1. Mending Wayward Wealth Strategies John F. Bergner Winstead P.C. jbergner@winstead.com 5603975

3. Popular Techniques Grantor Retained Annuity Trust (“GRAT”) Installment Sale to Grantor Trust Qualified Personal Residence Trust (“QPRT”)

4. Five Ways for Plans to Go Awry Bad design Economic changes Mortality changes Client’s wishes change Bad administration

5. Purpose of Presentation Discuss ways in which techniques may go astray Discuss potential solutions and planning considerations Consider drafting strategies to reduce, eliminate or cope with problems or take advantage of opportunities

6. GRATs Statutory technique Grantor must survive GRAT term Appreciation in excess of 7520 rate

7. Section 7520 Rates

8. Two Year GRAT Stock with a value of $1,000,000 Value of Remainder Gift to Children = $1* Grantor Retained Annuity Trust Annual annuity payments to Parent for the 2 year term total $1,031,024 At the end of the 2 year term, the remaining trust assets are distributed to children. With 25% annual growth, $414,314 will be shifted to children. Requirement: Parent must survive 2 year term *Gift is computed under Walton case, using November 2010 Section 7520 rate of 2.0% and annuity payments increasing by 20% per year

10. GRAT – Bad Design #1 Incorrect Annuity Percentage - Transpose annuity amounts Be careful Judicial modification or trust construction Proofread trust agreement Include savings clause

11. GRAT – Bad Design #2 Trust agreement omits a necessary provision: –Prohibition of commutation –Prohibition of payment of annuity with a note (9/99) –Rely on savings clause –Limited power to amend –Judicial modification

12. GRAT – Bad Design #2 (continued) Trust agreement omits a necessary provision Drafting suggestions: – Scrutinize GRAT forms – Do red-lined comparison to trusted form –Utilize a checklist

13. GRAT – Bad Design #3 Law requiring minimum 10-year term effective before (or same day) shorter term GRAT is funded –Apply to GRATs funded on or after “enactment date” –Drafting suggestions: Include a provisions that automatically increases GRAT term to minimum requirement; or Include provisions that Grantor may amend or revoke the GRAT

14. GRAT - funded with problem assets #1 Interest valued under Section 2701 –Make 2701 elections to give substantial value to preferred interest OR: –Avoid 2701 interests –Transfer a “vertical slice” –Computation of annuity amounts

15. GRAT – Economic Changes #1 Burnt-out GRAT Swap and re-GRAT Sale to grantor and re-GRAT Re-GRAT the annuity interest Do nothing Drafting Suggestions: –include a swap power –Omit or modify spendthrift clause –omit prohibitions against self-dealing

16. GRAT – Economic Changes #2 “Home Run GRAT” - assets perform well Lock-in wealth shift: –Swap GRAT assets for less risky assets –Sell the appreciated GRAT assets –Purchase a collar on publicly-traded security –Pay annuity amounts as early as possible Drafting Suggestions: –Include a swap power –Omit prohibitions against self-dealing

17. GRAT – Mortality Issue #1 Grantor’s life expectancy diminishes –Early death may cause GRAT assets to be included in grantor’s estate Possible Solutions: Grantor purchases remainder interest Separate grantor trust purchases GRAT assets for a private annuity or SCIN Beneficiaries purchase assets from GRAT Carefully consider doing nothing – 2010 DRAFTING SUGGESTIONS: Omit or modify spendthrift clause Omit self-dealing prohibitions Ensure grantor trust status

18. GRAT – Client Wishes Change #1-3 Grantor desires to shift fewer assets to remainder beneficiaries Grantor’s liquidity needs change The objects of the grantor’s bounty change

19. GRAT – Bad Administration #1 Failure to timely make annuity payments Pay annuity as soon as possible with interest Drafting Suggestion: –Include an agency provision (p 29-30)

20. GRAT – Bad Administration #2 GRAT is funded on multiple dates Treat as two GRATs Return all contributions other than the first to the grantor Treat cash as a loan Drafting Suggestions: –Include a revocation provision –Include a re-characterization provision

