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Understanding & Drafting Irrevocable Trusts. Presented By: WealthCounsel , LLC Bill Conway www.wealthcounsel.com. Good Morning!. Introductions Name? From? Practice experience? Hobbies/Interests? Why EP 203?. Good Morning!. EP 203 significantly overhauled Overview

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understanding drafting irrevocable trusts

Understanding & Drafting Irrevocable Trusts

Presented By:

WealthCounsel, LLC

Bill Conway

www.wealthcounsel.com

good morning
Good Morning!
  • Introductions
    • Name?
    • From?
    • Practice experience?
    • Hobbies/Interests?
    • Why EP 203?
good morning1
Good Morning!
  • EP 203 significantly overhauled
  • Overview
    • WealthDocx IRT Module
    • Insurance-Related IRT Issues
    • Sale Transactions with Defective IRTs
    • Asset Protection & Self-Settled Trusts
    • Split-Interest Trusts
wealthdocx irt module

WealthDocx IRT Module

Bill Conway

www.wealthcounsel.com

irrevocable trusts generally
Irrevocable Trusts Generally
  • Gifts are completed
  • Trust assets are removed from estate
  • Grantor trust?
    • Maybe
    • Maybe not
selecting the type of irt page 41
Selecting the Type of IRT (Page 4)
  • 2503(c) Trust
    • FBO Minor
    • Outright at 21
    • Included in estate
    • Alternative to UGMA/UTMA
  • Asset Protection
    • Self-Settled Trust
    • Delaware
    • Distribution advisor suggested
selecting the type of irt page 5
Selecting the Type of IRT (Page 5)
  • Family Bank Trust / BERT Trust
    • Inter Vivos Bypass Trust
  • Gifting Trust
    • Receptacle for lifetime gifts
  • HEET Trust
    • Health and Education Exclusion Trust
    • Appropriate where no GST exemption left
  • Intentionally Defective Grantor Trust
    • Grantor trust set to yes
    • Warning re: Crummey
selecting the type of irt page 51
Selecting the Type of IRT (Page 5)
  • Inheritor’s Trust
    • Settled by non-beneficiary
    • Only one beneficiary allowed
  • Life Insurance Trust (Single)
    • Doesn’t ask if insurance is appropriate investment
  • Life Insurance (2nd to Die)
    • Crummey rights automatically included
other irts in wealthdocx
Other IRTs in WealthDocx
  • Charitable Trusts
    • CRTs, CLTs, Foundations
  • Split-Interest Trusts
    • GRATs, QPRTs, QTIPs (Later)
  • Special Needs Trusts (3rd Party)
  • Retirement Trusts
other trust helpers page 7
Other Trust Helpers (Page 7)
  • Segregating functions
  • More on Protectors in a moment
utc provisions page 8
UTC Provisions (Page 8)
  • Be familiar with your state law!
  • Affects accountings, notice, etc.
crummey withdrawal rights page 81
Crummey Withdrawal Rights (Page 8)
  • Annual Gift Tax Exclusion
    • Saves $5 million lifetime credit
    • Future Interest Rule
    • Crummey Solution
gifting to irrevocable trust
Gifting to Irrevocable Trust
  • Crummey Solution (Page 9)
    • No notice required or given
    • Tax Court - withdrawal rights were illusory
    • 9th Circuit reversed – present interest as long as the withdrawal right is enforceable
    • IRS acquiesced in Rev Rul 81-7; Reasonable notice required
crummey issues
Crummey Issues
  • Minor Beneficiaries (Page 9)
    • Guardian may exercise
    • Should not be donor/parent
      • Inconsistent positions by IRS
      • WD precludes donor/parent from exercising
    • Non-guardian nominee??
crummey issues1
Crummey Issues
  • Grantor’s Control Over Withdrawal Rights (Page 10)
    • WD defaults
      • Withdrawal rights exist
      • Pro rata among all benes
    • Invert defaults?
crummey issues2
Crummey Issues
  • Contingent Beneficiaries (Page 12)
    • Cristofani(Tax Court)
      • 2 children as current benes
      • 5 grandchildren as contingent benes
      • Tax Ct said no vested interest required
crummey issues3
Crummey Issues
  • Contingent Beneficiaries (Page 12)
    • Cristofani(Tax Court)
    • Kholsaat(Tax Court)
      • 16 contingent benes
      • No withdrawal rights exercised
      • IRS argued implicit understanding
      • Tax Court said no evidence of an understanding and none would be inferred
crummey issues4
Crummey Issues
  • Contingent Beneficiaries (Page 13)
    • Cristofani(Tax Court)
    • Kholsaat(Tax Court)
    • Holland (Tax Court)
      • Family meeting to discuss not exercising
      • IRS argued implicit understanding
      • Tax Court said meeting evidenced knowledge of rights and conscious decision not to exercise
crummey issues5
Crummey Issues
  • Notice of Withdrawal Right (Page 13)
    • Oral vs. Written
crummey issues6
Crummey Issues
  • Notice of Withdrawal Right (Page 14)
    • Oral vs. Written
    • Frequency
      • “Current” notice
      • Schedule of contributions sufficient
      • WD requires notice upon each contribution
crummey issues7
Crummey Issues
  • Notice of Withdrawal Right (Page 14)
    • Oral vs. Written
    • Frequency
    • Duration
      • Reasonable period of time
      • Cristofani was 15 days
      • 4 days has been approved; 3 days disapproved
      • ETIP if spouse has withdrawal right
crummey issues8
Crummey Issues
  • Notice of Withdrawal Right (Page 16)
    • Oral vs. Written
    • Frequency
    • Duration
    • Accuracy
    • Waiver
crummey issues9
Crummey Issues
  • Maintaining Sufficient Assets (Page 16)
    • Satisfy from other trust assets
    • Distribute fractional portion of policy (if applicable)
    • WD provides for grant of line of credit from grantor
crummey issues10
Crummey Issues
  • Estate Tax Treatment (Page 16)
    • Withdrawal Right = GPOA
    • GPOA included in power holder’s estate
gift over problem page 17
Gift-Over Problem (Page 17)
  • Lapse of Withdrawal Right
    • IRC 2514 (vs. 2503)
    • Lapse over 5/5 = Release
    • Release = transfer to other beneficiaries (if any)
    • Transfer is of a future interest
gift over problem
Gift-Over Problem
  • Gift-Over Solutions (Page 18)
    • Limit withdrawal right to 5/5
    • Separate trusts
    • Common trust with hanging powers
    • Contribute assets so that 5/5 = $12,000
    • Loans in lieu of contributions
gift over solutions
Gift-Over Solutions
  • Common Trust (Page 19)
    • Limits withdrawal right to 5/5
    • No lapse greater than 5/5
    • Donee has to aggregate gifts for 5/5
gift over solutions1

