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Notre Dame 41st Annual Tax and Estate Planning InstituteSeptember 17 and 18, 2015Part 2 of 2By Martin M. Shenkman, Esq.Current Developments.Overview.A review of significant cases, administrative rulings (both public and private) from the IRS and the states, final and proposed regulations and recent legislation by Congress and the state legislatures. The impact of these recent developments for the future. IRS Priority Guidance Plan.Same-Sex marriage guidance (Obergefell v. Hodges).IRC Sec. 1411 material participation by trusts and estates.IRC Sec. 1411 NIIT issues.Guidance on the tax implications of grantor trusts under 1014 at death. Valuation of promissory notes.IRC Sec. 2704 restrictions on liquidation of an interests in corporations and partnerships.IRC Sec. 2801 guidance on gifts or bequests from certain expatriates.Final Portability Regulations.Final regulations were issued June 12, 2015. TD 9725.Treasury has discretion to file a late portability election for smaller estates under the basic exclusion amount, but not for larger estates.The DUSE for a non-citizen surviving spouse who is a beneficiary of a QDOT is not adjusted after the spouse become a citizen.Most of the provisions of the temporary regulations were retained.The mere filing of a return suffices to constitute the portability election.The executor can revoke the portability election until the filing due date.The election relates back to the decedent’s date of death.Filing a complete and proper return is required but special valuation rules are provided for marital and charitable deductions if non return is otherwise required. These rules permit estimates within certain parameters. Reg. Sec. 20.2010-2(a)(7)(ii)(A). This leniency is not permitted if:If the marital or charitable bequests are based on a formula that divides those bequests with non-charitable/marital. If less than then the value of the interest included in the gross estate is marital or charitable.If only a portion of the property qualifies for the marital deduction because of a partial disclaimer or partial QTIP election.Use the DSUE before the surviving spouse’s basic exclusion amount (“BEA”).Divorcing a later spouse before he or she dies will preserve the DUSE from the last predeceased spouse.With a non-citizen surviving spouse a QDOT presents complications. The property in the QDOT is taxed as if it was the deceased spouse’s with the tax due deferred until the death of the surviving spouse. Thus, the DSUE cannot be known until the death of the surviving spouse. Reg. Sec. 20.2010-2(c)(4)(i).Estate of Elkins v. Comr., 140 TC 82(2013), aff’d in part and rev’d in part, 767 F.2d 443 (5th Cir. 2014).The taxpayer’s discount on fractional interests in art were accepted because the IRS filed to produce any evidence to rebut the taxpayer’s expert’s determination of discount.There is no market for fractional interest in art, yet willing buyers/sellers might find a means.IRC Sec. 7491 if the taxpayer presents sufficient evidence to establish material facts the IRS has the burden to refute those facts. In Elkins it failed to do so.The Elkins’ court found that the restrictions in a co-tenants’ agreement and lease of art were subject to IRC Sec. 2703.The court did not discern different discounts for fractional interests of 50% or 73%.The decedent leased the art pursuant to a rental agreement so that he could have exclusive possession during his lifetime. The rental value was not determined and no rent was paid. The IRS did not raise this issue so this might be an issue in later cases.Estate of Pulling v. Comr. TC Memo 2015-134.The IRS argued that landlocked parcels should be aggregated with other adjacent parcels for purposes of determining their highest and best use value.Some of the parcels with which the IRS argued aggregation were owned by a partnership established long before decedent’s death and in which the decedent owned only a 28% interest.Family attribution rules did not apply and the Court held that attribution rules should not be extended beyond what Congress provided.Same-Sex Couples.Windsor v. US, 133 S. Ct 2675 (2013). DOMA’s definition of marriage as between persons of the opposite sex is unconstitutional.Obergefell v. Hodges, 135 S. Ct. 2584. State laws that discriminate against same-sex couples are unconstitutional.Rev. Rule. 2013-17, 2013-38 IRB 11. Federal tax consequences for same-sex couples. Followed state of celebration rule. In light of Obergefell this may no longer matter.Notice 2014-19, 2014-17 IRB 979. Qualified plans must recognize same-sex marriages.Estate of Olsen v. Comr., 107 TCM (CCH) 1301 (2014).The surviving spouse as trustee did not fund and administer the marital and credit shelter trusts under the deceased spouse’s will. Distributions were made during the surviving spouse’s life but it was not clear which trust they came from.The court had to determine how much remained in the marital trust that was subject to estate tax on the surviving spouse’s death and what remained in the credit shelter trust that would not be subject to tax.The non-marital credit shelter trust did not give the surviving spouse the right to appoint principal to himself.The court treated 73% of the distributions to be from the non-marital or credit shelter trust. The court considered that one of three major distributions was deposited in the surviving spouses’ personal bank account which violated the terms of the non-marital ment: With the large inflation adjusted exemption many clients will choose not to seek counsel and not to fund credit shelter trusts mandated under old wills. This case might provide some useful guidance as to how to reconstruct the appropriate treatment of an unfunded trust when called upon to do so by the IRS, remainder beneficiaries or others.Steinberg v. Commissioner, 141 TC 258 (2013).Consider the gift tax valuation/discount of a net-net gift.Taxpayer made gifts of cash and securities subject to a net gift agreement. The donees agreed to pay the gift tax incurred on the transfer. The gift and income tax consequences of a net gift are as follows:For gift tax purposes the donee’s assumption of the gift tax liability reduces the value of the gift.The donee’s assumption of gift tax liability constituted consideration for the transfer. Consideration results in part-sale/part-gift treatment for income tax purposes. The net-net component of the transaction was as follows. If a donor dies within three years of making a gift then, the gift tax paid would be included in the donor’s estate. IRC Sec. 2035(b). In Steinberg the gift tax was $32M. This result would be required even if the done agrees to pay the gift tax as if in a net gift situation. In Steinberg the donees agreed to pay any estate tax resulting from the inclusion of the gift tax in the donor’s estate if the donor died within3 years of the gift. Although the net-net component of the agreement was agreed to it does not appear that the donor died within 3 years of death so that this obligation did not have to be met by the donees. While the Tax Court case considered whether the value of a $109 million gift was reduced by the donees' agreement to reimburse the estate of the donor for any estate tax resulting from the inclusion of the gift tax paid in the donor's gross estate if the donor dies within three years after the gift, i.e., the net-net component, it did not reach a conclusion as to this matter and merely dismissed the motion for summary judgment by the IRS.It is not clear that the net-net component will have value as it will not necessarily augment the decedent’s estate. If it is deemed to have value that value may depend on the donor’s life expectancy at the time of the gift.SCIN.ILM 201330033 addressed a note sale to a grantor trust for an interest only balloon payment self-cancelling installment note. No payments were made as the donor/seller died within six months of the transaction.The IRS position was the transfer was a taxable gift and the note lacked the indicia of genuine debt.The ILM also put for the IRS position that the 7520 tables do not apply to the valuation of a note but only to an annuity.Notice 2008-99.Uniform basis allocation.In a IRC Sec. 644 split-interest trust if the charitable remainderman and the taxpayer/lead interest both terminate a CRT by selling their interests at one time, how should basis be allocated to determine gain?If sold at one time the rules of IRC Sec. 1001(e)(3) apply and basis should be determined under the IRC Sec. 7520 valuation rules.This could allocate basis to the taxable donor/lead interest holder that result from the CRTs sale of taxable property the gain of which was never allocated to that taxable donor/lead interest holder.Prop. Reg. Sec. 1.1014-5(c) and (d) the donor/lead interest holder’s share of trust basis is reduced to prevent this.Rev Proc 2015-37, 2015-26, IRB 1196.IRS will not issue a ruling addressing whether assets in a grantor trust will receive a basis increase if no estate tax mentators believe that this may be a response to interpretations of PLR 201245006 that property not included in a decedent’s estate could still qualify for a basis step up. That PLR dealt with an non-resident alien .IRC Sec. 1014(f).Enacted as part of the Surface Transportation and Veterans Health Care Choice Improvement Act (HR 3236) July 31, 2015.Property included in estate for estate tax purposes gets new basis that cannot exceed value reported for federal estate tax purposes.In various cases taxpayers claimed large fractional interest discount for estate tax valuation purposes but then beneficiaries did not claim same discount for discount and rather used an undiscounted value for income tax purposes.New 1014(f) says if included in estate value on return must be basis for recipient.Reporting obligation became effective August 1, 2015 no matter when the decedent died. Even if decedent died before Act must address.This creates burden of reporting to beneficiaries.Notice 2015-57 delayed reporting obligations.What happens with value of assets that are uncertain? If IRS audits and you give in on one issue and horse trade on another. This will have an impact on the beneficiary’s basis. Before this the beneficiary may have taken position that what was on the return was ment: Prior to the Act there was no requirement of reporting estate values to a beneficiary. The estates determination of income tax basis for estate tax purposes was, prior to the Act, not binding for income tax purposes on the beneficiaries receiving those assets. Example: Mom bequeaths a rental property to son and son later sells it. Mom’s executor valued the house at the date of Mom’s death at $2 million. Son, a month later, sells the rental property for $2.5 million and reports the income tax basis at $1.5 million paying no capital gains tax. That may have been permissible under prior law, it is no longer acceptable. This complex sounding change has important practical ramifications for anyone serving as an executor or personal representative of an estate or a trustee of a revocable trust subject to these new rules. It will also change the income tax reporting for anyone inheriting assets. These rules appear to be confined to only wealthy taxpayers subject to the estate tax, since they only seem to apply to estates subject to an estate tax. Executors should exercise caution because the estate tax return may require including new information reporting forms to comply with the newly enacted basis consistency requirements. Income tax return filed by anyone who inherited property from a decedent or a revocable trust formed by a decedent, may include new reporting requirements mandating more disclosures concerning gain or loss on the sale or exchange of property acquired from a decedent. These rules will be designed to confirm the compliance with the new rules regarding income tax basis. Where will beneficiaries obtain that information? From the executors. So transmitting appropriate information to beneficiaries will be yet another issue executors will have to address. How can and should this new administrative burden be handled? The executor or personal representative must provide information to each beneficiary as to the basis of assets distributed. New IRC Sec. 6035, “Basis Information To Persons Acquiring Property From Decedent.” How should this be done? Few executors had in the past sent an estate tax return, Form 706, to any beneficiary. While some executors might be tempted to send a copy of the entire return to each beneficiary to meet whatever disclosure obligation is imposed by the IRS, that quantum of disclosure may prove a significant mistake. That much information in the hands of each beneficiary might result in the executor being inundated with questions about valuation, dispositions and anything on the return. It might prove more prudent to have a schedule prepared for each beneficiary providing details as to the assets bequeathed to that particular beneficiary. This, however, will create more administrative costs and professional fees which executors might object to when they do not perceive a tax savings from the incremental efforts.Estate of Schaefer v. Comr., 145 TC No. 5 (2015).The Schafer case involved two Net Income Make-up Charitable Remainder Uni-Trusts (“NIMCRUTS”).The payout CRT must satisfy certain statutory requirements. The charity’s remainder interest must be10% or more of the initial value of the assets gifted to the CRT. The lower the market interest rates (hence the lower the 7520 rate, and the longer the term of the CRT (or the longer the life expectancy if a payment for life) the greater the risk that this required remainder interest won’t be met because corpus will have to be cannibalized to make the periodic payments to the donor.The annual payout must be a