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Understanding & Drafting Irrevocable Trusts Presented By: WealthCounsel, LLC Bill Conway www.wealthcounsel.com.

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Presentation on theme: "Understanding & Drafting Irrevocable Trusts Presented By: WealthCounsel, LLC Bill Conway www.wealthcounsel.com."— Presentation transcript:

1 Understanding & Drafting Irrevocable Trusts Presented By: WealthCounsel, LLC Bill Conway

2 Good Morning! Introductions Introductions  Name?  From?  Practice experience?  Hobbies/Interests?  Why EP 203?

3 Good Morning! EP 203 significantly overhauled EP 203 significantly overhauled Overview Overview  WealthDocx IRT Module  Insurance-Related IRT Issues  Sale Transactions with Defective IRTs  Asset Protection & Self-Settled Trusts  Split-Interest Trusts

4 WealthDocx IRT Module Bill Conway

5 WealthDocx IRT Module

6 Irrevocable Trusts Generally Gifts are completed Gifts are completed Trust assets are removed from estate Trust assets are removed from estate Grantor trust? Grantor trust?  Maybe  Maybe not

7 Selecting the Type of IRT (Page 4)

8 2503(c) Trust 2503(c) Trust  FBO Minor  Outright at 21  Included in estate  Alternative to UGMA/UTMA Asset Protection Asset Protection  Self-Settled Trust  Delaware  Distribution advisor suggested

9 Selecting the Type of IRT (Page 5) Family Bank Trust / BERT Trust Family Bank Trust / BERT Trust  Inter Vivos Bypass Trust Gifting Trust Gifting Trust  Receptacle for lifetime gifts HEET Trust HEET Trust  Health and Education Exclusion Trust  Appropriate where no GST exemption left Intentionally Defective Grantor Trust Intentionally Defective Grantor Trust  Grantor trust set to yes  Warning re: Crummey

10 Selecting the Type of IRT (Page 5) Inheritor’s Trust Inheritor’s Trust  Settled by non-beneficiary  Only one beneficiary allowed Life Insurance Trust (Single) Life Insurance Trust (Single)  Doesn’t ask if insurance is appropriate investment Life Insurance (2 nd to Die) Life Insurance (2 nd to Die)  Crummey rights automatically included

11 Other IRTs in WealthDocx Charitable Trusts Charitable Trusts  CRTs, CLTs, Foundations Split-Interest Trusts Split-Interest Trusts  GRATs, QPRTs, QTIPs (Later) Special Needs Trusts (3 rd Party) Special Needs Trusts (3 rd Party) Retirement Trusts Retirement Trusts

12 Grantor as Trustee (Page 6) Maybe, but why? Maybe, but why?

13 Distribution Adviser/Trustee (Page 7) Personal touch Personal touch

14 Other Trust Helpers (Page 7) Segregating functions Segregating functions More on Protectors in a moment More on Protectors in a moment

15 UTC Provisions (Page 8) Be familiar with your state law! Be familiar with your state law! Affects accountings, notice, etc. Affects accountings, notice, etc.

16 Crummey Withdrawal Rights (Page 8)

17 Annual Gift Tax Exclusion Annual Gift Tax Exclusion  Saves $5 million lifetime credit  Future Interest Rule  Crummey Solution

18 Gifting to Irrevocable Trust Crummey Solution (Page 9) 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

19 Crummey Issues Minor Beneficiaries (Page 9) Minor Beneficiaries (Page 9)  Guardian may exercise  Should not be donor/parent Inconsistent positions by IRS Inconsistent positions by IRS WD precludes donor/parent from exercising WD precludes donor/parent from exercising  Non-guardian nominee??

20 Crummey Issues Grantor’s Control Over Withdrawal Rights (Page 10) Grantor’s Control Over Withdrawal Rights (Page 10)  WD defaults Withdrawal rights exist Withdrawal rights exist Pro rata among all benes Pro rata among all benes  Invert defaults?

21 Crummey Issues Contingent Beneficiaries (Page 12) Contingent Beneficiaries (Page 12)  Cristofani (Tax Court) 2 children as current benes 2 children as current benes 5 grandchildren as contingent benes 5 grandchildren as contingent benes Tax Ct said no vested interest required Tax Ct said no vested interest required

22 Crummey Issues Contingent Beneficiaries (Page 12) Contingent Beneficiaries (Page 12)  Cristofani (Tax Court)  Kholsaat (Tax Court) 16 contingent benes 16 contingent benes No withdrawal rights exercised No withdrawal rights exercised IRS argued implicit understanding IRS argued implicit understanding Tax Court said no evidence of an understanding and none would be inferred Tax Court said no evidence of an understanding and none would be inferred