$2,500

$2,500

Dad

Mom

2514(e) lapse of $2,500 each(no gift)

Gift-Over Solutions
  • Common Trust (Page 19)

Annual Premium:$5,000

Beneficiaries:2-Son & Daughter

No Giftover Problem

$5,000

gift over solutions2

$26,000

$26,000

Dad

Mom

Deemed gift of $21,000 from each beneficiary to the other

2514(e) lapse of $5,000 each(no gift)

Gift-Over Solutions
  • Common Trust (Page 19)

Annual Premium:$52,000

Beneficiaries:2-Son & Daughter

$52,000

gift over solutions3
Gift-Over Solutions
  • Separate Subtrusts(Page 19)
    • Allows for full utilization of annual exclusion
    • Lapse in excess of 5/5 gifts over to no one
    • Beneficiary becomes grantor for GST purposes over released portion
    • Separate accounts must be funded
gift over solutions4

$26,000

$26,000

Dad

Mom

Lapse to Separate Trust for Son of $26,000

Lapse to Separate Trust for Daughter of $26,000

Gift-Over Solutions
  • Separate Subtrusts(Page 19)

Annual Premium:$52,000

Beneficiaries:2-Son & Daughter

$52,000

No Giftover because no other beneficiaries to whom to gift over

gift over solutions5
Gift-Over Solutions
  • Hanging Powers (Page 21)
    • Allows for full utilization of annual exclusion
    • Amounts in excess of 5/5 continue to be withdrawable
    • Estate inclusion in event power holder predeceases
    • Best of both worlds
gift over solutions6

$26,000

$26,000

Dad

Mom

Remaining $42,000 continues to “hang,” therefore no gift over

2514(e) lapse of $5,000 each(no gift)

Gift-Over Solutions
  • Hanging Powers (Page 21)

Annual Premium:$52,000

Beneficiaries:2-Son & Daughter

$52,000

gift over solutions7

$26,000

$26,000

Dad

Mom

Balance of $177,200 “hangs”

Year 1 $10,000 lapse

Year 2 $10,400 lapse

Year 3 $15,600 lapse

Year 4 $20,800 lapse

Year 5 $26,000 lapse

Gift-Over Solutions
  • Hanging Powers (Page 21)