minimum 5% of the initial value of the property gifted to the CRT (this is an annuity trust or CRAT) or 5% of the annual fair value of the trust assets determined each year (this is a unitrust payment or CRUT). The payout cannot exceed 50% of the values.How should the 10% minimum payment to charity be calculated to determine if the CRT is valid? The IRS applied the principals of Rev. Rule. 72-395, 1972-2 CB 340 and Rev. Proc. 2005-54, 2005-1 CB 353. The court concurred. The taxpayer’s position that the existence of the income limitation in the NIMCRUT structure should be factored into the analysis as it would result in more corpus compounding for the charity, even if correct economically, is not to be considered.US v. Marshall, 771 F.3d 854 (5th Cir. 2014).Donee of lifetime gift incurs transferee liability because donor did not pay gift tax and the interest on that unpaid tax (incurred during the time for IRS to chase donor then donee). How much interest can the donee be required to pay? If enough time passes the interest charges could make the aggregate of the tax and interest greater than the property involved. Is the aggregate payment by donee capped by value of property received? The Court held that cannot cap both donor and donee to value of the property. The rationale for this conclusion is that if a maximum or ceiling existed, once the tax due exceed that amount the donee would have no incentive to pay.Note that the opinion was reissued so that the above citation may not be correct. State law developments.SEC v. Wyle Case.Texas taxpayers trouble with SEC.Southern District of NY (Manhattan).Case being talked about is the disgorgement decision.Jury found Wyle brothers violated securities laws with non-disclosure offshore trusts. What penalty to they incur? Disgorgement action judge is deciding what penalty to apply.Judge is looking for hook to justify penalty she is imposing.The reason they did not disclose was that they feared it would disclose the income tax on trust. So penalty is the income tax and to do so the Court held that the trusts were defective grantor trust. The court went beyond what common tax practice would consider a defective grantor trust.Speaker sees no implications to grantor trusts generally. Issues were not briefed. There is a separate Tax Court case pending on grantor trust issues that will be the test in this area. It is too early to worry about ment: The basis for concluding that the trust was a grantor trust was based on the degree of control the grantors exercised over the trust decisions even though they had no legal right to do so. The trustees were required to take direction from trust protectors (the brother’s attorney and 2 employees). The court viewed these protectors as agents and that there was defacto control and therefore it was a grantor trust under IRC Sec. 674. All investment decisions were made by the brothers. This rationale, some have speculated, might yield the same result under IRC Sec. 2036 as to control. In past practitioners did not have to worry about the grantor’s power in this type of instance based on the Byrum case. But, some commentators have speculated that the Wyly case casts doubt on this conclusion and further suggested that practitioners should consider carefully how decisions are made in such trusts. Apparently, not everyone shares that view.Jimenez v. Corr., 766 S.E. 2nd 115 (Va. 2014)Two children active in business, son gets control.Shareholders agreement give stock in equal shares to two children.Issue is whether the trust or shareholders’ agreement controls. This is relevant to which child gets control.Court determined the later and more specific document controls. Stock split between children equally.Consider implications of this litigation. Drafting attorney who drafted stock purchase agreement will likely be sued. Did same draftsperson produce estate plan and stock purchase agreement?Even if a subsequent representation the coordination should have been ment: This points out a common estate planning issue affecting clients with complex closely held business interests, namely the coordination of the myriad of documents involved in the planning. If the underlying entity governing documents are not coordinated with the estate planning documents then havoc can result. The implications of this issue are even broader. If transfers of entity interests are made to a trust, does the entity even control the assets/property that is assumed? What if after the estate plan is in place the client hires other counsel to update entity documents? What if the client’s general real estate or general practice attorney handles the entity work and refers the client to specialized estate counsel only for the trust planning? If an S corporation is involved did/will the general practice attorney understand the nuances of S corporation planning and what should be included in a shareholders’ agreement? This case points out what is likely a very common problem that is often created and exacerbated by clients not understanding the importance of planning and believing that minimizing legal fees, rather than assuring coordinated legal documentation, is the primary goal.Trimble Trust, 826 N.W.2d 474 (Iowa 2013).UTC has been adopted in about 30 states.Sec. 603 treats revocable inter-vivos trusts as the equivalent as a will. While the settlor is alive the trustee has no duty to anyone except to settlor. It is as if drafter of UTC’s view was that a revocable trust is a will substitute and no one should have an interest in the estate other than settlor.Settlor was sole trustee of revocable trust and ceased serving 8 months before death. One child took over as successor trustee and served until the settlor’s death. Claims of impropriety in arose. The non-trustee child asked for accounting and trustee-child said UTC 603 provided protection and no accounting was required as child/trustee’s only duty was to settlor. The course of action was for the executor of the decedent’s estate, not the non-trustee child of the revocable trust, to request an accounting of the child/trustee. If the child/trustee was also the executor the non-trustee child could ask the court to have a temporary administrator appointed to seek an accounting.Key current issue is elder financial abuse and this will have to be ment: With the aging population revocable trusts are a common tool for planning for the settlor’s disability. During disability there may be a range of provisions to benefit others. For example, the prevalence of boomerang children who require ongoing support into adulthood might give them important interests in having a parent’s pre-disability largess continued. If the settlor has adult incapacitated/special needs children support for them too may be vital. Few individual trustees take any steps to account for their role as trustees. These issues are likely to arise with increasing frequency.Smoot v. Smoot, 2015 WL 2340822 (S.D. Ga. 2015).Life insurance paid to the decedent’s former spouse was included in the taxable estate. The decedent’s child endeavored to have that former spouse pay the tax attributable to the insurance. Thus, the issue was who pays estate tax attributable to estate tax inclusion and does that also include interest. IRC Sec. 2206 does not address interest. The court held that interest should be treated no differently than taxes. While a will can override state law to hold that a beneficiary is not liable for taxes on a bequest of even non-probate property, can the will impose estate tax on non-probate property (i.e., the insurance)? The court found that the will made before a divorce is finalized is interpreted as if the ex-spouse predeceased. Therefore the will provisions governing this were not relevant.Most matrimonial attorneys don’t understand or address tax allocation issues.Should apportion tax liability to former spouse who is getting insurance or annuity.GA is one of only four jurisdictions that puts tax burden on residue. Most states apportion to non-probate property. In 47 jurisdictions can say tax to be paid by former spouse.Should consider where to apportion the tax ment: Post-divorce every client should revise all of his or her estate planning, review and update his or her financial plan, etc. However, most clients after a divorce are often unwilling to incur addition legal fees to address planning and leave in place outdated planning and documents that cannot possibly serve them post-divorce.Hamel v. Hamel, 299 P.3d 278 (Kan. 2013) and Parker v. Benoist, 160 So. 3d 198 (Miss. 2015).In terrorem and binding arbitration considerations. Litigation is exploding. Is an in terrorem clause enforceable?The majority trend is that in terrorem clauses are not valid unless the contest is found to have been brought in bad faith (did not have reasonable prospect of success). Issue – what does a “good faith” contest “look like”? What are “reasonable grounds” for a challenge? What suit is not “frivolous?”In the Hamel case the beneficiaries relied on the advice of a disinterested counsel sought in good faith after disclosure of all the facts.Restatement (Third) of Property Sec. 8.5 comment c “evidence that would lead a reasonable person … to conclude that there was a substantial likelihood that the challenge would be successful.”Mikel v. Comr. 109 TCM (CCH) 1355.Significant case. Why only a TCM?IRS argument that gift tax annual exclusion was not available because the Crummey powers were illusory.Each spouse gift split and each spouse claimed 60 annual exclusions on gifts of real estate by each of the husband and wife to descendants and spouses of descendants [60 x 2 x $14,000].IRS was limited because of the Christofani upheld similar planning, so the IRS tried a different approach to challenge this large annual gift plan.The IRS argued that a binding arbitration provision means beneficiaries don’t have enforceable rights so annual demand power does not work. The court rejected the IRS argument that a legal enforcement of a Crummey power must take place in state court. Comment: The provision was a religious provision presumably included because the taxpayers were Orthodox Jews and did not want the children/descendants bringing litigation against each other in a secular court. So instead, disputes had to be brought to a religious court, or Bet Din. If a beneficiary/donee brought an action in secular court the provisions would exclude them from being a trust beneficiary. These are all common religious provisions used for many faiths to encourage that issues that might have a religious implication, and other matters, are addressed by a religious body and not a secular court.If IRS succeeded it could have jeopardized annual exclusions if an in terrorem or binding arbitration provision was used in the transaction.To reach the result that beneficiaries had legitimate withdrawal powers court concluded that arbitration did not apply to withdrawal right. Court also found that under NY law binding arbitration provisions are not enforceable unless consented to. So court effectively concluded that there is no binding arbitration or in terrorem problem.Speaker anticipates we will see this issue again.Subsequent to the taxpayer’s victory the taxpayer brought action asking for attorney fees but this was rejected by court.See McArthur v. McArthur, 224 Cal. App. 4th 651 (2014) which refused to honor a Christian dispute resolution provision that mandated binding arbitration. Brunton v. Kruger, 32 NE 3d 567 (Ill. 2015).Privilege versus confidentiality.Taxpayer argued that accountant and attorney privilege should be construed similarly. Court said no and they said accountant privilege is like a work-product privilege and CPA can deny access to work-product so estate of decedent cannot waive privilege.CPA had already disclosed information the plaintiff wanted in the estate litigation. Court reminds us that if you waive privilege as to one you waive as to all.Harrell v. Badger, 2015 WL 4486610 (Fla. Dist. Ct App)Decanting is not always assured.In this Florida case the parties wanted to decant into 1st party SNT, a pooled fund approach.The Court held that the decanting violated FL law because the entity running fund was not a beneficiary of the initial trust. Court said you cannot decant into a trust with a new beneficiary.Decanting is a power of appointment so you can only appoint among permissible appointees.Must ever beneficiary of old trust be beneficiary of new trust? Kaestner Family Trust v. North Carolina, 2015 WL 1880607 (NC Super. Ct).Can NC tax trust if a trust beneficiary is a NC resident?If distributed income to resident no question that NC could tax that income. The issue in case was whether undistributed income still held in the trust could be taxed?A beneficiary residing in state is not sufficient connection for NC to tax trust.Connections that might be adequate is where did settlor reside when set up trust? Where is trust administration conducted? Planning – should consider when designating trustees consider state income taxation exposure.Zahner Eastern PA.Medicaid spend down planning.Safe harbor that said annuity is safe asset.PA was challenging annuities individuals purchased to get under safe harbor because they were short term 12-14 months. Because they were so short term they were losing money.Court held the annuities were a sham because they were not economically sound so they were a resource that could be reached. Court rejected the challenge and held that an annuity is an annuity.If state reviews client might fail if they don’t continue to roll over the annuities if suing short term annuities. Freezing, Time Value of Money, IRA to Roth, etc.Overview.Estate planning techniques share a rationale for their success. However, it is not what most practitioners understand it to be. Estate freezing, using gifts, installment sales