Death Care Law Blog : Kansas Death Care and Preneed Lawyer & Attorney : Stalter Legal Services Law Firm : Funeral Law, Elder Law : Kansas City

For many Illinois funeral homes, April 15th served as a bitter reminder of Merrill Lynch and the financial losses suffered by the IFDA master trust. The final Merrill Lynch settlements (approximately $41 million) were received in 2012, and taxes had to be paid on those funds this past tax day. Funeral directors have questioned how those settlement payments could be taxed as income after the losses suffered when Merrill Lynch (as trustee) terminated the key man policies sold to the trust by a Merrill Lynch investment broker. After all, the aggregate settlement payments ($59 million) did not come close to covering the write downs taken by the trust ($76 million). But, Merrill Lynch took the position that a write down in a funeral home’s trust value for policy surrenders did not represent an investment loss. To compound the situation, Merrill Lynch filed a final Form 1041qft for each funeral home that transferred out of the master trust and treated the trust as terminated.

The question is whether Merrill Lynch could have characterized the value write downs so as to afford the funeral homes a capital loss carry over that could be applied to the settlement payments and future income. If one assumes the lowest Form 1041qft tax rate of 15%, Merrill Lynch could have saved the IFDA master trust participants income taxes of approximately $11.5 million.

With Merrill Lynch now out of the IFDA picture, funeral homes may want to turn to the IFDA’s new trustee for assistance. If the write downs can be properly characterized as losses that can be used as capital loss carryovers, it may be worthwhile to have those ‘final’ 1041QFT returns amended. As fiduciary of the Wisconsin Master Trust, the IFDA trustee may have already contemplated this issue.
 

• Email This
• Print
• Comments
• Trackbacks

They say that the devil is in the details, and that is proving true for the Obama definition of the “rich” (those families that earn more than $250,000) and the plan to fix the budget. The IRS provided some detail to the Obama plan last December when it published a proposed regulation that would increase the Medicare tax to 3.8% and impose the tax on the rich through their trusts and estates. The NFDA and ICCFA have been trying to get their respective members’ attention because the proposed regulation specifically includes their business trusts as ‘rich’ that are be subject to the Medicare tax. 

Sometimes it may seem that associations cry wolf to reinforce to the membership the need for the association. But, the proposed IRS regulation is somewhat unique in that it specifically identifies Section 685 qualified funeral trusts and Section 642 endowed care trusts as those which will be subject to the Medicare Tax. As both associations point out in comments submitted to the IRS, the proposal reflects how little the Service understands the purposes of these trusts.

To see each association’s comments click the following hyperlinks:NFDA           ICCFA 

There is a legitimate risk to qualified funeral trusts that do not make individual account allocations for composite filings. We would have thought most fiduciaries prepared QFTs in such a manner, but the Service’s comments from a few years ago suggests otherwise. And, what about those preneed trusts that have not taken the Section 685 election?

Even though the Service’s rationale for application of tax to Section 642 endowed care trusts is tenuous, these trusts lack the individual accounting ‘out’ that can save the QFT.
 

• Email This
• Print
• Comments
• Trackbacks

The Mississippi Secretary of State seems to be taking a very proactive approach to the regulation of preneed and perpetual care funds. Over the course of the last few years, the Regulation and Enforcement Division of the Secretary of State’s office has averaged an enforcement proceeding per month. We were curious what type of enforcement proceedings they were pursuing, and picked one at random. The luck of draw involved a situation where the Mississippi regulators alleged the preneed seller’s preneed contract form did not adequately disclose to the consumer the tax consequences of their preneed trust. While the preneed contract form stated that income taxes may be withheld by the trust, the seller’s trustee reported the income to the contract purchaser. This did not set well with the Mississippi regulators, particularly when the consumer had no right to cancel the contract and receive a refund of the trust income.

The Mississippi regulators are not alone in their perception of the inequities of this situation. Nebraska preneed regulators are also questioning why income should ever be reported to consumers when they may never receive it. The answer is that the Internal Revenue Service forced this issue with Rev. Rul. 87-127, with the goal of requiring a single method of income reporting for preneed trusts.