Beneficiaries:2-Son & Daughter

Year 5:Aggregate Contributions of $260,000

$260,000

incomplete gifts page 23
Incomplete Gifts (Page 23)
  • “dominion and control” retained
  • But can’t get it back
grantor trust provisions page 231
Grantor Trust Provisions (Page 23)
  • Overview & History
  • IRC 671-679
  • Created to eliminate income tax abuses involving (then-lower) trusts brackets
  • Grantor trust as to:
    • Income
    • Principal
    • Both
grantor trust opportunities page 24
Grantor Trust Opportunities (Page 24)
  • Tax free sale of appreciated assets
  • Tax burn as non-taxable contributions
  • Removal of assets from estate
  • Tax free distribution to trust beneficiaries
  • Permissible transferee of life insurance policy outside of transfer for value rules
achieving grantor trust status
Achieving Grantor Trust Status
  • 672 Definitions (Page 24)
    • Adverse = beneficial interest that is substantial and whose interest is adversely affected by exercise or nonexercise
    • Nonadverse = Not adverse
    • Related or Subordinate = Nonadverse + parent/issue/sibling/employee/corp
    • Spousal Attribution
achieving grantor trust status1
Achieving Grantor Trust Status
  • 672 Definitions (Page 24)
    • Adverse = beneficial interest that is substantial and whose interest is adversely affected by exercise or nonexercise
    • Nonadverse = Not adverse
    • Related or Subordinate = Nonadverse + parent/issue/sibling/employee/corp
    • Spousal Attribution
achieving grantor trust status2
Achieving Grantor Trust Status
  • Know your defect
  • One vs. More than One
    • Certainty
    • Ease of Toggling
achieving grantor trust status3
Achieving Grantor Trust Status
  • 674 Power to Affect Beneficial Enjoyment
    • 674(c) – Power to Distribute Income or Principal, or to add beneficiaries
    • Grantor holding power = inclusion
achieving grantor trust status4
Achieving Grantor Trust Status
  • 674 Power to Affect Beneficial Enjoyment
    • 674(d) – Power to allocate income
      • Power granted to someone other than grantor or “spouse living with grantor” to distribute, apportion or accumulate income to or for beneficiaries if limited by reasonably definite external standard
      • Power creates grantor trust as to income only
      • Possible to switch grantor trust status on and off merely by spouse moving out and back in?
achieving grantor trust status5
Achieving Grantor Trust Status
  • 675 Administrative Powers (Page 28)
    • 675(2) – Power given to nonadverse party to make loans to grantor without adequate interest or security
    • N/A if trustee has authority to make loans to anyone without regard to interest or security
    • Power alone will cause grantor trust status, even if no loan is made
achieving grantor trust status6
Achieving Grantor Trust Status
  • 675 Administrative Powers
    • 675(3) – Actual borrowing of funds
      • Direct or indirect loan to grantor or grantor’s spouse which is unrepaid at the end of year
      • N/A to loans with adequate interest and security
      • Creates grantor trust to extent amounts are unrepaid at year end, but . . .
      • IRS has apparently ignored requirement that loan remain outstanding until year end
achieving grantor trust status7
Achieving Grantor Trust Status
  • 675 Administrative Powers (Page 30)
    • 675(4) – General
      • Right exercisable in a non-fiduciary capacity by any person to reacquire trust corpus by substituting other property
      • Grantor can hold
achieving grantor trust status8
Achieving Grantor Trust Status
  • 675 Administrative Powers (Page 30)
    • 675(4) – General
      • Right exercisable in a non-fiduciary capacity by any person to reacquire trust corpus by substituting other property
      • Service’s position is that power alone isn’t sufficient, and applies a facts and circumstances analysis
      • Defective as to both income and principal
      • Grantor can release
      • Protector can re-grant
achieving grantor trust status9
Achieving Grantor Trust Status
  • 677 Power to Use Income for Benefit of Grantor (Page 34)
    • Grantor treated as owner of any portion of trust, whether or not under §674, the income of which, without the approval or consent of adverse party is, or in discretion of grantor or nonadverse party may be, distributed to or for benefit of grantor or spouse
    • Or used to pay premiums on life insurance on the life of grantor or spouse
achieving grantor trust status10
Achieving Grantor Trust Status
  • 677 Power to Use Income for Benefit of Grantor (Page 35)
achieving grantor trust status11
Achieving Grantor Trust Status
  • 677 Power to Use Income for Benefit of Grantor
    • Trust should disallow use of income to satisfy obligation of support
    • Discretionary power to pay income to grantor may cause inclusion under state law
    • Some states have changed their laws to not cause inclusion (Alaska, Delaware, and others)
achieving grantor trust status12
Achieving Grantor Trust Status
  • 678 Persons other than Grantor Treated as Owner (Page 35)
    • ONLY Code section attributing ownership to someone other than the actual grantor
    • Power to vest corpus or income exercisable solely by that person
      • surviving spouse as sole trustee of bypass trust?
      • limitation to ascertainable standard (HEMS) prevents estate tax inclusion
      • switch on/off grantor trust status by appointing/firing co-trustee
achieving grantor trust status13
Achieving Grantor Trust Status
  • 678 Persons other than Grantor Treated as Owner (Page 36)
  • Power to distribute income or principal which is “partially released or otherwise modified” that would cause grantor trust status under 671-677
    • 5/5 power holder, until released, modified, or allowed to lapse, is treated as grantor over portion of trust subject to power
    • Upon lapse, power holder is treated as grantor of amount in excess of 5/5
    • Crummey
achieving grantor trust status14
Achieving Grantor Trust Status
  • § 678 vs. §§ 671-677 (Page 36)
    • § 678 N/A with respect to power over “income” during any period actual grantor is treated as owner under §§671-677
    • Service has interpreted §678(b) as applying to principal as well as income
income tax reimbursement page 37
Income Tax Reimbursement (Page 37)
  • Silence = prohibition?
  • Mandatory = inclusion
  • Discretionary = ??
    • Prearrangement?
terminating grantor trust status
Terminating Grantor Trust Status
  • Maintain Flexibility
  • Power to terminate grantor trust status should not be in hands of grantor
reporting for a grantor trust
Reporting for a Grantor Trust
  • To File or Not to File (Treas. Reg. 1.671-4)
    • Option 1: No EIN or 1041
      • Provide payors with Grantor/owner’s TIN
      • Grantor provides W-9 to Trustee
      • Trustee statement for Grantor/owner
    • Option 2: EIN and 1041
      • Provide payors with Trust’s TIN
      • Trust files Forms 1099
      • Trustee statement for Grantor/owner
    • Page 134 – Letter to CPA
removing replacing trustees page 37
Removing & Replacing Trustees (Page 37)
  • Right to Remove and Replace
    • RR 77-182: No inclusion if trustee resigned
    • RR 79-353: Inclusion if grantor removed without cause
    • PLR 9303018: Facts and circumstances
    • Wall: No inclusion where replacement was corporate fiduciary
removing replacing trustees page 41
Removing & Replacing Trustees (Page 41)
  • Right to Remove and Replace (con’t)
    • Vak: 8th Circuit said power to change trustee did not prevent gift from being complete, contrary to Tax Court’s position
    • RR 95-58: 79-353 revoked, 77-182 modified; No inclusion if successor was not “related or subordinate” under §672(c)
related or subordinate a review
Related or Subordinate – A Review
  • Not adverse AND
  • Any one of
    • Spouse, if living with grantor
    • Parent
    • Issue
    • Sibling
    • Employee
    • Corporation where grantor has significant voting control
related or subordinate a review1
Related or Subordinate – A Review
  • Does not include issue of siblings (nieces and nephews, etc.)
  • Spousal attribution
    • Typically related or subordinate
    • Literally adverse but not technically due to spousal attribution
removing replacing trustees page 42
Removing & Replacing Trustees (Page 42)