to grantor trusts (the “IDGT”), GRATs, CLATs, sheltering the unified credit, or rolling an IRA over to a Roth IRA, all depend on one unique similarity, which is paying gifts taxes “early” by selling assets that will not appreciate in value over time to pay the gift tax. Selling assets that are not expected to increase in value allows one to use assets that are expected to appreciate over time for the planning techniques. The true benefit of these and other forms of planning is not always what practitioners anticipate. Consider the true economics of various successful planning techniques. Basis step up may be more beneficial than any gift, estate or GST tax savings.Estate Freezing.Should you give an asset today at a low value or wait and gift it away in the future at a higher value. Freezing suggests gifting today to avoid tax on the appreciation. That is not true. In a flat tax system estate freezing is not as relevant. $2M gift or triple in value to $6M and incur 40% tax now or then. Estate freezing doesn’t work in a flat tax world since the net amount transferred is really the same. If the donor pays 40% marginal tax today on a gift of the net value to the donee, versus holding the asset to appreciate and the estate pays tax on the appreciated assets bequeathing the net of tax result to the beneficiary, it is economically the same to the donee.Time value of Money.Discount to present value may be based on assumptions that were wrong. Time value of money suggests intuitively that a tax should be deferred so that the funds can be invested. While this may feel advantageous if the tax rate remains the same there is no economic advantage.Consider three different planning scenarios: rely totally on portability, determine the optimal marital deduction or make a bequest that equalizes estates between both spouses. The net economics of each are the same if all other factors are held constant.The key is whether you use exemption or marital deduction on gift. This is the principal that provides the benefit.Is it advantageous to use exemption now or in the future? While some practitioners might believe it is advantageous to incur a gift tax now to transfer an asset, that conclusion may not be correct. It doesn’t matter when you pay the tax. Acceleration or deferral makes no difference. If no change in value doesn’t matter when you pay.If you factor into the analysis tax on the appreciation of the assets that would have otherwise been placed into a credit shelter trust (remember the exemption is cold since it does not increase in value) the results of portability suffer as compared to other approaches. This is because appreciation is included in the survivor’s estate, but the credit shelter amount did not grow. Presently the marginal estate tax rate is 40% and the marginal capital gains rate 20% so that generates a negative spread with portability.What if assets decline in value? If values decline portability is king.The can be valuation opportunities that independently will make a planning technique provide economic benefit. Example, the assets transferred will produce more income than the income the IRS gift tax calculations assume will be generated.Hot versus Cold Assets.Use cold assets to pay tax on hot assets. That is the key benefit to planning.Hot assets will appreciate significantly, cold assets will not. If you pay the tax with cold assets and retainAssume all “hot” assets (i.e., all assets will grow substantially in value). If all values will increase are you better or accelerating or deferring payment of estate tax? It doesn’t matter. If all assets are growth assets they will increase in value. But you get the same net result either way (again, holding all other factors constant). The “coldest” asset is the unified credit. It is a “deposit” to pay tax. It doesn’t grow so this is the best asset to use early to shelter future appreciation.The benefits occur if the estate is a “half-hot” estate. That is, half of the assets will have a flat value and half will increase substantially in value, e.g. double. If you pay the tax using the assets that will not grow in value to shelter assets that will grow in value there is economic benefit. This benefit is not because you accelerated the tax as in a typical estate freeze, but rather because you used cold not hot assets to pay the estate tax. In marital deduction planning is if you choose to accelerate the tax what will you use to pay the tax? Do you have expendable assets to prepay to thus shelter the growth on other assets. This is why survivorship insurance may be a “sucker bet” in that you might be better off using single life insurance to shelter assets by paying tax on first death.IDIT.Why does it work?Most people that create them do not pay gift tax on creation by relying on unlimited marital deduction or unified credit/exclusion amount. Super charged credit shelter trust.What is the advantage of this technique?Pays income tax without making an additional gift.Consider capital appreciation. Consider that if you make a transfer today it is not only that the asset grows income tax free but also that the income tax paid escapes the gift tax. When a client creates a trust today you are paying gift tax on discounted present value of the income interest and discounted present value on remainder interest. There may be an economic benefit in the discounting. The real advantage is estate freezing. You are transferring a lower value today then you would transfer if you wait.This technique works because we don’t pay gift tax on the creation of the trust.GST.Direct skip is the most efficient useTaxable termination is tax inclusive is least the least efficient use.Converting a Regular IRA into a Roth IRA.Is conversion a good thing to do? Rolling a regular IRA into a Roth accelerating the income tax worth doing?Rolling to a Roth provides no benefit if you are only planning for the lifetime of client. The benefit arises if rolling to a Roth that will be held for another generation. The difference is growth over a long period of time. But in a flat tax world accelerating the tax is not beneficial. The real benefit of a Roth conversion is if you pay the income tax on the rollover from assets outside the Roth. Assets inside the Roth are “hot” assets in that they will grow free of income tax assets outside the Roth are “colder” in that they are subject to income tax.In every state 9other than CT which has a gift tax) you avoid state estate tax. In Washington State the tax is 19%. The maximum rate in other states with a state estate tax is 16%. So a conversion removes the value that you paid in tax from the state gift tax system.State income tax and basis are key considerations Powers of Appointment.Overview.Powers of appointment provide great flexibility. When used properly they can be used to enable the power holder to re-write the terms of a trust, extend the terms of a trust, or address changed circumstances without creating adverse tax consequences. The creation and exercise of powers of appointment, however, pose a number of property and tax issues that are frequently overlooked by practitioners. Powers are affected by a number of property and tax issues related to non-fiduciary powers of appointment.Consider implications to both drafting powers and administering trusts containing powers.Definitions.Uniform Powers of Appointment Act (“UPOA”).As of July 2015 only enacted in Colorado and Montana.Definition.Property law defines a power of appointment as a nonfiduciary power given by the donor to the donee/powerholder to direct the disposition of assets held in trust. Sec. 102 UPOA.Tax law defines power of appointment as a power held in a fiduciary or nonfiduciary capacity to distribute trust property, alter or amend the terms of at rust or even to remove and replace a trustee. Treas. Reg. Sec. 20.2041-1(b).General power of appointment (“GPOA”) is one that can be exercised in favor of the powerholder, his estate, his creditors or the creditors of his estate. Limited = Special = Nongeneral power of appointment (“LPOA”) – one that is exercisable other than to those listed under a general power.Uses of Powers of appointment.Powers can be used to infuse flexibility into trusts. The powerholder can rewrite the terms of a trust, extend a trust’s term, address changes in law, or circumstances.A GPOA can be used to take maximum advantage of a beneficiary’s estate tax or GST exemption by causing estate inclusion of trust assets. This can provide the coveted step-up in income tax basis.Controlling Exercise of Powers.How can the unintended exercise of a power be controlled?Beneficiaries could be given right to remove and replace the powerholder with a non-related non-subordinate party. IRC Sec. 672; Rev. Rul. 95-58.Who is included in the class of persons eligible to receive property under a power? Will a child born out of wedlock, an adoptee be included?How far can the indirect exercise of a power extend? If a power permits appointment to children and the power is exercised giving a child the right to appoint to a third party such as a charity (i.e. a donee exceeding the original scope of the power) is that exercise valid? Perhaps.If a power is directly exercised to a degree that extends beyond the terms of the power? That is a fraud on the power and not permitted.Agreements governing exercise of a power.Agreement governing the exercise of a presently exercisable LPOA is valid if no benefit on donee. UPOA 405.Agreement to govern exercise of a testamentary power is generally invalid.Creditor Issues.If powers are granted what exposure to credits can they create?LPOA won’t create exposure to powerholder’s creditors unless the powerholder previously owned the property to the trust in violating the rules against a fraudulent conveyance.GPOA whether a creditor can reach trust assets by virtue of a GPOA will depend on who the donor was and whether or not the power was exercised. If the powerholder also created the power his creditors can reach the assets. UPOA 501. If the powerholder can exercise the power it may be reachable by his creditors. UPOA 503. A testamentary GPOA created by another party is under the UPOA 541 reachable by creditors but under many state laws it is not.A spouse may reach assets under a deceased spouse’s estate, under some state laws, that was subject to a GPOAState law.Which state law governs? The law of the jurisdiction where the creator of the power was or where the holder of the power (donee) is?If the instrument specified a governing law, that should control.Issues as to creation, revocable or amendment of the power are governed under the laws of the donor’s domicile.Issues as to the exercise release or disclaimer of the power are governed by the laws of the powerholder’s domicile.Perpetuities – original period to apply. Power relates back to original donor of the power. Exception for Delaware tax trap.Tax considerations.Exercise of a lifetime LPOA is treated as a taxable transfer if the donee had a beneficiary interest in the property. Example, if donee has income interest in property exercise of the lifetime LPOA results in a gift of that income interest. IRC Sec. 2511 Rev. Rul. 79-327.Reciprocal trust doctrine concepts may be applied to trusts with LPOAs. PLR 9451049.A power is not characterized as a GPOA for tax purposes if requires consent of a person holding a substantial adverse interest. IRC Sec. 2041(b)(1)(C); 2514(c)(3)(B). Another trust beneficiary may not suffice to meet this test. Disclaimer of power effective if meets requirements of IRC Sec. 2518.Business Succession Planning.Overview.So many family businesses fail to successfully transition from one generation to the next besides having to satisfy an estate tax burden. Non-tax reasons disrupt family harmony and adversely affect the transition of ownership of a business from one generation to the next.Examples of families whose businesses were adversely affected by family dynamics. How attorneys and other professionals may assist a client to identify the stress factors that are likely to negatively impact a particular business and advise a client about instilling a family culture that promotes the same goals and virtues. How an attorney may be involved with instituting a proper organizational structure of the business to anticipate and minimize family disputes. Professional responsibility traps and pitfalls that often come into play for attorneys whose practice includes estate and family business succession planning. Insights into various family dynamics that often inhibit the successful transition of a family business from one generation to the next and to offer solutions.Planning and implementing a business succession plan. Statistics.5M+ family businesses in the US.Percentage of family businesses transitioning successfully to the next generation.30% from 1st to 2nd generation.12% from 2nd to 3rd generation.3% from 3rd generation to later generations.Succession Generally.Succession involves the transition of ownership to the next generation and the transition of management to new leadership.Non-tax obstacles to transition are significant.Emotional Tensions.Family business can be source of pride and image to family. Can use family business image/reputation for competitive edge.Strong emotional sentiments can divide the family making transition difficult.Sibling rivalry.Tensions between active and passive owners.Non-active and active owners often have different needs and perspectives.Non-active may believe active are withdrawing salaries/perquisites that are too large.Active members may view distributions to non-active as inappropriate and wasteful of profits that need to be reinvested.Tensions between heirs with children and those without children.Senior generation won’t ceded control over management.Divorce.No qualified (or interested) heirs.Employee