23 Crummey Issues Contingent Beneficiaries (Page 13) Contingent Beneficiaries (Page 13)  Cristofani (Tax Court)  Kholsaat (Tax Court)  Holland (Tax Court) Family meeting to discuss not exercising Family meeting to discuss not exercising IRS argued implicit understanding IRS argued implicit understanding Tax Court said meeting evidenced knowledge of rights and conscious decision not to exercise Tax Court said meeting evidenced knowledge of rights and conscious decision not to exercise

24 Crummey Issues Notice of Withdrawal Right (Page 13) Notice of Withdrawal Right (Page 13)  Oral vs. Written

25 Crummey Issues Notice of Withdrawal Right (Page 14) Notice of Withdrawal Right (Page 14)  Oral vs. Written  Frequency “Current” notice “Current” notice Schedule of contributions sufficient Schedule of contributions sufficient WD requires notice upon each contribution WD requires notice upon each contribution

26 Crummey Issues Notice of Withdrawal Right (Page 14) Notice of Withdrawal Right (Page 14)  Oral vs. Written  Frequency  Duration Reasonable period of time Reasonable period of time Cristofani was 15 days Cristofani was 15 days 4 days has been approved; 3 days disapproved 4 days has been approved; 3 days disapproved ETIP if spouse has withdrawal right ETIP if spouse has withdrawal right

27 Crummey Issues Notice of Withdrawal Right (Page 16) Notice of Withdrawal Right (Page 16)  Oral vs. Written  Frequency  Duration  Accuracy  Waiver

28 Crummey Issues Maintaining Sufficient Assets (Page 16) 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

29 Crummey Issues Estate Tax Treatment (Page 16) Estate Tax Treatment (Page 16)  Withdrawal Right = GPOA  GPOA included in power holder’s estate

30 Gift-Over Problem (Page 17) Lapse of Withdrawal Right 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

31 Gift-Over Problem Gift-Over Solutions (Page 18) 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

32 Gift-Over Problem

33 Gift-Over Solutions Common Trust (Page 19) Common Trust (Page 19)  Limits withdrawal right to 5/5  No lapse greater than 5/5  Donee has to aggregate gifts for 5/5

34 Gift-Over Solutions Common Trust (Page 19) Common Trust (Page 19) Annual Premium: $5,000 Beneficiaries: 2-Son & Daughter DadMom $2,500 $5, (e) lapse of $2,500 each (no gift) No Giftover Problem

35 Gift-Over Solutions Common Trust (Page 19) Common Trust (Page 19) Beneficiaries: 2-Son & Daughter DadMom $26,000 $52, (e) lapse of $5,000 each (no gift) Deemed gift of $21,000 from each beneficiary to the other Annual Premium: $52,000

36 Gift-Over Solutions Separate Subtrusts (Page 19) 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

37 Gift-Over Solutions Separate Subtrusts (Page 19) Separate Subtrusts (Page 19) Annual Premium: $52,000 Beneficiaries: 2-Son & Daughter $26,000 $52,000 No Giftover because no other beneficiaries to whom to gift over DadMom $26,000 Lapse to Separate Trust for Son of $26,000 Lapse to Separate Trust for Daughter of $26,000

38 Gift-Over Solutions Hanging Powers (Page 21) 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

39 Gift-Over Solutions Hanging Powers (Page 21) Hanging Powers (Page 21) Annual Premium: $52,000 Beneficiaries: 2-Son & Daughter DadMom $26,000 $52, (e) lapse of $5,000 each (no gift) Remaining $42,000 continues to “hang,” therefore no gift over

40 Gift-Over Solutions Hanging Powers (Page 21) Hanging Powers (Page 21) Beneficiaries: 2-Son & Daughter $26,000 $260,000 Balance of $177,200 “hangs” Year 5: Aggregate Contributions of $260,000 DadMom $26,000 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

41 Incomplete Gifts (Page 23) “dominion and control” retained “dominion and control” retained But can’t get it back But can’t get it back

42 Grantor Trust Provisions (Page 23)

43 Overview & History Overview & History IRC IRC Created to eliminate income tax abuses involving (then-lower) trusts brackets Created to eliminate income tax abuses involving (then-lower) trusts brackets Grantor trust as to: Grantor trust as to:  Income  Principal  Both

44 Grantor Trust Opportunities (Page 24) Tax free sale of appreciated assets Tax free sale of appreciated assets Tax burn as non-taxable contributions Tax burn as non-taxable contributions Removal of assets from estate Removal of assets from estate Tax free distribution to trust beneficiaries Tax free distribution to trust beneficiaries Permissible transferee of life insurance policy outside of transfer for value rules Permissible transferee of life insurance policy outside of transfer for value rules

45 Achieving Grantor Trust Status 672 Definitions (Page 24) 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

46 Achieving Grantor Trust Status 672 Definitions (Page 24) 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

47 Achieving Grantor Trust Status Know your defect Know your defect One vs. More than One One vs. More than One  Certainty  Ease of Toggling

48 Achieving Grantor Trust Status 674 Power to Affect Beneficial Enjoyment 674 Power to Affect Beneficial Enjoyment  674(c) – Power to Distribute Income or Principal, or to add beneficiaries  Grantor holding power = inclusion

49 Achieving Grantor Trust Status 674 Power to Affect Beneficial Enjoyment 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 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 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? Possible to switch grantor trust status on and off merely by spouse moving out and back in?