No

No 2036(a)(2) or 2038(a)(1) concern.

Power to remove and replace retained by the grantor?

Yes

2036(a)(2)/2038(a)(1) concern. Beyond Wall logic.

No

Is person being removed acting in a fiduciary capacity?

Yes

2036(a)(2)/2038(a)(1) concern. Beyond Rev. Rul. 95-58.

No

Must replacement be not related or subordinate to grantor with IRC 672?

Yes

Within Rev. Rul. 95-58

removal of trustee by bene page 43
Removal of Trustee by Bene (Page 43)
  • For cause = Court; good or bad?
corp fiduciary requirements page 44
Corp Fiduciary Requirements (Page 44)
  • Be careful!
  • Exclude expressly named institutions?
lifetime lpoa page 44
Lifetime LPOA (Page 44)
  • Ejection button
  • Trustee vs. Protector
amending an irt page 44
“Amending” an IRT (Page 44)
  • Lifetime LPOA
  • Sell assets to new IRT
  • Non-judicial modification per UTC
  • Judicial modification
  • Decanting (later)
  • Trust Protector
  • Other?
trust protectors page 46
Trust Protectors (Page 46)
  • Common in offshore jurisdictions
  • Little guidance in American law
  • Role is different from trustee
    • Perspective of trusted family friend or advisor
    • Counter-balance to impersonal institutional trustee
    • Enhanced flexibility without adverse tax consequences
trust protectors page 47
Trust Protectors (Page 47)
  • Who should serve?
    • Gift tax consequences
    • Income tax consequences
trust protectors page 49
Trust Protectors (Page 49)
  • Removal and Replacement?

No

No 2036(a)(2) or 2038(a)(1) concern.

Power to remove and replace retained by the grantor?

Yes

2036(a)(2)/2038(a)(1) concern. Beyond Wall logic.

No

Is person being removed acting in a fiduciary capacity?

Yes

2036(a)(2)/2038(a)(1) concern. Beyond Rev. Rul. 95-58.

No

Must replacement be not related or subordinate to grantor with IRC 672?