morale.Minimizing Succession Obstacles.Formal governance structure.Example, shareholders’ pensation policy agreed upon before disputes munication among management team.Ethical Considerations.MRPC Rule 1.7. lawyer shall not represent client if involves current conflict, if representation will be directly adverse to another client, etc.Confidentiality – MRPC Rule 1.6 cannot reveal information relating to representation of a client unless the client gives informed consent.MRPC Rule 1.4 inform the client of any decision or circumstance. In Terrorem, Mediation, Arbitration, Etc.Overview.How litigation relating to the administration of estates and trusts might be reduced by careful planning prior to the property owner’s transfer of wealth during lifetime or at death. Disclosure.In Terrorem Clauses.Mediation.Arbitration.Pre-Mortem Probate. Why litigation involving trust and estate matters often involves an emotional element not present in most other legally disputed matters. Methods to reduce the risk of such litigation occurring may be unique to such matters. Background matters relating to the climate for such litigation. Specific ways in which litigation or the scope and cost of litigation relating to the administration of estates and trusts might be reduced, including the use of mandatory mediation and arbitration, are presented.Litigation Causes.Often caused by “bruised” feelings.Divorce rate. More marriages then ever with one or both spouses having children from a different union. Less than half marriages last 25 years. NY Times, 9/20/07, P A1.Significant wealth passes outside of wills by operation of law and these non-testamentary transfers have not been subject to efforts to minimize litigation that wills have.State law can cause litigation because of the manner in which it requires proving a will via commencement of a suite against intestate heirs. EPTL 13-4.1-12. The formalities required for an accounting to release a fiduciary are so cryptic that the required reports themselves could trigger litigation.In Terrorem.Disinheritance clause in an instrument. If intestacy no disinheritance possible.Objectant is treated as if predeceased testator.Enforceability depends on and various based on state law.Uniform Probate Code enforce in terrorem only if no reasonable basis to object to the will.Client domiciled in state that will not enforce in terrorem clause:Direct in the instrument that the laws of a state that will enforce the clause should govern. Preferable approach would be to transfer assets to trust and designate a state law governing that inter-vivos trust that will enforce the provision.Bear in mind that many perhaps most challenges to a will are not what is typically considered a will contest. There may be a challenge to the construction of the will, the choice of fiduciaries, fiduciary actions, and so forth. Will an in terrorem clause even if permissible under applicable state law affect these non-will challenge litigations?Consider a broader provision in a trust instrument to protect against a broader range of contingencies.Reducing Disputes.Advise heirs of plan in advance while testator is alive may reduce risk of post-death fight.Request heirs enter into a pre-death contract not to contest will. Issue of enforceability may depend on quantum of consideration. Restatement of Property (third) Sec. 2.6, comment j.Will versus revocable trust.Will with dispositive provisions may be more difficult to challenge than a revocable trust as the standard of capacity is lower for the will. Matter of ACN, 133 Misc. 2D 1043 (Surr. Ct. N.Y. County 1956). However, with a revocable trust no lawsuit (probate proceeding) is necessary to prove the instrument or transmit assets pursuant to the terms of the instrument. The formalities are simpler for a trust then a will so that potential opening for a challenge may be avoided relying instead on a revocable trust.Further, with a trust the settlor has greater flexibility to designate a favorable state law as applying. Fend off undue influence change in trust by requiring the consent of an independent person for the settlor to change the revocable trust.Use Irrevocable Trust.The transfer to an irrevocable trust may be a completed or incomplete gift. If the transaction is structured as an incomplete gift that does not affect the nature of the trust as irrevocable.If a gift tax return is filed that further corroborates the donor/settlor’s intent as to the transfer.The creation of an intervivos trust, coupled with significant funding, may better confirm the settlor/donor’s intent than a will that may take effect years in the future with no current trasnfers.Trust Clauses to address a challenge.Consider a broader clause in a trust instrument to surcharge a beneficiaries share in the event of a challenge to the trustee, contest of the trust instrument, etc.In the event a court may hold a portion of these provisions invalid then direct the court to uphold the provisions to the extent feasible.Mediation and Arbitration as an Alternative.An in terrorem or forfeiture clause may be inadequate. The client might not really prefer a forfeiture and in many instances that type of clause may not address the challenge that occurs. Arbitration may not be viable unless the parties agree to it and state law permits it (will enforce it). One option might be to direct that the Will be probated in a jurisdiction that will enforce mandatory arbitration, like FL.Arbitration could be mandated for more than just a will’s validity (a will challenge) but also in a trust instrument for a challenge to, for example, a trustee’s investment decisions.The arbitration provision could also require parties to keep the proceedings confidential and to waive any rights to appeal the determination.Payment of a bequest could be made contingent on the beneficiary executing a binding arbitration agreement.Ownership/Title Options.Assets that pass by operation of law, e.g. a POD, TOD, joint account, may avoid the implications of a will challenge.Transfer effectuated by the form of ownership, however, is not immune to challenge. When was the ownership format established? Who created it? Pre-Mortem Probate.Some states permit a pre-mortem proceeding to confirm the validity of a will or trust.Alaska, Arkansas, New Hampshire, Ohio and North Dakota permit this.Tax considerations.Will a forfeiture clause undermine a charitable or marital deduction? It appears that it might not if the spouse/charity does not commence the action triggering forfeiture. PLR 8244020.See Mikel v. Comr. 109 TCM (CCH) 1355.IRS Transfer Tax Issues.Overview.Review of current transfer tax audit and litigation issues from the perspective of a seasoned litigator who deals with the IRS on a daily basis. Hard to value assets, formula clauses, GRATs, promissory notes, the IRS’s proposed Section 2704 regulations, and avoidance of penalties.Transfer to IDIT.“Wonderful estate planning tool.”Tax free gifts with tax burn each year especially if grantor is young.Many leverage these gifts with a note sale of discounted assets.IRS is looking at many aspects of these transactions.Valuation discount. What is the appropriate rate?Step-transaction doctrine analysis. When a sale is made to an IDIT what occurs first is a seed gift.Pierre case funded with $10M of cash or cash equivalents then created two trusts. Made seed gift to each trust of 9.5% interests in LLC. That same day she sold interests. Taxpayer’s expert did an analysis valuing 9.5% interest given and sale interests. IRS said transactions occurred on same day and nothing of substance occurred between the two transfers and therefore you should value in aggregate as 50% interests at higher value in terms of discounts. Pierre v. Comr., TC Memo 2010-106 (May 13, 2010).Court agreed with IRS position because of short lapse of time.Taxpayer was only party that put on an expert witness in the case. Expert opined as to a 35% discount. Change facts. What if in Pierre as a 50% interest carried a right of liquidation but the 9.5 and 40.5% interests did not?Recommendation: If you are going to make a seed gift put time between seed gift and date of sale. A month is fine, two weeks is ok but the longer the better. Why not make seed gift of cash. Nothing can then be aggregated.IRS is also looking at FMV of the asset/consideration received, typically a note. Even if a note is at the AFR the IRS may look at the quality of borrower and the security for that note. Is it a balloon note? This is not what the IRS should consider. Quality of the borrower and other factors relate to whether it is a real debt.Is the debt bona fide or is it really a disguised gift.Traditional 2036 argument to ignore LP and include all assets in decedent’s estate referred to as “Big 2036”. In contrast “Little 2036” is bringing back in interest sold.If the decedent owned at death a 1% GP interest. The IRS has argued that if they can bring back 99% LP interest into estate they can then aggregate the 99% LP with 1% GP interest and therefore no discount for lack of control or discount. That case is before the Tax Court.Pierre issue – if you go through 2036 elements one of the exceptions to application of the statute is a bona fide sale for full and adequate consideration. Part gift – part sale found in Pierre you won’t meet adequate and full consideration test and this is a strong exception. Planning recommendation: Make note payments and distributions from LP at different amounts and times. If, for example, the client has quarterly note payments, make LP distributions on different dates and in different amounts, e.g., LP distributions only twice a year. Put distance between payments and distributions from the LP.2036 remains the most litigated issue.Did LP operate in accordance with its terms?Estate inclusion if the decedent retained possession and enjoyment. Court has examined each non-tax reason for the LP put forth by the taxpayer. Estate of Turner v. Comr., TC Memo 2011-209 (2011)2036(a) (2) Decedent retained alone or in conjunction right to designated who will enjoy…. These are distribution powers e.g., held by GP of LP or manager of LLC.Consequences are draconian. All interests bought back into estate into estate at date of death value. See Korby case. On death of first spouse, see Turner, the marital deduction may not protect estate on first spouse’s death. Estate of Turner v. Comr., 138 TC 306 (March 29, 2012)Turner case. H transferred some but not all of units during his lifetime, some LP interests were transferred to non-spouse donees. These interests were included in H’s gross estate under IRC Sec. 2036.The estate passed to surviving W. The Estate argued that even the non-spousal inter-vivos gifts included in the estate under 2036 should therefore be added to the estate tax marital deduction since all subject to marital deduction so no tax. Court said with respect to units owned at death the marital deduction would apply, but with respect to units transferred during life there is no marital deduction because nothing passed to the surviving spouse. The court reiterated that the criteria for a marital deduction include a property interest that passes to or for the benefit of the surviving spouse.In Black case there would be a mismatch between gross estate which is not discounted and size of marital deduction which is discounted because of the partnership being respected. The gross estate is thus larger than the marital deduction.Most taxpayer wins are under the bona fide sale provision.Two part test.Adequate consideration is the easier component.Is value of contributed property credited to capital accounts?Bona fide sale requires a significant and legitimate non-tax reason for creating the entity. There is often more than one good reason. It is essentially a “smell” test. It is a case by case analysis.Centralized management. Stone case. Taxpayer was 86 and had inoperable cancer. Centralized asset management involving family members.Kimble Mrs. Kimble 86 years old and son managed.In Black he was 91 and putting assets into LP for management was a good non-tax reason. Son’s possible divorce was a concern. Stock in the company was not publically traded and Mr. Black was the second largest shareholder. Erie stock was concerned about the son’s marriage. After Mr. Black died son was in fact divorced and the stock was not touched in the divorce (presumably because of the planning). The stock that was pledged for a loan, in contrast, was divided in the divorce. The divorce lawyer testified for benefit of the partnership in the divorce proceeding and estate lawyer testified as to taxpayer’s intent.Asset protection has been held appropriate in some instances but has been viewed as more of a “technical” argument in others.Preservation of investment philosophy. Mrs. Church put family ranch into LP to avoid partition proceeding and preserve the family ranch for future generations. Avoiding spendthrift conduct of future generations. LP can provide control over ability to spend. Mr. Murphy wanted to benefit his children equally. Two children shared his investment philosophy and two did not and they also had creditor issues. The LLC that was the GP of the LLC was owned 49% by Mr. Murphy and the remainder by the two children of similar investment ilk equally. Mr. Murphy was a tie-breaker with 49% control. All children owned the LP interests equally.Retained right to possess or enjoy 2036(a)(1)Issue with personal use assets.Strangi had home in LP. This was not how arm’s length parties would structure an arrangement.Avoid use of LP/entity for personal use assets unless there are asset protection concerns. Use a separate entity for say a house to avoid exposing liability of securities in main LP, and avoid Strangi issue.Keeping accurate books and records is critical to success in many cases.Using POA to create entity. Was