Make Sure that a Durable Power of Attorney Is Truly Durable

A nondurable power of attorney is a short legal form easily and inexpensively obtained from most office supply stores. It is used to grant authority to another person to make property, business and other legal decisions on a person's behalf (i.e., on behalf of the principal).

A person can set up a power of attorney either as a "general" power of attorney (which gives an agent broad authority to handle virtually all legal transactions on a principal's behalf) or as a "specific" power of attorney (which authorizes the agent to perform only specific functions on the principal's behalf, such as a house closing or business transaction), when the principal is not available to sign necessary documents. All nondurable powers of attorney limit how the agent can act on the principal's behalf, provided the principal has legal capacity.

On the other hand, an individual fearing future incapacity due to advanced age, physical disability or illness often wants an agent to act in his stead, even after the principal becomes incapacitated, and executes a "durable" power of attorney. This enables the designated agent to act for the principal, even if the principal is no longer mentally competent or physically able to make decisions. A durable power of attorney remains effective until the principal revokes it or dies.

In addition to allowing for continuity of management and safeguarding the principal's assets in the event of incapacity, a durable power of attorney can be particularly useful for estate and other tax planning purposes. A properly drafted durable power of attorney allows an agent to carry out many of the principal's important planning objectives, by granting the agent powers, such as the power to file income and gift tax returns, make gifts, disclaim property and make critical IRA elections.

Two important issues that must be considered when executing a durable power of attorney relate to (1) the selection of the agent and (2) the specific powers granted.

First, signing a broadly drafted durable power of attorney is comparable to signing a blank check. Therefore, taxpayers should be careful to choose a trusted family member, a close friend or a professional with a strong reputation to serve as the agent; such individual must be competent to carry out the powers granted. While the agent is a fiduciary subject to strict standards of care and honesty, often there is no official or government body monitoring the agent's actions. Thus, a principal must be confident in the selection, and should insist on the agent keeping adequate records of all transactions conducted on the principal's behalf.

Second, as recently illustrated in Est. of Swanson, Fed. Cir. 5/25/01, failure to explicitly mention a specific power in the durable power of attorney document can prove fatal. A court may conclude that such a power has not been granted, even if the document was drafted broadly as a "general" power of attorney.

In Swanson, the decedent appointed her nephew as her agent under a general durable power of attorney two months before her death. The power of attorney purported to give the nephew legal authority to manage and dispose of his aunt's assets even in the event that she became incapacitated. Understanding that his aunt's life was shortly coming to a close and wishing to minimize the estate tax impact, the nephew wrote, signed and delivered 38 $10,000 checks to separate individuals. This course of action was intended to remove $380,000 from her estate and pass the wealth on to family and friends gift-tax free, as each of the gifts would qualify for the $10,000 gift-tax annual exclusion.

The nephew testified that (1) the 38 cash gifts were a result of his discussion with his aunt about ways of saving estate tax, (2) he prepared a list of 40 possible recipients and (3) his rapidly deteriorating aunt approved 38 of the 40 proposed gifts "by nodding her head" when he read each individual's name.

Despite the nephew's testimony and the broad language of the durable power of attorney, the Federal Circuit concluded that the nephew exceeded his authority when he made the 38 gifts on his aunt's behalf. As a result, such gifts were void under state law and, thus, were includible in the decedent's gross estate under Sec. 2038(a)(1).

Under California law, a general power of attorney does not give an agent the authority to make gifts of the principal's property. Rather, California law requires that the terms of the power of attorney expressly state that the agent has the authority to make gifts on the principal's behalf. The omission of this specification in the document was significant, as it cost the principal's estate over $140,000 in otherwise avoidable estate taxes.

Many states have similar laws that require detailed specifications in a general durable power of attorney. Thus, it is highly advisable that a principal consider all the powers that he wishes to convey and "spell them out" in the durable power of attorney. In New York, for example, Article 5, Title 15, of its General Obligations Law provides a statutory short form for a durable general power of attorney. The form permits the agent to make $10,000 annual exclusion gifts to members of the principal's family, provided the principal initializes item "M" on the form. If a principal wishes to authorize the agent to make the same gifts to nonfamily members, he has to customize the form and specifically provide for such power.

The durable power of attorney is an important and powerful legal tool, and the various options that a principal should include in such an instrument are not always apparent.

From Ira C. Olshin, CPA, J.D., LL.M., New York, NY