Thinking Beyond the $10,000 Box

Thinking Beyond the $10,000 Box

By Jeffrey G. Moore

For many people, it is important to know that their spouse will have money available for emergencies. So they put money aside for that purpose. At the same time, however, people want to minimize their taxable estate. That is understandable because gift and estate taxes can be as high as 55% of the estate’s amount. The question then becomes, is there a way to minimize your taxable estate and still retain control over resources that your spouse might need in the future? The short answer is yes. But the way to get there is a bit complicated.

Most people know that when they transfer money or other property to a spouse, they usually don’t have to pay gift or estate taxes. This is called the “unlimited marital deduction.” To qualify for the unlimited marital deduction, the spouse who receives the money must have an unrestricted right to use it or, at least, retain any income generated by it. Although gifts to a spouse are generally not subject to taxation, those gifts just add to the spouse’s estate. Thus, while there is no immediate taxation, there is also no reduction in the taxable estate.

The “annual exclusion” rule allows a person to transfer up to $10,000 per year to another person without having to pay any gift taxes on that amount. In a typical situation, both parents give $10,000 to their children each year. One major objective is to remove that amount from the parents’ estates and to minimize the potential estate tax liability upon their deaths. The drawback is that the parents do not retain any right to that money.

To avoid estate taxes entirely, the funds must pass out of both spouses’ estates. That normally means that both spouses lose control over the funds. But there is a way to retain at least some control over the funds so that your spouse can use them if they are needed in the future.

The way to achieve that is to put the money into a special type of trust. The trust benefits your spouse for life, but upon the spouse’s death, named beneficiaries (usually your children) will receive the assets in the trust. The trust’s assets will not be included in your spouse’s estate upon his or her death because the trust is drafted so that the gifts to the trust intentionally fail to qualify for the unlimited marital deduction. The trustee of that trust, and not your spouse, has total discretion over the trust payments to your spouse. Because the spouse does not have an unrestricted right to receive the trust income, the gifts made to the trust do not qualify for the unlimited marital deduction. Thus, the gifts are not added to the spouse’s taxable estate, but the gift is subject to immediate gift taxation.

Although the gifts do not qualify for the marital deduction, they can still qualify for the annual exclusion and avoid immediate gift taxation. If the spouse is given a right to withdraw any gifts to the trust within a specified period of time, say 30-45 days, then the gift qualifies for the annual exclusion and there is no gift tax. The underlying theory is that your spouse will not withdraw the funds in that period, but rather allow the withdrawal period to lapse and permit the gift to grow within the trust. However, if your spouse needs the money for some type of emergency, the trust funds are available for his or her use.

You are allowed to put in the greater of $5,000 or 5% of the current trust principal into the trust every year. Normally, the annual exclusion excludes up to a $10,000 gift per person, but in this case, any gift in excess of $5,000 or 5% of the trust is deemed a taxable gift from the donee spouse to the trust beneficiaries. The donee spouse is the person who receives the gift. Because the excess does not qualify for the annual exclusion, gifts to this type of trust should be limited to the greater of $5,000.00 or 5% of the trust principal, but not to exceed the $10,000 annual exclusion limit. The end result is exclusion from your and your spouse’s estate. The upside: When the donee spouse dies, the trust simply distributes to the beneficiaries without estate tax consequences. The downside: If the spouse dies before the donor spouse, the donor spouse cannot access the funds because the trust distributes to the children.

To illustrate, assume a 40-year-old man creates this type of trust for his wife and makes a $5,000.00 gift to the trust each year. The wife does not withdraw the gifts and the trust earns a total return of 8% a year. The trust will grow to over $930,000 by the time the man reaches age 75. All the assets in the trust can pass to the man’s children free of estate tax upon the wife’s death — all of which was built by simple gifts to a spouse. The income earned by the trust is reported on the man’s personal return, so the trust funds grow income tax free.

This estate planning technique allows you to reduce your estate without adding to your spouse’s taxable estate. At the same time, it minimizes your children’s estate tax liability upon your spouses’ death. Thus, the real benefit of this trust is obtaining all of the tax savings, while preserving the funds for your spouse’s benefit for life. If you want to learn more about this special type of trust, call us for a consultation.

Congress enacted the so-called “Stark” laws in response to studies showing that doctors who owned laboratory services made far more referrals for laboratory tests than those who did not. As a general principle, the Stark rules prohibit referrals from a physician to an entity to which the referring physician has a financial relationship. More specifically, unless an arrangement qualifies for an exception set forth in a statute or rule, a referral from a physician to an entity is prohibited, and an entity is prohibited from billing Medicare or Medicaid for services provided pursuant to a referral from a physician, when the referring physician (or an immediate family member of that physician) has a financial relationship with the entity and the referral is for the provision of “designated health services,” and the payment for such services would otherwise be payable under Medicare. For the purposes of both Medicare and Medicaid referrals under Stark, the term “physician” means not only a medical or osteopathic doctor, but also a dentist, oral surgeon, podiatrist, optometrist, or chiropractor.