there anyone else involved to enforce the fiduciary obligations?Turner Case – Mr. Turner had unilateral right to amend the partnership agreement.Cohen Case guidance as to whether or not and under what circumstances senior family member who contributed assets can make distribution decisions. Estate of Cohen v. Comr., 79 TC 1015 (1982). Senior family member had distribution power. The agreement did not say unlimited power so that could be arbitrarily exercised but had positive limits on the exercise of discretion. Power to make distribution decision subject to reasonable limit on discretion (i.e., not sole and absolute) then 2036(a) (2) is not applicable. The court in its analysis emphasized the fiduciary obligations a majority shareholder and corporate officer had. The court made comparisons to the corporate structure in the Byrum case and the Massachusetts business trust it faced in Cohen. If the agreement gave the trustees unlimited discretion so that dividends could be arbitrarily and capriciously withheld or declared that would constitute a right under IRC Sec. 2036(a)(2).Planning point – structure distributions in a manner that will be arm’s length. Mandate distributions of available cash flow over reasonable reserves determined by the GP through the exercise of reasonable discretion and subject to reasonable standards listed such as payment of expenses, etc. This is a “reasonable” standard and should suffice to negate application of 2036.The investment power is not a 2036(a) (2) power. The Byrum decision made this clear.So should a senior family member be a GP? Preferably no. If the deal won’t get done otherwise, then use it, but have limits on the exercise of distribution powers, etc. Murphy – children served with senior family member was positive.Planning for the dispute with the IRS on these issues begins at the estate planning stage, not when an audit notice is received.In many successful cases the contemporaneous documentation that addressed and corroborated non-tax reasons was quite strong.Valuation decisions.Clients want to see discounts that should be available. Not feasible to do.A review of cases reflects discounts are “all over the board.”Discounts.Regulations to restrict discounts have been discussed since 2007. 2704(b) partnership agreement provides only liquidate with unanimous consent might default to state law. Many state legislatures revised default rules to adopt the terms of the partnership agreement so 2704(b) has no practical teeth. 2704 permits disregarded restrictions to be ignored e.g., a family owned interest.Changes might follow Obama Greenbook. Some think government may impose its own standard, may address assignee issues, and may provide that if charities own interests they will be considered family owned interests.Will the proposed regulations if issued be valid extensions of the government’s regulatory authority?Formula transfers.Provide protection by defining dollar value of hard to value assets.Defined value clauses as finally determined for gift tax purposes like Petter and Wandry. Estate if Petter v. Comr., 98 TCM (CCH) 534 (2009); Estate if Wandry v. Comr., TC Memo. 2012-88 (Mar 26, 2012).Defined value clause in McCord -- the donees must agree amongst themselves as to the allocation.Reversal cases like Proctor do not work. Comr. v. Procter, 142 F.2d 824 (4th Cir. 1944).1944 case. Proctor transferred a specific number of shares of stock to trust for his children and the agreement provided that if court determined different value some of those shares would come back to Mr. Proctor.Court found that the clause was ineffective and void as against public policy by imposing a condition subsequent.Tax Court citing Proctor, Ward v. Comr., 87 TC 78 (1986), Harwood v. Comr., 82 TC 239 (1984), aff’d, 786 F.2d 1174 (1986), and other cases ignored defined value clauses.Much has occurred in formula area. Regulations allow formula marital and GST transfers, split interest charitable transfers based on formulas, and formulas in GRAT that if asset value determined to be a different value the amount of the annuity is adjusted. All these are triggered if value of property is determined to be different then the reported value was. So much has changed since the Procter decision.McCord 5th Circuit decision involved 6.9M to children/GST trusts. McCord v. Comr., 120 TC 358 (2003). What donees had to do (donors not parties to this) was to allocate units if the values were changed. What they the donor’s transferred in the assignment agreement were units with a value of $6.9M and the balance went to charity. But all units were transferred. If the IRS disagreed with valuation then charity may have made a bad deal, but absent collusion the transaction should be respected and McCord was upheld. Is McCord a good clause outside 5th Circuit? Better to use a Petter type clause.In Petter Mrs. Petter transferred to trust for son and daughter specific units as seed gift and remainder of value to foundation and then a sale of units with the first $4M to the trust and excess to charity. Had 50% discount and agreed to 35% discount before trial. Needed adjustment and IRS did not want to give charitable deduction. Courts held that the clause works. Estate of Petter v. Comr., 98 TCM (CCH) 534 (2009). The fact that the parties disagreed on the value did not invalidate it. It did not violate public policy because Mrs. Petter did not retain anything. The only question was allocation. Christiansen v. Comr., 130 TC 1 (2008) case was similar.Wandry 2012 case. Estate of Wandry v. Comr., TC Memo. 2012-88 (March 26, 2012). What they did was gift LLC units equal to say $1M split among children and grandchildren in dollar amounts determined. Obtained initial appraisal but when on audit a different value resulted there was a change in the number of units. IRS argued that the Procter reasoning should apply to disallow the application of this adjustment clause. Tax Court said no because clause provided a specific dollar value of units. Critical distinction is in state law property rights. Wandry was not a condition subsequent. Would have appealed to 10th Cir. Which approved King.On audits agents are saying that they will not respect a Wandry clause.Preferable approach is public charity or donor advised fund as they have independent fiduciary obligations. Private foundations used in Christiansen but it raises self-dealing and excess business holding issues. IDITs and GRATs and incomplete gift trusts have all be used in these adjustment clauses as the receptacles to hold an excess transfer. As a theoretical matter these approaches should work. Planning recommendation: Use different trustees for the various trusts. Theoretically these will work but there is no case law supporting it.Wandry is a “good decision…and should work.”Reporting these transactions.If you have a Petter clause you need to report on a gift tax return and adequately disclose to start statute of limitation running.Report the transaction consistently with the formula. You are transferring a dollar amount of units not a number of units. Reflect that dollar value of units. The Donor has transferred $1M of units based on values determined, based on appraisal attached, this gift is for X units.” Reflect the formula on the gift tax return schedule. IRS is looking at this.7872 application on promissory notes.IRS is looking at security.IRS is questioning balloon notes.Real issue is to you have a bona fide loan or a disguised gift.IRS has argued that refinancing notes at AFR is a gift. There is a good argument that this is not correct.At some point do an analysis that the note will be repaid?Factors Courts consider.Reasonable expectation is key.pliance audits.Does agreement comply with 2702.Is GRAT being operated in accordance with its terms?IRS is looking at Atkinson concepts wherein CRT set aside because not operated in accordance with its terms.If set aside entire value would be gift subject to gift tax.Use of hard to value assets to pay annuity.Exercise of swap in GRAT property there may be a valuation issue. Use a Wandry clause in these cases.Adequate disclosure.Be certain to focus on running statute of limitations.There is donee liability. If donor does not pay gift tax donee has liability. Donee’s liability runs one year after donor’s runs and donor’s doesn’t run until after statute runs which won’t begin if not disclosed.Donee liability IRC Sec. 6901 or 6324(b).Comment: See IRS Field Attorney Advice 20152201F. The documentation of the gift on the gift tax return didn’t rise to the level of disclosure required to trigger the beginning of the gift tax statute of limitations.23-Social Security.Overview.Overview of how the Social Security Administration provides workers and their beneficiaries with retirement, disability and survivor benefits.Determine how benefits are calculated and the eligibility requirements to receive benefits.Ramifications of starting retirement benefits early versus at Full Retirement Age (“FRA”) and the potential benefits of delaying until age 70.How benefits are impacted by earned income, unearned income and the taxation of Social Security benefits.Describe collection strategies for married spouses, divorced clients and widowed clients.Direct clients to the appropriate tools and resources made available by the Social Security Administration.Retirement.Set source of income/cash flow that can be readily determined.Increased each year by CPI.Get statements from mystatement. Full Retirement Age (“FRA”).Various by age.66 – If born between 1943-1954.66+ some number of months – if born between 1955-1959.67 – If born 1960 or later.Benefit Level.Reduced benefit - If apply at age 62 for early benefits reduced to 75% of PIA.Regular benefit – if apply at FRA – full retirement age above.Increased benefit – if apply pat FRA. Delay of benefits means greater benefits for each year of delay benefits increase by 8% up to age 70. Delay past that does not increase benefits further.Spousal Benefit.Spouse with no earnings can get benefit of ? of working spouse’s benefit.Divorce spouse can get benefits based on ex-spouse’s earnings record if the marriage for 10 years and single.Surviving spouse can get benefits based on age at which deceased spouse began receiving benefits and age at which the surviving spouse begins to take benefits.Taxation of Social Security Benefits.[MAGI = Modified Adjusted Gross Income + ? Social Security Benefits + Tax exempt interest] = base for determining taxability of benefits.If base above is between $32,000 and $44,000 for married filing joint (“MFJ”) 50% of benefits are taxed.If base above exceeds $44,000 MFJ then 85% of benefits are taxed.Disability Benefits.Two programs:Social Security Disability Insurance (“SSDI”).Supplemental Security Income (“SSI”).To get SSDI:Worked 5 of 10 years if disabled after age 31.Worked greater of six quarters or ? of the quarters from age 21 to when disability began.Must have physical or mental impairment that will prevent from any substantial work.5 month waiting period.Succession Planning.Overview.25-The concerns that need to be addressed for a family business interest when the senior family member retires or dies, depending on what is envisioned. Determining the appropriate estate and income tax planning technique depends upon whether (i) the intention is to sell the family business to an unrelated third-party upon the retirement or death of the senior family member, (ii) the senior family member’s interest in a closely-held business will be sold to the continuing owners of the business under a buyout agreement; (iii) if the senior family member intends to pass on the business to the next generation, how to efficiently accomplish this at the lowest estate tax cost, and how to deal with co-ownership when only some of the children are actively involved in the family business; and (iv) passing on the business to key employees using ESOPs and other financing approaches. Cash flow for surviving spouse.If owner/decedent withdrew most of her economic benefits as salary what will surviving spouse do to access cash flow?Comment: Consider a deferred compensation/salary continuation arrangement.If interests owned by trust how will trustee vote shares and vote for dividends or distributions. What if surviving spouse is trustee? What if child/business employee is the trustee?Are there non-business assets or insurance to fund cash flow needs of the surviving spouse?Business real estate.Owned in same or separate entity from the operating entity?Terms of written lease between real estate entity and operating entity.Long term lease with periodic inflation adjustments to provide long term cash flow to surviving spouse or non-active heirs.Should heir controlling business also control real estate?Heirs not active in business versus heirs active in business.Voting shares to heirs active in business and non-voting shares to non-active heirs? Other options?What market exists for non-voting shares other than to be purchased by voting shares?Trustee.Corporate fiduciaries unwilling to be trustee if corpus is family ment: Use directed trust.Should heir and/or surviving spouse be trustee?Key manager/employee as trustee.Should beneficiaries be given power to remove trustee?Co-trustee with tie breaker provisions.Discounts.Plan for surviving spouse to qualify for discounts.Consider dividing business now between husband and wife and transferring some shares to another so that each owns less than a controlling interest.Each block of stock will be valued separately – e.g. stock in bypass and stock held by surviving spouse. Estate of Mellinger, 112 TC 26 (1999). Since each block is less than 50% discounts should ment: For most estates discounts will reduce basis step up with no estate tax reduction benefit so the opposite planning may be more beneficial.Buy Sell Agreements.Terms