The Service struggled with the situation that troubles the Mississippi and Nebraska regulators: how can the purchaser be the grantor if he/she is never entitled to a refund of the income (or even trust deposits) upon the contract’s cancellation. But, as between the consumer and the funeral home, the funeral home’s right to the trust corpus is dependent upon performance of the contract. While the consumer may never receive a refund, he/she can choose a different funeral home to service the contract. The value of that service satisfies the grantor rules of the tax code, and supports the IRS’ conclusions in the Ruling.

The inequity of the situation may have led to the passage of IRC Section 685. Given an alternative is available to the seller, the Mississippi regulators sought to force the seller to either change its contract or require the trustee to change its income reporting. But in doing so, the Mississippi regulators misstate IRC Section 685. Irrevocability is not a key characteristic of an IRC Section 685 qualified funeral trust. While the Section 685 election is viewed as irrevocable, the irrevocability of the preneed contract has no impact on Section 685. The Mississippi regulators also fail to acknowledge that Section 685 is the trustee’s election to make, not the funeral home’s. While the two need to work in concert, it is the trustee that has ultimate control over the trust’s income reporting.
 

• Email This
• Print
• Comments
• Trackbacks

For the past few years, some Kansas cemeteries have been getting nasty grams from their regulator about their care fund trustee’s treatment capital gains taxes. Kansas, like most states, requires a portion of each grave space sale (interment right) to be contributed to a fund or trust for the future care of the cemetery. Kansas law calls that fund a permanent maintenance fund. Missouri law calls it an endowed care trust. In some states it is defined as a perpetual care trust.

Despite what the fund is called, these state laws universally seek to provide the cemetery a source of income to pay for the upkeep of graves (while keeping the contributions in tact). That latter objective, protecting the contributions, brings cemeteries and regulators into conflict when the fund realizes capital gains and losses. The Kansas cemetery regulator has been taking the conflict a step further by interpreting the law to preclude the trustee from paying taxes or fees out of capital gains.

The Kansas regulators (like many of their peers) perceive a ‘looming’ problem with cemeteries: abandonment and the eventual transfer to the municipality or county. Cemeteries are dependent upon the cash flow that comes from space sales (and the accompanying interment fees and marker sales). When a cemetery runs out of spaces, grave maintenance will be completely dependent upon income from the care fund. To minimize the financial burden placed on the county, the Kansas regulator has adopted a very strict interpretation of the law for the purpose of preserving the care fund for the day the cemetery transfers to the government. This interpretation not only precludes the fund from distribution capital gains earnings, but also the trustee’s payment of taxes and fees from the earnings. The regulator reasons that capital gains must be allocated to principal, and the law forbids all distribution of principal.

This puts the cemetery into a bind. The staple of care fund investments, the fixed income security, has been bearing returns of less than 2% for years. When trust expenses are netted from those returns, there is little left to distribute to the cemetery. Necessity has dictated that these funds begin investing in equities. But, the Kansas philosophy would penalize the cemetery. Not only is the cemetery prohibited from using the equity earnings, the cemetery must also pay the taxes incurred on those earnings (reducing what is received from the care fund). The only ‘winner’ is the county. Or is it? If the eventual abandonment takes years, and the cemetery has been deprived income for upkeep and repairs, isn’t the county getting the property in worse shape?
 

• Email This
• Print
• Comments
• Trackbacks

When news of the indictment of 6 National Prearranged Service officers was reported last November, many newspapers picked up the AP version that included a quote from the Internal Revenue Service criminal investigator. The fact is that the Federal investigation of NPS involves investigators from the IRS, the FBI and the U.S. Postal Inspection Service. An FBI press release regarding the NPS indictments includes comments from investigators with the three Federal agencies. To understand how NPS’ actions triggered the jurisdiction of the three agencies, a 2009 FBI press release concerning the indictment of Randall Sutton provides an explanation of the underlying facts.