50 Achieving Grantor Trust Status 675 Administrative Powers (Page 28) 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

51 Achieving Grantor Trust Status 675 Administrative Powers 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 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 N/A to loans with adequate interest and security Creates grantor trust to extent amounts are unrepaid at year end, but... Creates grantor trust to extent amounts are unrepaid at year end, but... IRS has apparently ignored requirement that loan remain outstanding until year end IRS has apparently ignored requirement that loan remain outstanding until year end

52 Achieving Grantor Trust Status 675 Administrative Powers (Page 30) 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 Right exercisable in a non-fiduciary capacity by any person to reacquire trust corpus by substituting other property Grantor can hold Grantor can hold

53 Achieving Grantor Trust Status 675 Administrative Powers (Page 30) 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 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 Service’s position is that power alone isn’t sufficient, and applies a facts and circumstances analysis Defective as to both income and principal Defective as to both income and principal Grantor can release Grantor can release Protector can re-grant Protector can re-grant

54 Achieving Grantor Trust Status 677 Power to Use Income for Benefit of Grantor (Page 34) 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

55 Achieving Grantor Trust Status 677 Power to Use Income for Benefit of Grantor (Page 35) 677 Power to Use Income for Benefit of Grantor (Page 35)

56 Achieving Grantor Trust Status 677 Power to Use Income for Benefit of Grantor 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)

57 Achieving Grantor Trust Status 678 Persons other than Grantor Treated as Owner (Page 35) 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? surviving spouse as sole trustee of bypass trust? limitation to ascertainable standard (HEMS) prevents estate tax inclusion limitation to ascertainable standard (HEMS) prevents estate tax inclusion switch on/off grantor trust status by appointing/firing co-trustee switch on/off grantor trust status by appointing/firing co-trustee

58 Achieving Grantor Trust Status 678 Persons other than Grantor Treated as Owner (Page 36) 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 Power to distribute income or principal which is “partially released or otherwise modified” that would cause grantor trust status under  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

59 Achieving Grantor Trust Status § 678 vs. §§ (Page 36) § 678 vs. §§ (Page 36)  § 678 N/A with respect to power over “income” during any period actual grantor is treated as owner under §§  Service has interpreted §678(b) as applying to principal as well as income

60 Income Tax Reimbursement (Page 37) Silence = prohibition? Silence = prohibition? Mandatory = inclusion Mandatory = inclusion Discretionary = ?? Discretionary = ??  Prearrangement?

61 Terminating Grantor Trust Status Maintain Flexibility Maintain Flexibility Power to terminate grantor trust status should not be in hands of grantor Power to terminate grantor trust status should not be in hands of grantor

62 Reporting for a Grantor Trust To File or Not to File (Treas. Reg ) To File or Not to File (Treas. Reg )  Option 1: No EIN or 1041 Provide payors with Grantor/owner’s TIN Provide payors with Grantor/owner’s TIN Grantor provides W-9 to Trustee Grantor provides W-9 to Trustee Trustee statement for Grantor/owner Trustee statement for Grantor/owner  Option 2: EIN and 1041 Provide payors with Trust’s TIN Provide payors with Trust’s TIN Trust files Forms 1099 Trust files Forms 1099 Trustee statement for Grantor/owner Trustee statement for Grantor/owner  Page 134 – Letter to CPA

63 Removing & Replacing Trustees (Page 37) Right to Remove and Replace Right to Remove and Replace  RR : No inclusion if trustee resigned  RR : Inclusion if grantor removed without cause  PLR : Facts and circumstances  Wall: No inclusion where replacement was corporate fiduciary

64 Removing & Replacing Trustees (Page 41) Right to Remove and Replace (con’t) 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: revoked, modified; No inclusion if successor was not “related or subordinate” under §672(c)

65 Related or Subordinate – A Review Not adverse AND Not adverse AND Any one of Any one of  Spouse, if living with grantor  Parent  Issue  Sibling  Employee  Corporation where grantor has significant voting control

66 Related or Subordinate – A Review Does not include issue of siblings (nieces and nephews, etc.) Does not include issue of siblings (nieces and nephews, etc.) Spousal attribution Spousal attribution  Typically related or subordinate  Literally adverse but not technically due to spousal attribution

67 Removing & Replacing Trustees (Page 42) Power to remove and replace retained by the grantor? Yes No Is person being removed acting in a fiduciary capacity? No Yes No 2036(a)(2) or 2038(a)(1) concern. Must replacement be not related or subordinate to grantor with IRC 672? 2036(a)(2)/2038(a)(1) concern. Beyond Wall logic. No 2036(a)(2)/2038(a)(1) concern. Beyond Rev. Rul Yes Within Rev. Rul

68 Removal of Trustee by Bene (Page 43) For cause = Court; good or bad? For cause = Court; good or bad?

69 Corp Fiduciary Requirements (Page 44) Be careful! Be careful! Exclude expressly named institutions? Exclude expressly named institutions?