should be clear and value current.Is the formula appropriate for the business?If appraisal method to be used who selects appraiser?Should valuation discounts apply?Divorce.Agreement could provide that in event stock is part of a divorce settlement the entity shall repurchase it.Should divorcing owner be given an option to first purchase interests awarded to his or her ex-spouse?Transfers to spouse.Agreement may prohibit transfers to spouse.This could prevent marital deduction on death.Agreement could permit transfer to QTIP on ment: Consider a separate business asset only QTIP that has trustees selected to be cooperative with business.Lifetime transfer of ownership interests.Benefits/detriments of inter-vivos gifts.Lifetime transfers don’t have insurance proceeds to fund payments.Other Comments.Name a family protector with authority to change the plan.S corporation restrictions on transfer to owners who would not qualify to hold S corporation stock.Prenuptial.Overview.Negotiating and drafting pre and post nuptial agreements. Family law and estate planning considerations including federal income and estate tax and state income tax ramifications, of the various aspects of nuptial agreement. How portions of these agreements have been successfully attacked and what can be done to protect the integrity of these agreements.Tax saving ideas that these agreements can implement.General.Gained more acceptance starting in 1970s.Prenuptial entered into before marriage and post-nuptial agreement during marriage.Default rules if do not enter erned by statute if no agreement.Varies depending on whether equitable distribution or community property state.Purpose is to hedge not only against existing law but laws that might be enacted in future.In many states income from non-marital assets is deemed marital. Laws in others states may change.Mobile society so should you count on default state law?In event of death statutory share on estate or in some states on the augmented estate.If marriage terminates by death.Spousal allowance may be modest.Rights to dispose of deceased spouse’s remains.Right to serve as personal mon reasons to enter into nuptial agreement.Change default.Structuring expectation of parties.Protect mutual children.Creditor protection concerns.Protect economically disadvantaged spouse.Protecting family money or family business.Disparate wealth from persona accumulation.Control expectations of prior children.Nuptial Agreements Generally.Many states have enacted 1983 Uniform Premarital Agreement Act of 1983 (UPAA”).Uniform Premarital and Marital Agreements Act of 2012 on CO and ND have adopted so far.Look to Act if no law on point in determining for example validity.Case law varies from state to state and supplements and interprets law as to pre and post-marital agreements.Most states have requirements for what an agreement must have to be valid.Cannot be unconscionable when executed.No unfair disclosure or a waiver of disclosure. If you made disclosure and acknowledge that it is fair and reasonable then analysis should stop at that point. If there is a waiver that can be relied on. If no waiver may be able to impute adequate knowledge to signing spouse. This may occur with very high net worth people.Confidential relationship doctrine creates higher level of fiduciary obligation between spouses. This creates a higher level of responsibility as it relates to disclosure. So a waiver may be trickier if in a confidential relationship state so disclosure instead of waiver there is more important.Estate planning content.Lifetime gifting.Filing income tax returns joint or separate.Finalizing and executing.In writing. Do not rely on any oral arrangements.Statutory requirements for execution such as testamentary and provisions requirements.ERISA waivers – to waive right an ERISA waiver must be re-documented after the marriage. Witnesses a good idea even if not required.Maintenance of originals.Consider video or transcript. Especially if sports figure, wide disparity of wealth, close to wedding date or other issues.Separate counsel. Have spouse formally retain separate counsel to document retaining separate counsel. If no separate counsel must have acknowledgement by other party that you are not representing them and that they had resources and opportunity to hire separate counsel. Existence of separate counsel risk of challenge far greater. Also consider separate but equal counsel. If separate counsel is a new solo general practitioner and you are experienced published specialist it may not really constitute separate counsel.Nuptial agreements generally.Enforceability. Generally prenuptial agreements done properly are enforced.Pre- 1990 vs. post 1990.UPAA.In writing.Must be voluntary.Must be conscionable unless there was full disclosure when executed.Must be pursuant to disclosure of financial information unless expressly waived.Unanticipated intervening circumstances have not made the terms unreasonable.Partial enforcement. Property settlement may be enforced but alimony provisions may not be. Courts won’t leave spouse in position where he/she cannot support himself/herself. Example: W gets home in agreement. At time of divorce H’s non-marital wealth has remained intact but there is no home a court may provide an equivalent settlement to the W even if residence does not exist.Burden of proof.Timing.Enough to avoid duress or undue influence.30 days is minimum.Ideally before invitations go out.Sign at last one week before the wedding.Begin discussions (= retain lawyers) the sooner the better.Cases have permitted/enforced agreements signed the day before the wedding. If negotiations had been ongoing for a while it supports the arrangement. Contrast this with the non-moneyed spouse getting the agreement for the first time the week of the wedding.Consider giving series of payments after execution of agreement and after wedding to the non-moneyed spouse. Each time a payment is made/received it may be interpreted as a ratification of the agreement/contract. Content.Day to day marital rules and expectations such as frequency of sex, completion of house chores, are generally not enforceable.Other non-monetary financial provisions such as weigh gain, living in one location are not enforceable.Sometimes in makes sense to include provision even if unenforceable. If they subsequently divorce these provisions may not be enforceable it may be good evidence of intent of parties when married. This may be persuasive to court even if not enforceable.Drafting considerations.Consider average judges ability to read and understand contract.Avoid unrealistic accounting practices.In some jurisdictions can amend or do a post-nuptial to fix mechanisms that were not observed.Document all financial disclosure.Keep copies of correspondence corroborating what was given.Have parties sign listing of disclosures made/received.Include express waivers for hard to value assets.Include an express waiver of additional information as to that asset.Example using estate planning appraisal of family business which is relied on for the prenuptial agreement. If in 10 years asset is worth much more it could raise an issue.Acknowledge that the parties may inherit or be gifted assets not contemplated by the agreement.Be wary of alimony waivers in long term marriages. In 20 years of marriage may want to have an agreement as to maintenance buyout. More likely to be enforced if some amount then a waiver.Include provisions that permit creativity in estate and financial planning. For example, there is maintenance buyout provision make sure that trust is in lieu of and not in addition to the maintenance buyout. If not clear and there is a later divorce spouse will ask for both?Post-Nuptial Agreements.What can estate counsel do if couple/client wants a post-nuptial? May be best to recommend that each spouse retains his and her own matrimonial counsel.Why use post-nuptial.One spouse has been naughty and the agreement is a plan to save a marriage.Some are used to plan for divorce by simplifying future issues.If one spouse wants to be in the marriage and the other wants out of the marriage caution should be exercised.Uses.Document verbal agreements made prior to marriage but not formalized as prenuptial agreement.Clarify rights with respect to commingled, community or separate property. Clarify accounting procedures that were not adhered to.Address family wealth transfer or business succession planning.Address assisted reproductive technology issues.Modify an existing prenuptial agreement.Enforceability.Post-nuptial agreement does not contemplate divorce which is what a property settlement agreement does contemplate.Post-nuptial will have same execution requirements as a premarital agreement to be valid but there is a higher standard for disclosure of information and fairness. Waiver of disclosure is quite risky in a post-nuptial agreement unless there is a specific statute to rely on. Courts are more likely to be protective and consider fairness of a post-nuptial agreement then a prenuptial agreement. If presented with an unfair prenuptial agreement they can choose not to marry. If presented with an unfair post-nuptial agreement there is no choice. Some commentators argue the opposite. There is no time limit for a wedding as in an prenuptial agreement and there is likely more information. Document that a more powerful spouse did not impose his will on a less powerful spouse. If there is any indication of domestic violence it will be very difficult to enforce.Waivers.What should be considered when waiving potential or actual rights.No rights to children such as custody or financial rights can be waived in a prenuptial or postnuptial agreement.Example a waiver of attorney fees should be segregated as to waiving fees as to child related and not child related.If include property settlement rights and interests if you don’t specifically state you are not following statute you may create a problem. Example: new definition of marital property in the post-nuptial agreement. Illinois statute refers to dissipation or waste in other states. If waste assets during marriage break-down it could be treated as a distribution to that spouse. Discussing definition of marital property but because agreement did not void this aspect of the statute the dissipation claim remained valid.Massachusetts can inquire about potential inheritance.Tax considerations.Consider income and transfer tax implications included in agreement.1041 property settlement in divorce. Settlement between spouses are income tax free. Income tax free if between former spouses if specified in decree. 1 year before or within 6 years after if pursuant to terms of decree.Basis and capital gains spouse will take carryover basis.Watch citizenship.Alimony rules.Support paid pursuant divorce decree is subject to rules. Recapture rule if pay support over short period of time it could trigger recapture rule. If amount of support drops too quickly it could be reclassified as a property settlement instead of alimony.Anti-Lester rule. You can combine maintenance and child support as or in unallocated family support that is entirely taxable to recipient and deductible for payor. Per Anti-Lester rule if payments stop simultaneously with emancipation of child the IRS can retroactively reclassify all as being child support. Gift tax IRC Sec. 2516 need to have agreement to make transfer 2 years before or 1 year after gift tax free. Harris rule is a savings clause. If court orders a payment to be made it is not a gift.Alternative to nuptial agreements.Own separate trusts prior to marriage designated as separate property trust and which are maintained as separate property trusts and not commingled.Third party spendthrift trusts created by other family members.Family business entities and documentations.Life insurance planning can provide an option. Use life insurance to replace separate property. Use ILIT.Asset registration; Inter-spouse transfer is only for estate planning purposes and in the event of divorce this is not intended to be your asset.Trusts Created by Parents.Overview.Typically, clients want it all. They want to control how the beneficiaries can enjoy their trusts, to continue to benefit from their assets, and to be protected from both creditors and the tax man. The objective of this session is to explore how planners can use new and existing trusts created by a client’s parents to accomplish all of the client’s planning goals. It will present and evaluate various planning techniques, including non-grantor installment sales and the creation and use of the Beneficiary Defective Irrevocable Trust (“BDIT”), with particular attention to the income, gift, estate, and GST tax consequences of various planning techniques. The material will also address how these trusts are initially funded and what can be done to insure that they will not be disregarded by the IRS or the courts.Advantages of being a beneficiary.Trust provides creditor protection.Transfer property without transfer taxes from a trust.Control over investments.Hire and fire trustees within limits.Long term/dynastic trust, e.g., formed by parent.Distributions could be in discretion of independent trustee.Control beneficiary can holdTestamentary limited power of appointment.Inter-vivos limited power of appointment. Some commentators are concerned that the IRS may argue that the appointment of property of which the person is a beneficiary is a gift of that person’s interest in the trust. This could be an issue if the income interest is mandatory. Reg. Sec. 25.2514-1(b)(2). It may also be the case in the case of a beneficiary subject to an ascertainable distribution standard. PLR 8535020; PLR 9419007. However, if the beneficiary’s right to distributions is in the discretion of an independent trustee this is not clear.Trustee