21. GRAT – Bad Administration #3 Grantor pays GRAT’s expenses Risk of deemed additional contributions Repay the Grantor with interest Treat payment as a loan Drafting suggestion: –Include re-characterization provision

22. Other GRAT problems – potential solutions, drafting suggestions Funding after 7520 rate changes GRAT never properly funded Failure to elect out of automatic allocation of GST exemption Failure to document GRAT transactions Failure to adequately report on 709

23. Other GRAT problems – potential solutions, drafting suggestions –GRAT funded with non-vested stock options –GRAT funded with stock options that may violate SOGRAT patent –GRAT funded with community property –GRAT funded with Insider Stock –GRAT funded with Section 2036(b) stock

24. Installment Sales to Grantor Trusts (“ISGTs”)

25. Installment Sale to Grantor Trust (ISGT) Popular wealth shifting technique $5MM asset appreciate to $20MM? IRS is a partner in growth (45% ?); Effectively converts assets with high income or appreciation potential into fixed-yield, non-appreciating assets (low interest rate Note) Unlike a GRAT, effective for leveraged GST planning

26. Installment Sale to Grantor Trust Grantor Trust for Descendants $1MM Cash Gift Limited Partnership (owning $10MM assets) Parent 1% GP & 99% LP Interests $10MM assets

27. Installment Sale to Grantor Trust Sale of limited pshp. interests (99%) Parent Limited Partnership (owning $10MM assets ) Grantor Trust for Descendants $1MM Cash & $6MM installment note

28. Resulting Ownership Grantor Trust for Descendants Parent Limited Partnership (owning $10MM assets) 1% GP Interest 99% LP Interest $6MM Installment Note

29. Five ways for ISGTs to go awry Bad Design Economic changes Mortality changes Client’s wishes change Bad administration

30. ISGT – Economic Changes #1 Underwater transaction Renegotiate the note Contribute the note to a GRAT Sell the note to a grantor trust Unwind the transaction Drafting Suggestions: –Eliminate duty to diversify –Permit prepayment of note –Limit guarantees

31. ISGT – Economic Changes #2 Transferred assets perform well - the “home run” Lock in wealth shift: –Prepay the note –Swap for a less risky asset –Sell the appreciated asset Drafting Suggestions: –Include a swap power –Omit prohibitions against self-dealing

32. ISGT – Economic Changes #3 Transferred assets perform too well - the “grand slam home run” Limit further wealth shift : –Exercise swap power –Sell assets back to Grantor – tax free –Add or change beneficiaries –Turn off grantor trust status Drafting solutions : Include a “waterfall” provision Draft to facilitate grantor trust termination Include power to lend to grantor Permit 3 rd party to change beneficiaries

33. Potential benefit of waterfall provisions

34. ISGT – Mortality Issue #1 Seller’s life expectancy diminishes Problems: –Future interest payments taxable –Continuing debate – tax consequences when holder of installment note dies Possible Solutions: –Pay off note before death –Keep note in place (possible discount in Seller’s estate) –Sell note for an annuity –Restate the note as a SCIN –Exchange low basis assets in trust for high basis assets owned by seller

35. Other ISGT problems – potential solutions, drafting suggestions 3 problems relating to: – “clients wishes have changed” 6 problems relating to: – “bad administration”.

36. Qualified Personal Residence Trust (“QPRT”)

37. QPRT Example Qualified Personal Residence Trust Client Home $1,000,000 Value of Gift = $390,430 Amount Passing Tax-Free $609,570 (plus appreciation ) Client retains the right to live in the home for 20 years At end of 20-year term, Home is distributed to children - tax-free Requirement: client must survive 20-year term Assumptions: client is age 60; retains reversion if death occurs before trust terminates; Section 7520 rate is 2.0% (November 2010)

38. QPRT – Problems Grantor/trustee powers too broad Impecunious grantor Grantor’s life expectancy reduced Grantor stays too long

39. QPRT – Bad Administration Grantor stays too long Grantor continues to live in the residence after the QPRT term without paying rent. Grantor should sign a lease and pay “back rent” Drafting Suggestion: –QPRT should grant Grantor right to lease residence; lease should be signed before QPRT terminates