The main thrust of the IRS investigation will be to determine whether the NPS officers committed income tax evasion with regard to what they individually received, or with regard to what the company received. The investigation will need to determine how the distributions from insurance, and from trusts, should have been reported by NPS. The investigation will also need to examine how NPS’ sister corporation, Lincoln Memorial Life, reported its income. And, the investigation will look at how the preneed trusts controlled by NPS reported their income.

Shortly after the Federal investigation of NPS was initiated, the Springfield Journal-Register reported that a Federal investigation of the Illinois Funeral Directors Association master trust had been initiated. As with NPS, Federal investigators will look closely at whether the reports mailed to funeral homes, and the statements mailed to consumers, were fraudulent, and thereby, violated mail fraud statutes. However, another line of investigation will be whether the master trust violated the Federal tax code.

What does the IRS’ role in these investigations mean to funeral homes and consumers? If these entities failed to accurately report income, the IRS (and state authorities) will view the unreported income as lost revenue to government. Preneed trust income must either be reported to the consumer or taxed by the trust. NPS trusts may have had annual tax liabilities in the tens of millions of dollars. No small potatoes considering the plight state coffers currently face.

Consequently, consumers and funeral homes may see taxing authorities become more aggressive in the enforcement of preneed income reporting requirements. With fewer agents due to budget constraints, the IRS may begin promoting its whistleblower program. If the situation reported this past weekend is an indicator of the future, non-compliant preneed companies may have more to fear from the disgruntled employee than being selected for a random audit by the IRS or state department of revenue.
 

• Email This
• Print
• Comments
• Trackbacks

The financial fallout from the failures of NPS and IFDA regarding compliance with state and federal laws has accelerated the decision of many funeral directors to switch to the non-guaranteed preneed contract. That non-guaranteed contract represents a fundamental change in the relationship that is established between the consumer, the funeral home and the preneed fiduciary.

The trust-funded preneed contract establishes a fiduciary account that has two beneficiaries: the funeral home and the consumer. It is quite common for fiduciaries to administer trusts with beneficiaries with competing interests. With competing beneficiary interests, the fiduciary must look to the trust provisions, and applicable state law, to determine who may exercise discretionary authorities regarding the trust.

State preneed laws are written in response to existing practices, and historically, the guaranteed contract defined preneed practices. When the funeral home sells a guaranteed contract it is the funeral home that assumes the risk of the trust’s investment performance. With that risk, preneed statutes typically vest in the funeral home the authority to establish the trust, to hire and replace the fiduciary, and to participate in decisions such as investments. State preneed laws have generally been vague or silent about administrative and accounting issues, and fiduciaries have turned to the funeral home for instructions regarding accounting and income reporting.

With the non-guaranteed contract, the funeral home has both deferred the sale of the funeral (until death) and transferred the risk of investment performance to the consumer. Appropriately, the consumer may have questions to put to the funeral home, the fiduciary and the preneed regulator:

• Must the fiduciary follow a different investment policy with regard to funds held for guaranteed contracts versus non-guaranteed contracts?
• How is trust asset value allocated to the contracts?
• How is income and expenses allocated among the types of contracts?
• How will income and expenses be reported?

For many funeral homes, the latter issue (the reporting of trust income) drove both investment policies and accounting procedures. No one likes to get a tax statement on a preneed contract, and so many funeral homes went to tax exempt bonds in belief this relieved the trust from reporting income to the consumer. But, the IRS requires tax-exempt income to be reported because it impacts the taxability of social security benefits. If the consumer hasn’t received an accurate statement of income and expenses, his account has exposure for a $50 penalty if the trust isn’t being reported pursuant to a Form 1041QFT. (This accuracy reporting penalty more than likely led the IFDA corporate fiduciary to effect a Section 685 election for all master trust accounts.)
 

For the upcoming wave of non-guaranteed contracts, there are only two permissible methods of reporting income: grantor statements to the consumer or a Section 1041qft. Regardless of which income reporting method is used, the funeral home and fiduciary can not simply park the consumer’s funds in a tax-exempt fund. The preneed trust’s allocation of income and expenses for tax reporting will be similar for both approaches, thus making the trust’s tax return a tool for regulators when evaluating the fiduciary’s administration and accounting.
 

• Email This
• Print
• Comments
• Trackbacks