termination/replacement.Beneficiary can remove and replace trustees. Rev. Rul. 95-58.Beneficiary as Trustee.Beneficiary can be trustee so long as does not hold tax sensitive powers.Beneficiary can control investments.Avoid 2036(b) control over voting stock.Avoid 2042 incidents of ownership in life insurance.Funding.Settlor can fund trust with taxable gifts.Trust can be grantor as to settlor for income tax purposes.Installment sale to grantor trust.Structure of installment sale.Promissory note from trust.Third party guarantee.Use redemption of entity interest from other owners to affect a greater ownership interest in the trust.Seller’s disposition of installment obligation accelerates unreported gain.Death should not trigger installment obligation.Beneficiary Defective Trust (“BDT”).Divergent opinions of commentators from BDT being an ideal planning step to it being controversial and unproven.Use jurisdiction that permits long term or perpetual trust.Form BDT in DAPT jurisdiction to mitigate some of the risks some commentators have suggested BDTs are subject to.Independent trustee can make discretionary distributions to beneficiary only.Beneficiary can be given limited testamentary power of appointment.Beneficiary may be given an inter-vivos limited power of appointment. See possible tax risks noted above.Beneficiary can be given power to hire/fire trustees and to serve as co-trustee subject to restrictions. See above.Tax considerations of BDT.Grantor trust status as to beneficiary not settlor.Beneficiary given Crummey withdrawal right.Lapse of Crummey withdrawal right should not constitute the release of a general power so not more than the greater of $5,000 or 5% of trust assets.What if withdrawal right fully exercised or fully lapsed?Some planners left small withdrawal right that never lapsed.See PLR 200949012.GST allocation should be allocated to trust.Use third party guarantees to support trust purchase of assets.State Taxation: Situs, Property Rights, Domicile.Overview.Income taxation of trusts.Minimize income tax treatment of trusts.What are characteristics of trusts involved?What is situs and governing law?Creditor rights exist because of a general power of appointment? If you include GPOA where will creditor rights arise and different state law will have significantly different impact.State income taxation of non-grantor trusts.A statement designating a particular state as governing law for that trust will not necessarily create sufficient nexus for the named state to tax that trust.7 states do not tax trusts (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming). You can thus create a trust in Alaska or Florida and may avoid state income tax.Some states tax a trust based on a trust being created by a resident of that state or under a will probated in that state. Other states tax based on administration of a trust in that jurisdiction, having individual trustees resident in that jurisdiction or corporate trustees doing business sin that jurisdiction, and a few states assert taxation based on resident beneficiaries.Some states are not easy for a trust to leave for income tax purposes once nexus is established. Source Rules.If you create a trust in a no-tax state like Florida you may still face a state income tax if you have income derived from business interests in another taxable jurisdiction. States have become aggressive on this taxation of trust income. OH case about to go before Supreme Court. OH says if NBA player plays in OH he is doing business in OH and should pay income tax on that business income.How do states source income within their taxing jurisdiction:Intangible assets are treated as located in the state where the trustee is domiciled/based.Income from tangible personal property and real estate is sourced to the state where the property or real estate is located.Business income is sourced to the state where the trade or business is conducted.The only sure way to limit source income sis to use C corporation but that has disadvantages. S corporations raise other issues. States are not as sophisticated about S corporations so you may be able to effectuate some planning. Note NY has a special rule for C corporations with 100 or less shareholders.Place of administration is another basis some states use to tax a trust. The location of administration is a question of fact.NY has taken an aggressive view that if an adviser or trust committee member lives in NY the trust will be taxable in NY. NY TSB-A-04(7)I, (2004).If you have co-trustees in another state and delegate administration of the trust to them you may be able to document that principal place of administration of the trust is someplace else and document that there is no tie with the other state.There is uncertainty as to how various advisers, investment trustees, distribution committees and other modern trust positions will affect state taxation. Comment: This may be a reason to consider creating an LLC to “house” these positions in a trust friendly jurisdiction.Constitutionality of state income taxation of trusts.A state can tax a trust administered in that state or by the trustee being a resident of that state.It is less clear that a state can assert taxing jurisdiction over a trust merely because the settlor was resident in that state when the trust was created or funded.Consider the nexus of the trust to the particular state and the benefits that state affords trust beneficiaries.District of Columbia v. Chase Manhattan Bank, 689 A. 2d 539 (DC 1997) held that DC could tax a testamentary trust created by a DC decedent even though the trustee, trust and beneficiaries were outside DC. Kimberly Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue, 12 CVS 8740 (NC Super. Ct. April 23, 2015).Kimberly Rice Kaestner 1992 Family Trust. Nothing happened in NC. All assets and administration outside NC. Beneficiaries in NC argued no contacts sufficient for NC to impose a tax. NC Supreme Court agreed with beneficiaries.Linn v. Department of Revenue 2013 Il. App. (4th) 121055 (December 18, 2013).Illinois could not continue to tax trust just because formed in that state. On a testamentary trust the place decedent died can always tax trust since trust was created by probate process of that state. Planning point if you customarily use testamentary trusts you may be diminishing the ability to move that trust around. Consideration should be given to favoring revocable trusts instead of wills creating trust.McNeil v Commonwealth of Pennsylvania, 2013 Pa Comm. LEXIS 168 (2013).A trust was created by a PA resident during lifetime, but governed by DE law and administered in DE, no PA assets or income. Discretionary beneficiaries lived in PA could not be taxed in PA. The mere fact that the settlor and discretionary beneficiaries are in PA was not sufficient.Kassner v. Division of Taxation, 2013 NJ Tax LEXIS 1(Jan. 3, 2013); 2015 NJ Tax LEXIS 11 (2015).NJ could tax source income but no other income.The state could not tax undistributed income of S corporations that owned NJ property.Testamentary trust created by NJ domiciliary.Trustee was NY not NJ.Trust was administered outside of NJ.Only NJ portion of earnings of the S corporation should be taxed in NJ. The fact that the trust owned stock in an S corporation that owned NJ real estate was not equivalent to the trust owning that real estate directly.California. CA will tax if have a non-contingent beneficiary in CA or a trustee in CA. If a trust is created for parent and all descendants, and a grandchild lives in CA, CA law provides that there is a CA tax on the trust but frequently no one understands this. There is a position that if you are a purely discretionary beneficiary then that is really contingent interest that should not be taxed. “As to any beneficiary residing in CA the trustee can make or not make distributions in the trustee’s absolute discretion.”Consider using LLC and have managers of LLC and name managers to serve as investment trustee, trust protector, etc. Set up LLC in a different trust friendly state jurisdiction. Expressly provide that LLC cannot act if anyone is in CA. If in CA they cannot act. Does that work. LLC can have a power of appointment.Consider this technique for any DAPT done by a client in a home state that does not have a DAPT statute.Think about LLC intermediary. State might try to pierce LLC veil but that might be difficult.Powers of Appointment.May be able to exercise a power of appointment to change the grantor of a trust and cut off unfavorable state income taxation of that trust.If Mom has trust for Son’s benefit and son has LPOA over trust then mother continues to be the grantor of the trust for all purposes. If it is a lifetime LPOA i.e., mother is still living but son can appoint to modified trust mother remains grantor of trust. Contrast the LPOA with a GPOA. If Son has GPOA when son exercises the GPOA son becomes the grantor for tax purposes. If mother is in CA and paid tax to CA if son has and exercises GPOA son becomes grantor and if son resides in a tax favorable state the state income tax problem may be solved.Distributable Net Income (“DNI”).Minimize state tax by distributing income out to beneficiaries. What about capital gains? What does state law/trust instrument provide?Impact of beneficiary in a high or low bracket?The nub of allocating capital gain to income and getting DNI starts with trust terms. Does trustee do it consistently? “Consistently” may not mean what it means in general usage.Treas. Reg. Sec. 1.643(a)-3(a): capital gains are included in DNI to the extent the governing instrument an applicable state law, or pursuant to a reasonable and impartial exercise of discretion by the trustee are allocated to income, allocated to corpus but treated consistently by the trustee as part of a distribution to a beneficiary; or allocated to corpus but actually distributed to the beneficiary. Thus the terms of the governing instrument an applicable state law must mandate that capital gains are included in DNI or an exception above applies pursuant to a reasonable and consistent exercise of discretion by the trustee under a power granted under the trust instrument or state law.See Sec. 104(a) of the Uniform Principal and Income Act (“UPAIA”). and sign up to follow new principal and income act.NIIT.Advisers should be fiduciaries to count as material participation.But want distributions made out of trust not subject to fiduciary standard.How do you accomplish these objectives?A power to distribute without being subject to a fiduciary standard is to specify that person holding that power is not a fiduciary but rather has a current lifetime power of appointment.September 9, 2015 NY Case - Person exercised power of appointment. There is no fiduciary standard over a power of appointment. Trust is in high bracket and beneficiary is not.Trust is in a high tax bracket, beneficiary is in a low bracket so a distribution will carry income out to a low bracket taxpayer. However, there is a concern that the beneficiary should not have access to the funds that would have to be distributed.What can you do if concerned about beneficiary having money?Create an LLC and distribute 99% non-voting interest to beneficiary.Beneficiary might complain but if trustee has discretion to make distributions give LLC interests and can make distributions into LLC. The distribution out will appear on tax return of beneficiary.This may lower overall income tax rate and thereby increase what beneficiary might receive.Trust modification of an Irrevocable Trust.UTC Sec. 111 – interested persons can enter into a non-judicial settlement agreement with respect to a trust so long as a material purpose of the trust is not violated.UTC Sec. 411(a) permits trustor and all beneficiaries to modify a term of a trust even if it violates a material purpose of the trust. UTC Sec. 411(b) A court can modify a trust with the consent of the beneficiaries if not inconsistent with a material purpose.UTC Sec. 412(a) A court can modify a trust dispositive provisions because of changed circumstances settlor did not anticipate.A trust may be decanted under state law into a new trust that may change situs, distribution standards, etc. Uniform Trust Decanting Act (“UTDA”) gives broad discretion.Difference between decanting and non-judicial modification? If decant trying to avoid beneficiaries having to agree. If all agree it may be a modification. Do you care?Non-Tax erning law versus situs. Governing law is the legal system governing the validity and construction of the trust. Whatever is specified in the trust document will generally be respected.Situs is where the trust assets are or the trust is administered.If you have “A” court applying “B” law. Situs and governing law are generally “close.” Creditor rights and powers of appointment.State laws on GPOAs and LPOAs are limited.Uniform Powers of Appointment Act (“UPAA”) issued in 2013.GPOAs have creditor consequences. Example, if powerholder/done exercise GPOA by will that powerholder’s creditors may reach the assets appointed. At common law the mere possession of a testamentary GPOA did not give rise to creditor rights. Some states have changed this, example Illinois, Michigan.Restatement 3rd says by default creditors can get to assets subject to a testamentary GPOA.Uniform Power of Appointment Act followed Restatement 3rd. By default if state adopts to Restatement 3rd it subjects GPOA to creditor reach. When Act was being drafted no one was thinking about what has become a wide use of GPOAs.Delaware tax trap.You can use this as a means of including assets into an estate to achieve a basis step up.Wherein most states it appears that you could not trigger Delaware tax trap if you wanted to. So that is a problem with the plan.Silent Trusts.State law varies tremendously as to what if anything a trustee must