70 Lifetime LPOA (Page 44) Ejection button Ejection button Trustee vs. Protector Trustee vs. Protector

71 “Amending” an IRT (Page 44) Lifetime LPOA Lifetime LPOA Sell assets to new IRT Sell assets to new IRT Non-judicial modification per UTC Non-judicial modification per UTC Judicial modification Judicial modification Decanting (later) Decanting (later) Trust Protector Trust Protector Other? Other?

72 Trust Protectors (Page 46) Common in offshore jurisdictions Common in offshore jurisdictions Little guidance in American law Little guidance in American law Role is different from trustee Role is different from trustee  Perspective of trusted family friend or advisor  Counter-balance to impersonal institutional trustee  Enhanced flexibility without adverse tax consequences

73 Trust Protectors (Page 47) Who should serve? Who should serve?  Gift tax consequences  Income tax consequences

74 Trust Protectors (Page 49) Removal and Replacement? Removal and Replacement? Power to remove and replace retained by the grantor? Yes No Is person being removed acting in a fiduciary capacity? No Yes No 2036(a)(2) or 2038(a)(1) concern. Must replacement be not related or subordinate to grantor with IRC 672? 2036(a)(2)/2038(a)(1) concern. Beyond Wall logic. No 2036(a)(2)/2038(a)(1) concern. Beyond Rev. Rul Yes Within Rev. Rul

75 Trust Protectors (Page 49)

76 Trust Protectors (Page 50) Fiduciary or Not? Fiduciary or Not?  Silence vs. express answer  Statute?  Ability to exercise power if fiduciary?

77 Trust Protectors (Page 51)

78 Distribution of Estate Tax Includable Property (Page 53) Marital deduction issues Marital deduction issues

79 Bypass(-type) Trust Issues (Page 54) Mandatory vs. Discretionary Income Mandatory vs. Discretionary Income  Trust income tax rates better? 5/5 Powers 5/5 Powers

80 Administration of Remaining Trust (Page 55) Guidelines for discretionary distributions Guidelines for discretionary distributions  Silences = required? 5/5 Powers 5/5 Powers Providing for children-in-law Providing for children-in-law

81 Standby SNTs (Page 55) Why not? Why not?

82 Decanting Powers (Page 56) Broad powers Broad powers Discuss with client Discuss with client Tutorial Tutorial

83 GST Exempt & Non-Exempt (Page 57) Again, why not? Again, why not?

84 Generation Skipping (Page 57) Annual GST Exclusion Annual GST Exclusion  Only for direct-skip gifts (outright or in trust)  If in trust: Only one beneficiary; and Only one beneficiary; and Trust assets fully included in donee’s estate Trust assets fully included in donee’s estate

85 Generation Skipping (Page 57) Annual GST Exclusion Annual GST Exclusion  Qualifying Trusts include: 2503(c) Trusts 2503(c) Trusts Separate Trusts for skip persons Separate Trusts for skip persons  Non-Qualifying Trusts include: Dynasty trusts Dynasty trusts Common trusts Common trusts

86 Generation Skipping (Page 59) GST Exemption GST Exemption  $5.0M in  $??M in 2013  Can only be allocated by the transferor Crummey Powers Crummey Powers

87 Generation Skipping (Page 61) Allocating the GST Exemption Allocating the GST Exemption  Allocation is irrevocable  Automatic allocation to: Lifetime direct skips Lifetime direct skips At death, of any remaining GST exemption to trusts from which there could be a generation skip 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” Lifetime indirect skips to a “Generation-Skipping Transfer Trust”  Opt Out of Automatic Allocation on 709

88 IRS Form 709 If you aren’t preparing them …. If you aren’t preparing them …. Part 1 – personal information Part 1 – personal information Schedule A Schedule A  Part 1 – Gifts Subject Only to Gift Tax Gifts to children Gifts to children  Part 2 – Direct Skips Gifts to grandchildren Gifts to grandchildren  Part 3 – Indirect Skips Gifts to trust for children and grandchildren Gifts to trust for children and grandchildren

89 IRS Form 709 Part 4 Part 4  Line 1 – total gifts  Line 2 – annual exclusions  Line 3 – net of the two Schedule B – Prior returns Schedule B – Prior returns Schedule C – Computing GST Schedule C – Computing GST  Part 2 – Allocating Remember to allocate to entire gift, not just taxable portion!! Remember to allocate to entire gift, not just taxable portion!! Use formula allocation just in case Use formula allocation just in case

