a reminder that because these rules differ by state, the existence of an insurable interest should be confirmed. If at all feasible, beneficiary designations and other ancillary documents should be appropriately completed and attached to the settlement agreement as exhibits to be certain that they have been addressed. Finally, a post-divorce estate and financial planning review is essential for all divorcing clients.

Dependency Exemption for Separated or Divorced Parents

The IRS recently issued a Revenue Procedure (2008-48, 2008-36 IRB) addressing the treatment of dependents. The general rule is that a child may be treated as a dependent of the non-custodial parent for income tax purposes only if the custodial parent released a claim to the exemption for that child under the rules of Code Section 152. This ruling follows recently issued Regulations Section 1.152-4 (T.D. 9408, 7/1/08).

A client may claim the child as an exemption if the child is a “qualifying child.” A child may be treated as a qualifying child of a noncustodial parent if the child receives over half of his or her support from one or both parents for more than half the year, and the custodial parent signs a written declaration that the custodial parent will not claim that child as a dependent. Code Section 152(e)(2).

For tax purposes, under the Revenue Procedure, a child will be treated as a dependent of both of the parents, regardless of how the personal exemptions for that child are allocated under Code Section 152, for purposes of:

• Employer-provided medical expense reimbursements under Code Section 105(b).
• Medical deductions under Code Section 213(a).
• Accident or health plans under Code Section 132(h)(2)(B) (excluding fringe benefits).
• Archer Medical Savings Accounts under Code Section 220(d)(2).
• Health Savings Accounts under Code Section 223(d)(2).

To qualify for this favorable treatment, the child must receive over half of his or her support during the year from the parents. Prior to this Revenue Procedure, the non-custodial parent could only treat the child as a dependent for purposes of these provisions if the custodial parent released the claim to the exemption. These benefits generally apply for Aug. 18, 2008 and later, although in some instances they may apply retroactively to the beginning of 2005. While it does not seem necessary to carve out these rights in the grant of a dependency exemption in a settlement agreement, consideration could be given to amending standard language to include these carve-outs.

Pension Benefits and the Ex Strike Again!

Does divorce automatically terminate your client's ex-spouse's rights to a pension plan if the ex remains listed as beneficiary with the plan administrator? In 2001 the Supreme Court held in Egelhoff v. Egelhoff that ERISA pre-empted state law which provided that the divorced spouse's rights terminate. 532 U.S. 141, 121 S. Ct. 1322 (2001). In Egelhoff, the husband failed to change his group life insurance beneficiary designation and pension beneficiary designation to remove his ex-wife. Although Washington law provided that the beneficiary designation of the former spouse was automatically revoked on divorce, the Court held that ERISA preempted state law and the ex-spouse received the insurance and pension because she was the named beneficiary. ERISA provides that the terms of the plan control over state law. Nevertheless, it appears that this tough lesson has still not been learned by some people. In Kennedy, Executrix v. Plan Administrator for DuPont Savings and Investment Plan, No. 07-636, Jan. 26, 2009, the decedent designated his wife as the beneficiary of his benefits under his employer's ERISA pension plan. However, following the divorce the husband never executed new beneficiary documents removing his now ex-wife as beneficiary. Following his death, the ex-wife claimed the benefits. The husband's estate argued that the divorce decree constituted a waiver by the ex-wife of her interests as a beneficiary. The Supreme Court held that the plan administrator's ignoring the waiver was appropriate, because the waiver contradicted the beneficiary designation made by decedent under the plan's documents. The moral of this story remains the same. Post-divorce, clients must update plan beneficiary designations to remove their ex-spouse if that is what the settlement agreed to.

Martin M. Shenkman, CPA, MBA, JD, a member of this newsletter's Board of Editors, is an estate planner in New York City and Teaneck, NJ. His Web site, www.laweasy.com, provides information on matrimonial, investment and related matters.

A payor-ex-spouse buying life insurance for the payee-ex-spouse as part of a divorce settlement is almost ubiquitous. Although estate planners routinely recommend that clients review their planning periodically ' especially if a change occurs ' few clients tend to listen. The cost of not heeding that advice, and a few interesting legal issues, were pointed out in McCall v. Smith , 252 S.W.3d 663; 2008 Tex. App. LEXIS 2387.

Insurable Interest Post-Divorce

Les Williams (“Husband”) divorced Mary McCall (“Wife”) after 25 years of marriage. The divorce agreement mandated that Husband pay Wife alimony until March 2001, and maintain a life insurance policy on his life sufficient to fund any alimony not paid at Husband's death. Four years after the divorce, Husband finally purchased a $250,000 life insurance policy. Husband finished up his second divorce in 2001, then died in June 2002. Since Husband's date of death was after the date the alimony requirement to Wife ended, there was no obligation for Husband to maintain insurance for Wife. The parties in this case, and their counsel, seemed to forget about the concept of follow-through. While each of the points below will be received by practitioners with a yawn as obvious and simple, the reality seems to be that these errors in the McCall v. Smith case are common:

• Where was the follow-through by Wife and her counsel? Husband waited four years after the divorce to fulfill his insurance obligation. Wife's counsel seems never to have specified the type of insurance or reporting requirements in the agreement. Neither Wife nor her counsel seemed to have followed up.
• When Husband filled out the beneficiary designation, he should have restricted the payments to Wife to the amount required under the agreement, or used a trust to hold it so that a trustee could make the minimum payment required to Wife, and the balance could be distributed however he chose.
• When Husband's obligations to provide insurance for Wife ended in March 2001, he should have met with his estate or financial planner and revised the beneficiary designation. Even if the designation had been written correctly, a revision was required to remove the Wife entirely and avoid any ambiguity of her interests.

