I found the following article helpful from the Veterans Information Services, Inc. Monthly Newsletter, written by Dorotha M. Ocker at the Law Office of Douglas F. Ocker & Associates. www.TexasVAbenefits.com
Tax-Free Does Not Mean Tax-Consequence-Free: Common Tax Consequences of Aid & Attendance Planning
Many estate-planning attorneys who also dabble in veterans benefits, most commonly the "Aid & Attendance" benefit, are quite knowledgeable about estate taxes and helping their clients avoid or minimize them. However, A&A planning often has an effect on a client's personal income taxes (or as I call them, "1040 taxes") of which attorneys who work with veterans benefits need to at least have a passing understanding. Most of the time, the veterans benefits outweigh the tax consequences, but the client likes to know about the consequences up front. While an attorney can always have the standard "consult a qualified tax professional" attached to every veterans benefits plan, no attorney wants to get a call in April from a client exclaiming, "You didn't tell me that I'd have to pay more in taxes!"
Here are the most common tax consequences of Aid & Attendance planning that I see in my practice:
1: Increase in Amount of Social Security Income Taxed: Income from Social Security is taxed on a sliding scale, depending on the amount of total income a client has. Often, if the client has a relatively small amount of Social Security income, he or she is paying little to no tax on it. However, if a client enters into an annuity in order to pay his or her monthly expenses, then the taxable amount of that annuity is new income. That new income increases the amount of Social Security income that is taxed. Due to this complicated sliding scale, I often make spreadsheets for my clients and run various scenarios for them.
2: Loss of Itemized Deductions Due to "Maintenance:" A common practice for Aid & Attendance planning is for an attorney to advise a client's family to pay some of the expenses for the client. This would be "maintenance" under the VA regs, thus not counting as income to the client. However, be very careful which expenses you advise a client's family to pay. A cardinal rule of tax deductions is that you only get to deduct the amount that you actually paid. A client could lose his or her tax deductions for certain expenses if the family begins to pay for them. Common tax deductions that are lost are: (1) medical expenses deduction, (2) home mortgage interest deduction, and (3) property tax deduction. I also make spreadsheets for these deductions in order to show families which bills they could pay and which bills to let the client pay.
3: Creation of Passive Losses without Enough Passive Income: Often clients rent out their houses for a while when they first move into a senior community. Rental income is passive income and must be reported to the IRS on Schedule E. Passive income rules are extremely complex. If you don't know them, don't worry - you're not alone. The main point is this: expenses relating to a rental property can only be deducted against income from the property, not against ordinary income. That means that if a client is renting out her house to her daughter for $100 a month and the property taxes, mortgage payment, maintenance, depreciation, etc. are more than $1,200 a year, the client cannot deduct those losses from her ordinary income. It's much like Point #2, where the client is no longer entitled to take a deduction for property taxes and mortgage interest. I make sure that my clients' passive income is completely canceled out by expenses so that it is not taxable income and the client hasn't "lost" a deduction.
Taxes are complicated but very important. Making sure that your client doesn't have a surprise tax increase is something that attorneys can quite easily do by including CPAs or other tax professionals in the early stages of Aid & Attendance planning.
Written by Dorotha M. Ocker at the Law Office of Douglas F. Ocker & Associates. www.TexasVAbenefits.com
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