90 Divorce Provision (Page 63) Need to discuss to avoid appearance of conflict Need to discuss to avoid appearance of conflict

91 Gift Splitting (Page 63) A legal fiction A legal fiction Only to third parties (not to spouses) Only to third parties (not to spouses) All or nothing annually All or nothing annually Consent must be made on Form 709 Gift Tax Return Consent must be made on Form 709 Gift Tax Return

92 Drafting for Lifetime Benefits (Page 64) Loans to grantor 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”)

93 Drafting for Lifetime Benefits (Page 65) Inter-vivos Bypass Trust Inter-vivos Bypass Trust  Spouse has access  Danger is spouse’s death Self-Settled Trust Jurisdictions Self-Settled Trust Jurisdictions

94 Reciprocal Trust Doctrine (Page 65) Estate of Grace (US Sup Ct.) 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

95 Reciprocal Trust Doctrine (Page 65) Estate of Grace (US Sup Ct.) Estate of Grace (US Sup Ct.) Estate of Bischoff (Tax Court) Estate of Bischoff (Tax Court)  Applied doctrine to trusts established by grandparents for the benefit of grandchildren and naming grandparents as trustees.

96 Reciprocal Trust Doctrine (Page 65) Estate of Grace (US Sup Ct.) Estate of Grace (US Sup Ct.) Estate of Bischoff (Tax Court) Estate of Bischoff (Tax Court) Estate of Green (2 nd Cir) Estate of Green (2 nd Cir)  Refused to follow Bischoff stating that Grace court required benefit to be retained by grantors before doctrine was applicable. PLR PLR

97 Insurance-Related IRT Issues (ILITs) Bill Conway

98 ILIT Benefits (Page 67) Remove death benefits from taxable estate Remove death benefits from taxable estate Control disposition of death proceeds Control disposition of death proceeds Utilize annual gift tax exclusion for gifts to the trust Utilize annual gift tax exclusion for gifts to the trust Asset Protection Asset Protection

99 ILIT Objections Cost to set up Cost to set up Administrative hassle Administrative hassle Perceived loss of access to cash value build-up within policy Perceived loss of access to cash value build-up within policy

100 ILIT Alternatives (Page 67) Continued individual ownership Continued individual ownership Ownership by adult children Ownership by adult children Family Insurance Partnership Family Insurance Partnership

101 Estate Taxation of Insurance (Page 68) Insurance is included if: 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)

102 Estate Taxation of Insurance (Page 68) IRC 2042 IRC 2042  Incidents of ownership Power to change beneficiary Power to change beneficiary Power to surrender or cancel the policy Power to surrender or cancel the policy Power to assign the policy Power to assign the policy Power to revoke an assignment Power to revoke an assignment Power to pledge the policy Power to pledge the policy A reversionary interest in the policy A reversionary interest in the policy  Payable to or for the benefit of the estate

103 Valuation of Insurance (Page 69) Generally: Generally: Interpolated terminal reserve Interpolated terminal reserve + Unused premiums + Accumulated dividends - Policy Loans Single premium policies valued by replacement Single premium policies valued by replacement Group term has no value but continued payment of premiums are on-going gifts from the employee Group term has no value but continued payment of premiums are on-going gifts from the employee

104 Income Taxation of Insurance (Page 69) General Rule: Excluded from income (IRC 101(a)(1)) General Rule: Excluded from income (IRC 101(a)(1)) Exception: Transfer for Value (IRC 101(a)(2)) Exception: Transfer for Value (IRC 101(a)(2)) Exception to the Exception: 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))

105 Avoiding 3 Year Rule of 2035 (Page 70) Never possess incidents of ownership Never possess incidents of ownership Purchase new policy Purchase new policy Sell policy to grantor trust Sell policy to grantor trust Sell policy to partner of the insured Sell policy to partner of the insured Sell policy to partnership in which insured is a partner Sell policy to partnership in which insured is a partner

106 Avoiding 3 Year Rule of 2035 (Page 70) Sell policy to grantor trust Sell policy to grantor trust Revocable Living Trust ILITILIT $150,000 + other assets $150,000 Policy

107 Avoiding 3 Year Rule of 2035 (Page 71) Sell policy to partner of the insured Sell policy to partner of the insured Revocable Living Trust ILITILIT Limited Partnership (or LLC) $150,000 + other assets Other assets L.P. Int. Assets G.P. & L.P. Int. $150,000 Policy

108 Drafting to Provide Liquidity (Page 71) Trustee is authorized to lend to the estate Trustee is authorized to lend to the estate Trustee is authorized to purchase assets from estate Trustee is authorized to purchase assets from estate WD provides these options WD provides these options