Naturally, the children sued, claiming that Wife had no insurable interest in Husband's life, so that the proceeds should be paid to them. State law permitted anyone to purchase insurance on themselves, naming another as beneficiary and that named beneficiary would have an insurable interest. Because Husband named Wife as beneficiary, without limiting her rights to the claims under the divorce agreement, alimony due, or the date at which that interest should have ended, Wife's insurance interest was not cut off. Had Wife's interest been denominated as that of a creditor, the termination of the alimony obligation would have cut her rights off, so that avenue of foreclosing her interests was also not available.

This case serves as a reminder that because these rules differ by state, the existence of an insurable interest should be confirmed. If at all feasible, beneficiary designations and other ancillary documents should be appropriately completed and attached to the settlement agreement as exhibits to be certain that they have been addressed. Finally, a post-divorce estate and financial planning review is essential for all divorcing clients.

Dependency Exemption for Separated or Divorced Parents

The IRS recently issued a Revenue Procedure (2008-48, 2008-36 IRB) addressing the treatment of dependents. The general rule is that a child may be treated as a dependent of the non-custodial parent for income tax purposes only if the custodial parent released a claim to the exemption for that child under the rules of Code Section 152. This ruling follows recently issued Regulations Section 1.152-4 (T.D. 9408, 7/1/08).

A client may claim the child as an exemption if the child is a “qualifying child.” A child may be treated as a qualifying child of a noncustodial parent if the child receives over half of his or her support from one or both parents for more than half the year, and the custodial parent signs a written declaration that the custodial parent will not claim that child as a dependent. Code Section 152(e)(2).

For tax purposes, under the Revenue Procedure, a child will be treated as a dependent of both of the parents, regardless of how the personal exemptions for that child are allocated under Code Section 152, for purposes of:

• Employer-provided medical expense reimbursements under Code Section 105(b).
• Medical deductions under Code Section 213(a).
• Accident or health plans under Code Section 132(h)(2)(B) (excluding fringe benefits).
• Archer Medical Savings Accounts under Code Section 220(d)(2).
• Health Savings Accounts under Code Section 223(d)(2).

To qualify for this favorable treatment, the child must receive over half of his or her support during the year from the parents. Prior to this Revenue Procedure, the non-custodial parent could only treat the child as a dependent for purposes of these provisions if the custodial parent released the claim to the exemption. These benefits generally apply for Aug. 18, 2008 and later, although in some instances they may apply retroactively to the beginning of 2005. While it does not seem necessary to carve out these rights in the grant of a dependency exemption in a settlement agreement, consideration could be given to amending standard language to include these carve-outs.

Pension Benefits and the Ex Strike Again!

Does divorce automatically terminate your client's ex-spouse's rights to a pension plan if the ex remains listed as beneficiary with the plan administrator? In 2001 the Supreme Court held in Egelhoff v. Egelhoff that ERISA pre-empted state law which provided that the divorced spouse's rights terminate. 532 U.S. 141, 121 S. Ct. 1322 (2001). In Egelhoff, the husband failed to change his group life insurance beneficiary designation and pension beneficiary designation to remove his ex-wife. Although Washington law provided that the beneficiary designation of the former spouse was automatically revoked on divorce, the Court held that ERISA preempted state law and the ex-spouse received the insurance and pension because she was the named beneficiary. ERISA provides that the terms of the plan control over state law. Nevertheless, it appears that this tough lesson has still not been learned by some people. In Kennedy, Executrix v. Plan Administrator for DuPont Savings and Investment Plan, No. 07-636, Jan. 26, 2009, the decedent designated his wife as the beneficiary of his benefits under his employer's ERISA pension plan. However, following the divorce the husband never executed new beneficiary documents removing his now ex-wife as beneficiary. Following his death, the ex-wife claimed the benefits. The husband's estate argued that the divorce decree constituted a waiver by the ex-wife of her interests as a beneficiary. The Supreme Court held that the plan administrator's ignoring the waiver was appropriate, because the waiver contradicted the beneficiary designation made by decedent under the plan's documents. The moral of this story remains the same. Post-divorce, clients must update plan beneficiary designations to remove their ex-spouse if that is what the settlement agreed to.

Martin M. Shenkman, CPA, MBA, JD, a member of this newsletter's Board of Editors, is an estate planner in New York City and Teaneck, NJ. His Web site, www.laweasy.com, provides information on matrimonial, investment and related matters.