Yes

Within Rev. Rul. 95-58

trust protectors page 50
Trust Protectors (Page 50)
  • Fiduciary or Not?
    • Silence vs. express answer
    • Statute?
    • Ability to exercise power if fiduciary?
bypass type trust issues page 54
Bypass(-type) Trust Issues (Page 54)
  • Mandatory vs. Discretionary Income
    • Trust income tax rates better?
  • 5/5 Powers
administration of remaining trust page 55
Administration of Remaining Trust (Page 55)
  • Guidelines for discretionary distributions
    • Silences = required?
  • 5/5 Powers
  • Providing for children-in-law
decanting powers page 56
Decanting Powers (Page 56)
  • Broad powers
  • Discuss with client
  • Tutorial
generation skipping page 57
Generation Skipping (Page 57)
  • Annual GST Exclusion
    • Only for direct-skip gifts (outright or in trust)
    • If in trust:
      • Only one beneficiary; and
      • Trust assets fully included in donee’s estate
generation skipping page 571
Generation Skipping (Page 57)
  • Annual GST Exclusion
    • Qualifying Trusts include:
      • 2503(c) Trusts
      • Separate Trusts for skip persons
    • Non-Qualifying Trusts include:
      • Dynasty trusts
      • Common trusts
generation skipping page 59
Generation Skipping (Page 59)
  • GST Exemption
    • $5.0M in 2011-2012
    • $??M in 2013
    • Can only be allocated by the transferor
      • Crummey Powers
generation skipping page 61
Generation Skipping (Page 61)
  • Allocating the GST Exemption
    • Allocation is irrevocable
    • Automatic allocation to:
      • Lifetime direct skips
      • At death, of any remaining GST exemption to trusts from which there could be a generation skip
      • Lifetime indirect skips to a “Generation-Skipping Transfer Trust”
    • Opt Out of Automatic Allocation on 709
irs form 709
IRS Form 709
  • If you aren’t preparing them ….
  • Part 1 – personal information
  • Schedule A
    • Part 1 – Gifts Subject Only to Gift Tax
      • Gifts to children
    • Part 2 – Direct Skips
      • Gifts to grandchildren
    • Part 3 – Indirect Skips
      • Gifts to trust for children and grandchildren
irs form 7091
IRS Form 709
  • Part 4
    • Line 1 – total gifts
    • Line 2 – annual exclusions
    • Line 3 – net of the two
  • Schedule B – Prior returns
  • Schedule C – Computing GST
    • Part 2 – Allocating
      • Remember to allocate to entire gift, not just taxable portion!!
      • Use formula allocation just in case
divorce provision page 63
Divorce Provision (Page 63)
  • Need to discuss to avoid appearance of conflict
gift splitting page 63
Gift Splitting (Page 63)
  • A legal fiction
  • Only to third parties (not to spouses)
  • All or nothing annually
  • Consent must be made on Form 709 Gift Tax Return
drafting for lifetime benefits page 64
Drafting for Lifetime Benefits (Page 64)
  • Loans to grantor
    • Trustee borrows against policy and re-loans
    • If adequately documented and secured, should be no incident of ownership
    • No taxable income – trust is grantor trust under IRC 675(3)
    • Interest accrued is debt against estate (“Tax Burning”)
drafting for lifetime benefits page 65
Drafting for Lifetime Benefits (Page 65)
  • Inter-vivos Bypass Trust
    • Spouse has access
    • Danger is spouse’s death
  • Self-Settled Trust Jurisdictions
reciprocal trust doctrine page 65
Reciprocal Trust Doctrine (Page 65)
  • Estate of Grace(US Sup Ct.)
    • Applicable where trusts are interrelated and grantors are left in the same economic position as if no trusts had been created
reciprocal trust doctrine page 651
Reciprocal Trust Doctrine (Page 65)
  • Estate of Grace (US Sup Ct.)
  • Estate of Bischoff(Tax Court)
    • Applied doctrine to trusts established by grandparents for the benefit of grandchildren and naming grandparents as trustees.
reciprocal trust doctrine page 652
Reciprocal Trust Doctrine (Page 65)
  • Estate of Grace (US Sup Ct.)
  • Estate of Bischoff(Tax Court)
  • Estate of Green (2nd Cir)
    • Refused to follow Bischoff stating that Grace court required benefit to be retained by grantors before doctrine was applicable.
  • PLR 200426008
insurance related irt issues ilits

Insurance-Related IRT Issues(ILITs)

Bill Conway

www.wealthcounsel.com

ilit benefits page 67
ILIT Benefits (Page 67)
  • Remove death benefits from taxable estate
  • Control disposition of death proceeds
  • Utilize annual gift tax exclusion for gifts to the trust
  • Asset Protection
ilit objections
ILIT Objections
  • Cost to set up
  • Administrative hassle
  • Perceived loss of access to cash value build-up within policy
ilit alternatives page 67
ILIT Alternatives (Page 67)
  • Continued individual ownership
  • Ownership by adult children
  • Family Insurance Partnership
estate taxation of insurance page 68
Estate Taxation of Insurance (Page 68)
  • Insurance is included if:
    • Insured possessed incidents of ownership (IRC 2042)
    • Proceeds are payable to or for the benefit of the estate (IRC 2042)
    • Policy (or incidents of ownership) are transferred within 3 years of death (IRC 2035)
estate taxation of insurance page 681
Estate Taxation of Insurance (Page 68)
  • IRC 2042
    • Incidents of ownership
      • Power to change beneficiary
      • Power to surrender or cancel the policy
      • Power to assign the policy
      • Power to revoke an assignment
      • Power to pledge the policy
      • A reversionary interest in the policy
    • Payable to or for the benefit of the estate
valuation of insurance page 69
Valuation of Insurance (Page 69)
  • Generally:

Interpolated terminal reserve

+ Unused premiums

+ Accumulated dividends

- Policy Loans

  • Single premium policies valued by replacement
  • Group term has no value but continued payment of premiums are on-going gifts from the employee
income taxation of insurance page 69
Income Taxation of Insurance (Page 69)
  • General Rule: Excluded from income (IRC 101(a)(1))
  • Exception: Transfer for Value (IRC 101(a)(2))
  • Exception to the Exception:
    • Transferee determines basis from transferor’s basis, i.e., carry-over basis (IRC 101(a)(2)(A))
    • Transferee is insured, partner of the insured, partnership in which insured is a partner, or corporation in which insured is shareholder or officer. (IRC 101(a)(2)(B))
avoiding 3 year rule of 2035 page 70
Avoiding 3 Year Rule of 2035 (Page 70)
  • Never possess incidents of ownership
  • Purchase new policy
  • Sell policy to grantor trust
  • Sell policy to partner of the insured
  • Sell policy to partnership in which insured is a partner
avoiding 3 year rule of 2035 page 701

$150,000 + other assets

$150,000

Policy

Avoiding 3 Year Rule of 2035 (Page 70)
  • Sell policy to grantor trust

RevocableLivingTrust

ILIT

avoiding 3 year rule of 2035 page 71

Assets

G.P. & L.P. Int.