109 Community Property Issues (Page 71) Non-insured spouse cannot contribute to trust of which he or she is beneficiary Non-insured spouse cannot contribute to trust of which he or she is beneficiary Solution is Partition Agreement Solution is Partition Agreement

110 ILITs for Survivorship Policies (Page 72) Neither spouse/insured can be trustee Neither spouse/insured can be trustee Incidents of ownership exist even in fiduciary capacity Incidents of ownership exist even in fiduciary capacity Co-trustee may solve Co-trustee may solve Joint trust can hold individual policies Joint trust can hold individual policies

111 Trustee Liability for Policy Performance (Page 72) Recent lawsuits Recent lawsuits Trend to statutorily reduce liability Trend to statutorily reduce liability Audits Audits

112 Sale Transactions to Grantor Trusts Bill Conway

113 Introduction (Page 74) Chapter 14 Chapter 14 Lack of certainty with GRAT Lack of certainty with GRAT Grantor trust rules remain Grantor trust rules remain Less frequency with $5 million gift exemption Less frequency with $5 million gift exemption

114 Sequence Grantor establishes defective IRT Grantor establishes defective IRT Grantor contributes assets, allocates GST exemption Grantor contributes assets, allocates GST exemption Grantor engages in sale (or part-gift/part- sale) with IRT Grantor engages in sale (or part-gift/part- sale) with IRT

115 Initial Funding (Page 74) Seeding the trust Seeding the trust  10% “Rule”  Guarantees as alternative

116 Types of Consideration (Page 76) Case Case  Not typically Installment Note Installment Note  Interest-only vs. Self-amortizing  Refinancing  Income tax concerns at death IRD? IRD? Step-up in basis? Step-up in basis?

117 Types of Consideration (Page 74) Self-Canceling Note Self-Canceling Note  Term > life expectancy = Private Annuity  Even for the young and healthy Private Annuity Private Annuity  Even for the young and healthy  Exhaustion test

118 2036 Recharacterization (Page 82) LaFarge & Lazarus (9 th Cir.) LaFarge & Lazarus (9 th Cir.) Weigl Weigl Key is cash flow! Key is cash flow!

119 Defined Value Formulas (Page 82) Procter, King, Ward Procter, King, Ward McCord McCord  Tax Court Lots of politics Lots of politics Full Tax Court Decision Full Tax Court Decision See Judge Laro’s dissent (Page 86) See Judge Laro’s dissent (Page 86)  5 th Circuit

120 Defined Value Formulas (Page 82) Christiansen Christiansen  Formula disclaimer of 75% to near-zero CLAT and 25% to Foundation  Disclaimant was CLAT remainderman  8 th Circuit slams IRS – see page 88 Petter Petter  UPS stock  LLC with three classes  Sale for promissory notes three days after gift  Defined value amount; excess to charity

121 Reporting a Sale to Grantor Trust (Page 90) New Question 12(e) on 706 New Question 12(e) on 706 Better to report now or later? Better to report now or later?

122 Asset Protection Trusts (APTs) and Self-Settled Trusts Bill Conway

123 Asset Protection & Estate Taxation (Page 91) Creditor may reach beneficiaries’ interest based on: Creditor may reach beneficiaries’ interest based on:  Enforceability of spendthrift provision;  Beneficiary’s control over trust; and  Whether beneficiary has property interest

124 4 Exceptions to Spendthrift (Page 92) Self-Settled Trusts Self-Settled Trusts 3 Exceptions under Restatement (Second) of Trusts 3 Exceptions under Restatement (Second) of Trusts Tort creditor Tort creditor Misc. case law exceptions Misc. case law exceptions

125 Enforceability of Spendthrift Provision (Page 92) Self-Settled Trust Exception to Spendthrift 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 Revocable “Living” Trusts Charitable Remainder Trusts Charitable Remainder Trusts Grantor Retained Annuity Trusts Grantor Retained Annuity Trusts

126 Enforceability of Spendthrift Provision (Page 93) Self-Settled Trust Exception Self-Settled Trust Exception Restatement of Trusts Exceptions 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)

127 Enforceability of Spendthrift Provision (Page 94) Self-Settled Trust Exception Self-Settled Trust Exception Restatement of Trusts Exceptions Restatement of Trusts Exceptions Tort Public Policy Exceptions Tort Public Policy Exceptions  MS court vs. MS legislature

128 Enforceability of Spendthrift Provision (Page 94) Self-Settled Trust Exception Self-Settled Trust Exception Restatement of Trusts Exceptions Restatement of Trusts Exceptions Tort Public Policy Exceptions Tort Public Policy Exceptions Case Law 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

129 Beneficiary’s Control (Page 95) Non Self-Settled Trusts Non Self-Settled Trusts  Bene/Sole Trustee can’t protect from own improvidence therefore no protection – FL AR expressly states otherwise AR expressly states otherwise Check your state law! Check your state law!  Co-trustee provides protection  Fiduciary duties prevail if other benes