Effective January 1, 1995, the definition of “designated health services” was expanded (The expansion is referred to as “Stark II.”) Under Stark II, “designated health services” includes clinical laboratory services; physical and occupational therapy services, radiology and MRI, CAT, and ultrasound services; radiation therapy services and supplies; durable medical equipment and supplies; parenteral and enthral nutrients, equipment and supplies; prosthetics, orthotics, and prosthetic devices and supplies; home health services; outpatient prescription drugs; and in-patient and out-patient hospital services.

The Stark rules provide ample incentive for compliance, and unlike other federal statutes in this area which require knowledge of wrongdoing, intent is not an element of Stark. In other words, Stark can be violated without any knowledge of wrongdoing.

The various penalties for violation of the Stark rules include non-payment of claims, recovery of any payment already made for prohibited claims, civil money penalties of up to $15,000 per claim, exclusion from federal heath care programs (sometimes referred to as the “death penalty”) and a fine of $100,000 for each arrangement found to be a scheme to circumvent the law.

The Health Care Financing Administration (HCFA) has taken the position that a referring physician is subject to these penalties for making an improper referral in addition to the entity billing for the designated health services. Although the penalties for violating these rules can be quite severe, to date there are no reported Stark enforcement actions. However, because violations of Stark also may be found to violate other federal statutes, the risk of some kind of enforcement action is greatly increased — especially through private enforcement by disgruntled employees or knowledgeable competitors.

Under Stark, a referral includes either: 1) any request by a physician for an item or service payable under part B of Medicare or Medicaid, including a request for a consultation with another physician (and any past procedure ordered or to be performed by or under the supervision of that other physician) or 2) any request for establishment of a plan of care by a physician which includes the provision of “designated health service.” A “referral” under Stark also includes any request by a physician for an item or services payable under Medicare including a request for a consultation with another physician and includes any test or procedure ordered by or to be performed by or under the supervision of that other physician. Therefore, even “indirect” referrals would very likely be considered a prohibited referral.

Under Stark II, a physician with an ownership interest in an outside provider of “designated health services” can violate the self-referral prohibition if he or she “attempts to influence” an employed physician to refer tests to that entity. It is difficult to determine exactly what is meant by “attempt.” However, it appears the drafters of the legislation have a broad construction in mind. Therefore, we suggest that medical practices specifically prohibit any “borderline” referral practices.

There are three major categories of exceptions to the Stark self-referral prohibition: 1) exceptions applicable to all financial relationships, 2) exceptions applicable to ownership or investment interests, and 3) exceptions applicable to compensation arrangements. Exceptions to both compensation arrangements and ownership or investment interests include physician services provided personally by or under the personal supervision of other physicians in the same group practice, in-office ancillary services, and services furnished by prepaid health plans.

The most significant exceptions under the Stark rules apply to group practices. As a general principal, provided that the group strictly meets the definition of a “group practice” under Stark, the group may bill Medicare or Medicaid for clinical laboratory services or other designated health services.

Another often applicable exception relates to payments for office space rental. Such payments will not trigger the Stark referral ban if the following apply: 1) the arrangement is in writing, is signed by the parties, specifies the leased premises, and is for a term of at least one year; 2) the space lease is reasonable for the business purpose and is used exclusively by the lessee (except for payments for common areas on a pro rata usage basis); 3) rental charges are set in advance at fair market value; 4) the payment amount does not take into account the volume or value of referrals or other business between the parties; and 5) the terms would be reasonable without any referrals by the lessee to the lessor.

Because the penalties for violation of the Stark rules are so severe, a conservative approach toward referrals of any Medicare or Medicaid patient (including Oregon Health Plan patients) is warranted. Stark II added a prohibition on the use of federal matching funds in state Medicaid programs to pay for services that violate Stark II, but Oregon has not yet adopted legislation specifically prohibiting billing for such services. Therefore, further legislation clarifying the overlap will no doubt follow.

Medical practices should take a great deal of care to avoid any violation of the Stark rules. At a minimum, medical practices can avoid compliance problems through careful documentation practices and through the adoption of a formal compliance plan recognizing the various restrictions and prohibiting any forbidden practices. In addition, medical practitioners should become more familiar with the Medicare evaluation and management documentation guidelines currently in effect.

This article is only intended to provide a broad overview of the Stark Regulations. Please feel free to contact our office with specific questions.