Otherassets

L.P.Int.

$150,000 + other assets

$150,000

Policy

Avoiding 3 Year Rule of 2035 (Page 71)
  • Sell policy to partner of the insured

Limited Partnership (or LLC)

RevocableLivingTrust

ILIT

drafting to provide liquidity page 71
Drafting to Provide Liquidity (Page 71)
  • Trustee is authorized to lend to the estate
  • Trustee is authorized to purchase assets from estate
  • WD provides these options
community property issues page 71
Community Property Issues (Page 71)
  • Non-insured spouse cannot contribute to trust of which he or she is beneficiary
  • Solution is Partition Agreement
ilits for survivorship policies page 72
ILITs for Survivorship Policies (Page 72)
  • Neither spouse/insured can be trustee
  • Incidents of ownership exist even in fiduciary capacity
  • Co-trustee may solve
  • Joint trust can hold individual policies
trustee liability for policy performance page 72
Trustee Liability for Policy Performance(Page 72)
  • Recent lawsuits
  • Trend to statutorily reduce liability
  • Audits
sale transactions to grantor trusts

Sale Transactions to Grantor Trusts

Bill Conway

www.wealthcounsel.com

introduction page 74
Introduction (Page 74)
  • Chapter 14
  • Lack of certainty with GRAT
  • Grantor trust rules remain
  • Less frequency with $5 million gift exemption
sequence
Sequence
  • Grantor establishes defective IRT
  • Grantor contributes assets, allocates GST exemption
  • Grantor engages in sale (or part-gift/part-sale) with IRT
initial funding page 74
Initial Funding(Page 74)
  • Seeding the trust
    • 10% “Rule”
    • Guarantees as alternative
types of consideration page 76
Types of Consideration (Page 76)
  • Case
    • Not typically
  • Installment Note
    • Interest-only vs. Self-amortizing
    • Refinancing
    • Income tax concerns at death
      • IRD?
      • Step-up in basis?
types of consideration page 74
Types of Consideration (Page 74)
  • Self-Canceling Note
    • Term > life expectancy = Private Annuity
    • Even for the young and healthy
  • Private Annuity
    • Even for the young and healthy
    • Exhaustion test
2036 recharacterization page 82
2036 Recharacterization(Page 82)
  • LaFarge & Lazarus (9th Cir.)
  • Weigl
  • Key is cash flow!
defined value formulas page 82
Defined Value Formulas (Page 82)
  • Procter, King, Ward
  • McCord
    • Tax Court
      • Lots of politics
      • Full Tax Court Decision
      • See Judge Laro’s dissent (Page 86)
    • 5th Circuit
defined value formulas page 821
Defined Value Formulas (Page 82)
  • Christiansen
    • Formula disclaimer of 75% to near-zero CLAT and 25% to Foundation
    • Disclaimant was CLAT remainderman
    • 8th Circuit slams IRS – see page 88
  • Petter
    • UPS stock
    • LLC with three classes
    • Sale for promissory notes three days after gift
    • Defined value amount; excess to charity
reporting a sale to grantor trust page 90
Reporting a Sale to Grantor Trust (Page 90)
  • New Question 12(e) on 706
  • Better to report now or later?
asset protection estate taxation page 91
Asset Protection & Estate Taxation (Page 91)
  • Creditor may reach beneficiaries’ interest based on:
    • Enforceability of spendthrift provision;
    • Beneficiary’s control over trust; and
    • Whether beneficiary has property interest
4 exceptions to spendthrift page 92
4 Exceptions to Spendthrift(Page 92)
  • Self-Settled Trusts
  • 3 Exceptions under Restatement (Second) of Trusts
  • Tort creditor
  • Misc. case law exceptions
enforceability of spendthrift provision page 92
Enforceability of Spendthrift Provision (Page 92)
  • Self-Settled Trust Exception to Spendthrift
    • No protection except in twelve states and twenty offshore jurisdictions
    • More states are changing laws
    • Common self-settled trusts:
      • Revocable “Living” Trusts
      • Charitable Remainder Trusts
      • Grantor Retained Annuity Trusts
enforceability of spendthrift provision page 93
Enforceability of Spendthrift Provision (Page 93)
  • Self-Settled Trust Exception
  • Restatement of Trusts Exceptions
    • Alimony or child support;
    • Necessary services or supplies rendered to beneficiary (such as medical services)