130 Beneficiary’s Control (Page 96) Self-Settled Trusts in AP Jurisdictions Self-Settled Trusts in AP Jurisdictions  Statutory specificity  Classic jurisdictions: Isle of Man Isle of Man Jersey Jersey Guernsey Guernsey  Conflicts of Laws issues  Contempt Orders Affordable Media Affordable Media

131 Property Interest (Page 97) Creditors may recover against debtor’s property interests Creditors may recover against debtor’s property interests A discretionary interest in a trust is not a property interest A discretionary interest in a trust is not a property interest A property interest is one that can be sold or exchanged A property interest is one that can be sold or exchanged

132 Property Interest (Page 97) Spendthrift precludes Spendthrift precludes Mandatory distributions – “shall” Mandatory distributions – “shall”  QTIPs  GRTs & CRTs Ascertainable Standards – “shall” for HEMS Ascertainable Standards – “shall” for HEMS  Beneficiary can sue under state law  Creditor stands in beneficiary’s shoes Special Needs Trusts Special Needs Trusts

133 Property Interest (Page 99) Conflicting Provisions Conflicting Provisions  Discretionary language + ascertainable standards  “may” for HEMS  Have to consult state law to determine how provision is interpreted

134 Discretionary Trusts (Page 101) Beneficiary may not sue trustee Beneficiary may not sue trustee Erosion of protection for: Erosion of protection for:  Necessities of beneficiary  Tax liens  Alimony

135 Contingent Remainder vs. Dynasty Trust (Page 102) Trend to treat contingent remainder as property interest 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 Logic doesn’t apply to Dynasty Trust

136 Offshore or Domestic APT (Page 103) Self-settled trusts Self-settled trusts  Questionable protection in other than APT jurisdiction  Split-interest trusts Non-Self Settled has fewer concerns Non-Self Settled has fewer concerns Divorce – equitable division Divorce – equitable division Cost/Benefit Cost/Benefit

137 Domestic Self-Settled Trust (Page 104) More states changing laws More states changing laws Having it and not having it Having it and not having it  Ownership vs. Exclusion Interplay between asset protection and estate tax exclusion Interplay between asset protection and estate tax exclusion State law and creditor’s ability to reach trust assets State law and creditor’s ability to reach trust assets Prearrangement Prearrangement

138 Domestic Self-Settled Trust (Page 105) Alaska Alaska Delaware Delaware Nevada Nevada Rhode Island Rhode Island Utah Utah South Dakota South Dakota Oklahoma Oklahoma Missouri? Missouri? Tennessee Tennessee New Hampshire New Hampshire Wyoming Wyoming Colorado Colorado Hawaii Hawaii

139 Domestic Self-Settled Trusts (Page 106) The evolution of the case law The evolution of the case law  Herzog Augustus Hand Augustus Hand NY trust; completed gift NY trust; completed gift  Holtz External standard for distributions = incomplete External standard for distributions = incomplete  Outwin MS trust; incomplete gift MS trust; incomplete gift

140 Domestic Self-Settled Trusts (Page 107) The evolution of the case law The evolution of the case law  Irving Trust Augustus Hand again Augustus Hand again NY trust; assets excluded NY trust; assets excluded  Uhl IN trust; assets included IN trust; assets included  Rev. Rul Retained “Right” is the problem Retained “Right” is the problem Alaska’s Logical Next Step Alaska’s Logical Next Step

141 Split-Interest Trusts Bill Conway

142 Techniques for leveraging gifts Techniques for leveraging gifts Distinct economic interests Distinct economic interests  Division of time of ownership  Division of the type of interest That which is not given away is retained That which is not given away is retained Split-Interest Trusts (Page 78) Grantor Gifted Asset Retained Benefit Remainder

143 Split-Interest Trusts (Page 111) Common Split-Interest Trusts 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 We’re going to focus on the taxable gift trusts, i.e., non-charitable split-interest trusts

144 Split-Interest Trusts & Ch. 14 (Page 112) Chapter 14 Chapter 14  Designed to reduce intra-family undervaluations of split-interest transfers  Valuation provisions  Fixed annuity or unitrust amount

145 Benefit of Split-Interest Trusts (Page 112) Assumes: Assumes:  Property will produce income equal to 120% of Federal Mid-Term Rate (§7520 rate)  Principal value neither increases or decreases

146 General Rules (Page 113) Who Can Serve as Trustee Who Can Serve as Trustee  During income interest, may be grantor  After income interest, other than grantor