    • Claim by US or State (such as tax liens)
enforceability of spendthrift provision page 94
Enforceability of Spendthrift Provision (Page 94)
  • Self-Settled Trust Exception
  • Restatement of Trusts Exceptions
  • Tort Public Policy Exceptions
    • MS court vs. MS legislature
enforceability of spendthrift provision page 941
Enforceability of Spendthrift Provision (Page 94)
  • Self-Settled Trust Exception
  • Restatement of Trusts Exceptions
  • Tort Public Policy Exceptions
  • Case Law Exceptions
    • ERISA protects assets until paid out
    • NY statute exposing principal “unnecessary for reasonable requirements of judgment debtor”
    • Income paid is exposed
beneficiary s control page 95
Beneficiary’s Control (Page 95)
  • Non Self-Settled Trusts
    • Bene/Sole Trustee can’t protect from own improvidence therefore no protection – FL
      • AR expressly states otherwise
      • Check your state law!
    • Co-trustee provides protection
    • Fiduciary duties prevail if other benes
beneficiary s control page 96
Beneficiary’s Control (Page 96)
  • Self-Settled Trusts in AP Jurisdictions
    • Statutory specificity
    • Classic jurisdictions:
      • Isle of Man
      • Jersey
      • Guernsey
    • Conflicts of Laws issues
    • Contempt Orders
      • Affordable Media
property interest page 97
Property Interest (Page 97)
  • Creditors may recover against debtor’s property interests
  • A discretionary interest in a trust is not a property interest
  • A property interest is one that can be sold or exchanged
property interest page 971
Property Interest (Page 97)
  • Spendthrift precludes
  • Mandatory distributions – “shall”
    • QTIPs
    • GRTs & CRTs
  • Ascertainable Standards – “shall” for HEMS
    • Beneficiary can sue under state law
    • Creditor stands in beneficiary’s shoes
  • Special Needs Trusts
property interest page 99
Property Interest (Page 99)
  • Conflicting Provisions
    • Discretionary language + ascertainable standards
    • “may” for HEMS
    • Have to consult state law to determine how provision is interpreted
discretionary trusts page 101
Discretionary Trusts (Page 101)
  • Beneficiary may not sue trustee
  • Erosion of protection for:
    • Necessities of beneficiary
    • Tax liens
    • Alimony
contingent remainder vs dynasty trust page 102
Contingent Remainder vs. Dynasty Trust (Page 102)
  • Trend to treat contingent remainder as property interest
    • CO – child bene has property interest in bypass trust during life of surviving spouse
    • CO – property interest in inter vivos trust even during life of grantor
  • Logic doesn’t apply to Dynasty Trust
offshore or domestic apt page 103
Offshore or Domestic APT (Page 103)
  • Self-settled trusts
    • Questionable protection in other than APT jurisdiction
    • Split-interest trusts
  • Non-Self Settled has fewer concerns
  • Divorce – equitable division
  • Cost/Benefit
domestic self settled trust page 104
Domestic Self-Settled Trust (Page 104)
  • More states changing laws
  • Having it and not having it
    • Ownership vs. Exclusion
  • Interplay between asset protection and estate tax exclusion
  • State law and creditor’s ability to reach trust assets
  • Prearrangement
domestic self settled trust page 105
Domestic Self-Settled Trust (Page 105)
  • Alaska
  • Delaware
  • Nevada
  • Rhode Island
  • Utah
  • South Dakota
  • Oklahoma
  • Missouri?
  • Tennessee
  • New Hampshire
  • Wyoming
  • Colorado
  • Hawaii
domestic self settled trusts page 106
Domestic Self-Settled Trusts (Page 106)
  • The evolution of the case law
    • Herzog
      • Augustus Hand
      • NY trust; completed gift
    • Holtz
      • External standard for distributions = incomplete
    • Outwin
      • MS trust; incomplete gift
domestic self settled trusts page 107
Domestic Self-Settled Trusts (Page 107)
  • The evolution of the case law
    • Irving Trust
      • Augustus Hand again
      • NY trust; assets excluded
    • Uhl
      • IN trust; assets included
    • Rev. Rul. 77-378
  • Retained “Right” is the problem
  • Alaska’s Logical Next Step
split interest trusts