147 General Rules (Page 113) Problems with Gift-Splitting 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

148 General Rules (Page 113) Estate Tax Inclusion Period & GST 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

149 Practical Matters to Consider (Page 114) Effect of Interest Rate Effect of Interest Rate  Higher rate = higher retention = lower gift Term Term  Longer term = more retained = lower gift  Mortality risk increases over longer term  Hedge mortality risk with insurance Appraisal – Get them! Appraisal – Get them! EIN EIN  Grantor trust during initial term  May or may not be grantor trust after initial term

150 GRITS (Page 116) Income to Grantor for term Income to Grantor for term Remainder paid to remainder beneficiary Remainder paid to remainder beneficiary Significant benefit with Significant benefit with  Non-income producing property  Low income producing property 2702 eliminates use with family members 2702 eliminates use with family members Specific exception for personal residence - QPRT Specific exception for personal residence - QPRT

151 GRITS (Page 117) Still useful for Still useful for  Business situations  Gift to nieces and nephews  Non-family settings

152 QPRTs (Page 117) Gift to family members with retained right to live in the residence for term of years Gift to family members with retained right to live in the residence for term of years  QPRTs generally overvalue use  QPRTs assume no appreciation

153 QPRTs (Page 118) Income Tax Consequences Income Tax Consequences  Grantor trust during term  Mortgage interest deduction passes through to grantor  IRC 121 exclusion still available

154 QPRTs (Page 118) Gift Tax Consequences Gift Tax Consequences  Ch. 14 doesn’t apply

155 QPRTs (Page 118) PRTs PRTs  Residence can’t be sold  May not hold cash  No contemplation of destruction of home QPRT QPRT  Residence may be sold Reinvest within 2 years Reinvest within 2 years  May hold cash  Residences must be “personal residence” Principal residence Principal residence One other residence of grantor One other residence of grantor

156 Attributes of QPRTs (Page 119) Attributes Attributes Prohibitions Prohibitions Requirements Requirements

157 QPRTs (Page 121) Sale or disuse of residence disqualifies Sale or disuse of residence disqualifies Upon disqualification, may Upon disqualification, may  Distribute outright to grantor  Convert to GRAT Payment based on original 7520 rate Payment based on original 7520 rate Begins on date of sale, disuse, destruction, etc. Begins on date of sale, disuse, destruction, etc.

158 QPRTs (Page 122) Effect of transferring property subject to mortgage 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

159 QPRTs (Page 123) Joint Property Joint Property  Each spouse can contribute one-half interest to separate QRPTs  Beware Reciprocal Trust Doctrine!

160 QPRTs (Page 123) Options at End of Term Options at End of Term  Lease  Life-estate in non-grantor spouse

161 QPRTs (Page 124) Capital Gain Tax on Sale Capital Gain Tax on Sale Prohibition of Repurchase by Grantor Prohibition of Repurchase by Grantor Grantor Trust Beyond Term where Administrative Powers Retained Grantor Trust Beyond Term where Administrative Powers Retained

162 QPRTs (Page 125) Asset Protection 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 Remainder is protected Annuities are exempt in many states Annuities are exempt in many states

163 GRUTs (Page 125) Why They Do NOT Work 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

164 GRATs (Page 125) Assets best suited are appreciating assets Assets best suited are appreciating assets Discounts provide leverage Discounts provide leverage No-Lose Propositions No-Lose Propositions

165 GRATs (Page 127) Rules for GRATs Rules for GRATs Can Increase Payouts (up to 120%) Can Increase Payouts (up to 120%) Gift Tax Valuation Gift Tax Valuation Estate Taxes Estate Taxes  If grantor fails to survive term, inclusion of all property Income Taxes Income Taxes  GRAT is a grantor trust Spousal Annuity Interest Spousal Annuity Interest

166 GRATs (Page 129) Zero’ed Out GRATs- Walton Case Zero’ed Out GRATs- Walton Case

167 GRATs (Page 130) “Amoeba” or Rolling GRATs “Amoeba” or Rolling GRATs

168 GRATs (Page 131) Effects of Rolling GRATs Effects of Rolling GRATs

169 Lifetime QTIPs (Page 132) Trust created by one (“propertied”) spouse for another (“non-propertied”) spouse Trust created by one (“propertied”) spouse for another (“non-propertied”) spouse Equalize estates without propertied spouse giving up control Equalize estates without propertied spouse giving up control Requires all income be paid at least annually to donee spouse Requires all income be paid at least annually to donee spouse Can create secondary life estate for donor spouse Can create secondary life estate for donor spouse

170 Lifetime QTIPs (Page 133) Asset Protection Asset Protection  During life of donee spouse – spendthrift trust  After death of donee spouse

171 Lifetime QTIPs (Page 133) Elements 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 No cure if you miss this!!! See PLR

172 Lifetime QTIPs (Page 134) Estate Tax Effects Estate Tax Effects  Death of donee before donor renders donee transferor for future trusts Can Allocate GST Exemption Can Allocate GST Exemption

173 Thank You! Please fill out reviews!! Bill Conway


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