Split-Interest Trusts

Bill Conway

www.wealthcounsel.com

split interest trusts page 78

Gifted Asset

Retained Benefit

Remainder

Split-Interest Trusts (Page 78)
  • Techniques for leveraging gifts
  • Distinct economic interests
    • Division of time of ownership
    • Division of the type of interest
  • That which is not given away is retained

Grantor

split interest trusts page 111
Split-Interest Trusts (Page 111)
  • Common Split-Interest Trusts
    • CRTs
    • CLTs
    • GRTs
    • QPRTs
  • We’re going to focus on the taxable gift trusts, i.e., non-charitable split-interest trusts
split interest trusts ch 14 page 112
Split-Interest Trusts & Ch. 14 (Page 112)
  • Chapter 14
    • Designed to reduce intra-family undervaluations of split-interest transfers
    • Valuation provisions
    • 2702- Fixed annuity or unitrust amount
benefit of split interest trusts page 112
Benefit of Split-Interest Trusts (Page 112)
  • Assumes:
    • Property will produce income equal to 120% of Federal Mid-Term Rate (§7520 rate)
    • Principal value neither increases or decreases
general rules page 113
General Rules (Page 113)
  • Who Can Serve as Trustee
    • During income interest, may be grantor
    • After income interest, other than grantor
general rules page 1131
General Rules (Page 113)
  • Problems with Gift-Splitting
    • If spouses gift-split and one dies, only one-half of the applicable credit is restored
    • All or nothing in any given year
general rules page 1132
General Rules (Page 113)
  • Estate Tax Inclusion Period & GST
    • 2642(f)(3) values transfer of asset at end of period “during which the value of the property involved would be included in the gross estate of the transferor under chapter 11 if he died immediately upon making such transfer.”
    • Not appropriate for split-interest trusts
    • Cannot allocate GST until after ETIP period
    • Grant GPOA if trust provides for skip persons
practical matters to consider page 114
Practical Matters to Consider (Page 114)
  • Effect of Interest Rate
    • Higher rate = higher retention = lower gift
  • Term
    • Longer term = more retained = lower gift
    • Mortality risk increases over longer term
    • Hedge mortality risk with insurance
  • Appraisal – Get them!
  • EIN
    • Grantor trust during initial term
    • May or may not be grantor trust after initial term
grits page 116
GRITS (Page 116)
  • Income to Grantor for term
  • Remainder paid to remainder beneficiary
  • Significant benefit with
    • Non-income producing property
    • Low income producing property
  • 2702 eliminates use with family members
  • Specific exception for personal residence - QPRT
grits page 117
GRITS (Page 117)
  • Still useful for
    • Business situations
    • Gift to nieces and nephews
    • Non-family settings
qprts page 117
QPRTs (Page 117)
  • Gift to family members with retained right to live in the residence for term of years
    • QPRTs generally overvalue use
    • QPRTs assume no appreciation
qprts page 118
QPRTs (Page 118)
  • Income Tax Consequences
    • Grantor trust during term
    • Mortgage interest deduction passes through to grantor
    • IRC 121 exclusion still available
qprts page 1181
QPRTs (Page 118)
  • Gift Tax Consequences
    • Ch. 14 doesn’t apply
qprts page 1182
QPRTs (Page 118)
  • PRTs
    • Residence can’t be sold
    • May not hold cash
    • No contemplation of destruction of home
  • QPRT
    • Residence may be sold
      • Reinvest within 2 years
    • May hold cash
    • Residences must be “personal residence”
      • Principal residence
      • One other residence of grantor
attributes of qprts page 119
Attributes of QPRTs (Page 119)
  • Attributes
  • Prohibitions
  • Requirements
qprts page 121
QPRTs (Page 121)
  • Sale or disuse of residence disqualifies
  • Upon disqualification, may
    • Distribute outright to grantor
    • Convert to GRAT
      • Payment based on original 7520 rate
      • Begins on date of sale, disuse, destruction, etc.
qprts page 122
QPRTs (Page 122)
  • Effect of transferring property subject to mortgage
    • If non-recourse, gift is FMV – debt; Continued payment on debt are recurring gifts
    • If recourse, gift is FMV; Continued payments on debt are not additional gifts
qprts page 123
QPRTs (Page 123)
  • Joint Property
    • Each spouse can contribute one-half interest to separate QRPTs
    • Beware Reciprocal Trust Doctrine!
qprts page 1231
QPRTs (Page 123)
  • Options at End of Term
    • Lease
    • Life-estate in non-grantor spouse
qprts page 124
QPRTs (Page 124)
  • Capital Gain Tax on Sale
  • Prohibition of Repurchase by Grantor
  • Grantor Trust Beyond Term where Administrative Powers Retained
qprts page 125
QPRTs (Page 125)
  • Asset Protection
    • After term, asset is removed
    • During term, income interest is likely reachable by creditors
    • Regs require trustee to dispose of residence if not used by grantor
    • Conversion to GRAT may help
      • Remainder is protected
      • Annuities are exempt in many states
gruts page 125
GRUTs (Page 125)
  • Why They Do NOT Work
    • Payout is unitrust amount
    • As trust increases, payout increases
    • Effect is that corpus remains about same as if property had been gifted
    • Direct gift has no reversion possibility
grats page 125
GRATs (Page 125)
  • Assets best suited are appreciating assets
  • Discounts provide leverage
  • No-Lose Propositions
grats page 127
GRATs (Page 127)
  • Rules for GRATs
  • Can Increase Payouts (up to 120%)
  • Gift Tax Valuation
  • Estate Taxes
    • If grantor fails to survive term, inclusion of all property
  • Income Taxes
    • GRAT is a grantor trust
  • Spousal Annuity Interest
grats page 129
GRATs (Page 129)
  • Zero’ed Out GRATs- Walton Case
grats page 130
GRATs (Page 130)
  • “Amoeba” or Rolling GRATs
grats page 131
GRATs (Page 131)
  • Effects of Rolling GRATs
lifetime qtips page 132
Lifetime QTIPs (Page 132)
  • Trust created by one (“propertied”) spouse for another (“non-propertied”) spouse
  • Equalize estates without propertied spouse giving up control
  • Requires all income be paid at least annually to donee spouse
  • Can create secondary life estate for donor spouse
lifetime qtips page 133
Lifetime QTIPs (Page 133)
  • Asset Protection
    • During life of donee spouse – spendthrift trust
    • After death of donee spouse
lifetime qtips page 1331
Lifetime QTIPs (Page 133)
  • Elements
    • Only permissible beneficiary is donee spouse
    • All income paid at least annually
    • No person has power to appoint property during life of donee spouse
    • QTIP election is timely made on 709
      • No cure if you miss this!!! See PLR 201109012
lifetime qtips page 134
Lifetime QTIPs (Page 134)
  • Estate Tax Effects
    • Death of donee before donor renders donee transferor for future trusts
  • Can Allocate GST Exemption
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Bill Conway

www.wealthcounsel.com