disclose to beneficiaries. Trustee notifications and silent trusts or whispering trusts (tell some but not all)?UTC Sec. 813 requires trustee to keep beneficiaries informed and has specific notice requirements. Every state that has adopted the UTC provisions has modified to some degree the UTC provision.State courts have interpreted the statutes in different ways.Wilson v. Wilson, 690 S.E.2nd 710 (NC Ct. App. 2010).NC decision said trustee always had to provide some information to beneficiaries. NC legislature changed that to provide that trustee doesn’t have to provide information if trust says they don’t. Wilson court said yes we’ve read the statute but trustee is a fiduciary and must act as such. The court felt that the information sought was reasonable and necessary to enforce beneficiary rights and could not be withheld.Directed Trusts.Some state laws permit the trustee to completely delegate investment and other specified functions.Restatement (Second) Trusts Sec. 185 relives a trust if delegation made.Delaware has most comprehensive directed trust statute. Do you want to invoke this? Do you really want the trustee to have such a low level of responsibility? Should you draft to raise liability and responsibility of the beneficiary?If trustee is following direction the trustee is only liable for intentional misconduct.Asset Protection.Overview.Treatment of asset protection techniques that can be incorporated into the professionals’ estate planning practice.Identifying protected and unprotected assets in your client’s portfolio.What exemptions from creditor claims are available under state law for the principal residence (homestead), retirement plans, life insurance policies, annuities, 529 plans and inherited IRAs.Examining creditor remedies under state law against unprotected assets.Evaluating existing and potential liabilities of the client.Developing an understanding of fraudulent transfers under state law and under the Bankruptcy Code essential for the protection of the practitioner.Analyzing the tools available to the asset protection planner in the appropriate situation such as transfers between spouses; asset wrappers; umbrella coverage; irrevocable spendthrift trusts for a spouse and descendants; the self-settled spendthrift trust (asset protection trust).Choosing the law of another state to govern trust agreements or forming entities under the laws of another state. Will the law of the chosen state be respected?Creditors (and predators) involving trust beneficiaries (other than the settlor) under state law.After the plan has been implemented, what steps can be taken to protect family assets into the future.Consider possible claims/liabilities.Gaps in insurance coverage.Claims above coverage limits.Board memberships.Fiduciary positions.Guarantees’.Environmental.Types of assets to protect.Homestead exemption.Bankruptcy Code Sec. 522(d)(1) $15,000 of equity.Can claim state exemption if higher. Example OH $132,900.Tenancy by Entireties.Varies greatly by state.Some states permit only for real property, some limit that to marital residence.Some states permit application to personal property.On death of one spouse protection is lost for survivor’s claims.Life Insurance.State may exempt/protect some part of monetary value of policy.Some states require that the spouse or a dependent be beneficiary.May lose protection if beneficiary is a trust.Annuities.Some states exempt.Rules sometimes track state law exemption for insurance, but not always.ERISA Plans.Broad asset protection under ERISA.ERISA plans must include spendthrift provision.Attack on ERISA plans focuses generally on whether the plan was complain with ERISA requirements. In re Youngblood, 29 F.3d 225 (5th Cir. 1994).IRAs/Roth IRAs.State law protection varies but many provide exemption for IRAs.Bankruptcy Act protection.Exempt up to $1M.Limit does not apply to amounts rolled over from certain qualified plans, e.g., 40(k).529 Plans.States are increasingly providing protection but rules vary.MI no protection. Illinois protected if state’s program. OH protected for distributions made within federal contribution limits.Fraudulent transfers.Any transfer that is a fraud on creditors is not valid.Asset Protection Trusts.Traditional rule that a creditors of settlor can reach trust.Domestic Asset Protection Trust (“DAPT”).16 states permit these.First was Alaska in 1997.DAPT state rules as to exception creditors differ.Child support.Spouse or former spouse with respect to a marital property claim.Secured creditor.Tort.Bankruptcy Code Sec. 548(e)(1).Trustee can reach/avoid self-settled trust corpus if transferred within 10 years of the date of filing a petition in bankruptcy.If it was made to a self-settled trust or similar device.Debtor made the transfer.Actual intent to hinder, delay or defraud.Uniform Fraudulent Transfers Act (“UFTA”).May avoid transfer to self-settled trust if prove debtor/settlor intended to hinder, delay or defraud creditors.Badges of fraud may evidence such intent.State law varies.Narrowest standard is in Ohio and South Dakota where creditor must prove specific intent to defraud particular creditor.Limitations periods.Generally 4 years. Examples: Delaware and Alaska.2 years in Mississippi, Nevada, TN and SD.18 months in OH.Will choice of law in DAPT jurisdiction be respected?Non-DAPT state may attack if violates strong public policy of the state with the closest pleted versus incomplete gift for tax purposes.Third Party Trusts.Spendthrift/Discretionary Trusts.Traditional spendthrift clause. May not be effective against divorcing spouse.Court, depending on state law, may consider trust assets/income in analysis or in some instances even in the division of marital property.Restatement (Third) Trusts Sec. 58 a spendthrift provision is valid unless as to settlor.Sec. 59 exceptions to spendthrift validity include child, spouse or former spousal support or the provisions of necessities or protection of the beneficiaries’ interest in the trust.Divorce.Court may be permitted to apply equitable principals in considering separate property when dividing martial property.Court may be permitted to consider the amount of property division, standard of living in marriage, present and future earning capacity and other factors in making a division.Under some states the divorcing spouse’s interest in a trust settled by a third party, e.g., a parent, can be considered in an overall property award or in determining support. In re Marriage of Benz, 116 Ill. Dec. 336, 518 N.E. 2nd 1316 (App. 4th Dist. 1988).Mandatory income interest is reachable. Fox v. Fox, 592 N.W. 2d 541 (ND 1999). Mandatory income interest is not necessarily reachable. Sayer v. Sayer, 492 A.2d 238 (De. 1985).Contingent future interests may even be reachable. Buxbaum v. Buxbaum, 692 P. 2d 411 (Mont. 1984). Others have taken a contrary view. Loeb v. Loeb, 201 N.E. 2d 349 (Ind. 1973).If the spouse’s interest is completely discretionary it should not be reachable. In re Marriage of Jones, 812 P.2d 1152 (Colo. 1991).Planning recommendation: use multi-generationally, discretionary pot trust.Moving to a Lower Tax State.Overview.State income and estate tax landscape.Illinois imposes both income and estate tax. In contrast Florida and Nevada impose neither.The mass exodus from northern states to more tax friendly states.An overview of the differences between tax residence and tax domicile and an examination of applicable state laws.Examination of rulings and case law regarding tax residency and tax domicile. Review of best practices and checklists for severing tax connection to one state and establishing a tax connection to a new state.Tax savings which may be realized by changing tax connection to a low tax state.Residency/Domicile.Definitions are key to achieving planning goals. Many are nuanced, vary by state and in most instances are quite fact specific.If deemed a resident for income tax purposes home state will tax all income including income outside home state. If not a resident a state can only tax income earned within that particular state. Residence is a taxpayer’s home, but may have a temporary connotation. The Illinois Department of Revenue issued Regulations clarifying whether a person is in state for a temporary or transitory purpose and therefore not a resident for tax purposes. 86 Ill. Adm. Code Sec. 100.3020(c): “…if an individual is simply passing through…will not be a resident by virtue of his or her presence here. If however, an individual is in Illinois to improve his or her health and his or her illness is of such a character as to require a relatively long or indefinite period to accomplish, or is employed in a position that may last permanently or indefinitely, or has retired from business and moved to Illinois with no definite intention of leaving shortly thereafter, he or she is in Illinois for other than temporary or transitory purposes.Residency is generally the litmus test for income taxation whereas domicile is generally the litmus test for state estate taxation.Domicile has a more permanent sense. It is the place where the taxpayer has her true fixed principal and permanent home and to where that person intends to return and remain.The Illinois Department of Revenue issued regulations defining domicile. 86 Ill. Adm. Code Sec. 100.3020(d): “…true, fixed, permanent home and principal establishment, the place to which he or she intends to return whenever absent…with the present intention of making a permanent home, until some unexpected event shall occur to induce adoption of some other permanent home….has fixed his or her habitation and has a permanent residence without any present intention of permanently moving. An individual can have at any one time but one domicile. If an individual has acquired a domicile at one place, he or she retains that domicile until he or she acquires another elsewhere….”More than one state can claim that a person was domiciled in that state. There are no treaties. In re Dorrance’s Estate, 309 Pa 151, cert. denied., 287 US 660 (1932).Much more than tax is at stake. The determination of domicile will determine which state law applies as to intestacy, administration of the estate, creditor rights and more.Proof/Factors:Affidavits.Location of spouse and dependents.Voter registration.Auto/boat registration.Income tax return residency status.Home ownership.Professional licenses.Location of dentist and physicians.Phone and utility usage.Cases.Cain v. Hamer, Ill. App. Ct., No. 1-11-2833 (July 16, 2012)/TP lived in Illinois and hand homes in Ill. And FL. Planned to sell Ill. Home but instead built addition.Filed declaration of FL domicile, changed Ill to FL license, purchased burial plots in FL. 73% credit card purchases outside Ill.Court found that social and civic connections were stronger in FL then in Ill so move was respected. Documentation is key to winning gray fact cases.Indiana Letter of Findings 01-20140470.1999 put home in IN into QPRT. 2004 QPRT ended and TP leased home back from trustee.Key to change in domicile is abandonment of original place of domicile. Lease for home form post-QPRT trustee gave TP responsibilities for home and exclusive use of home. Continuing to rent prior home that had been in QPRT contradicted this change.Steps to Sever Residency/Domicile.Sever connection with old state.Sell home.Spend less time in old state then in new state. Keep a log to prove.Report change of residency to old state voter’s registration office.Surrender old state driver’s license, car and boat registrations, etc.Cancel club memberships, professional licenses, cable, and other in old state.Terminate professional advisers in old state.Establish/corroborate residency/domicile in new stateLease or preferably purchase property/home in new rm Post Office of change in address.File declaration of domicile in new state.Obtain driver’s license, car/boat registrations, etc. in new state.Use new state address on all tax filings.Establish and engage in activities in new state.Spend holidays with family in new state.Join clubs in new state.Document changes and save alarm system, utility and cellular phone reports showing locus of activities in new state.Maintain a calendar of meetings with dentist, CPA and others in new state.Capacity.If client has no capacity cannot change domicile since domicile is based on intent. Rishell v. Jane Phillips Episcopal Memorial Medical Ctr., 12 F.2d 171 (10th Cir. 1993).To change domicile person must be competent enough to understand the nature and effect of his acts. Acridge v. evangelical Lutheran Good Samaritan Soc’y., 334 F.3d. 444 (5th Cir. 2003).Agent under power of attorney may not have authority to change domicile of an incompetent principal. In re Estate of Wilhelm, 134 Misc.2d 448, 511 N.Y.S. 2d 510 (Sur. Ct. 1987). The court reasoned that if domicile is a matter of personal concern and has no bearing on the actions of the agent to care for the principal then the agent should not be able to do ment: Consider a clause in a POA: “Principal expressly authorizes the Agent hereunder to take reasonable steps to maintain or change Principal's domicile from the State to any other state. Principal deems this power and right to be fundamental to the management and administration of Principal’s financial affairs.”Inter-Vivos QTIPs.Overview.The addition of portability brings to the forefront the creation of the lifetime QTIP marital deduction trust as a strategic planning technique that can achieve both estate tax and income tax savings.Can be used to take advantage of high estate tax exemptions regardless of order of death of spouses.Basics of the Inter-Vivos QTIP Trust, from technical requirements to income and transfer tax effects.Use of the Inter-Vivos QTIP in estate plans of all complexities, from beginner (using both the donor’s estate and generation-skipping transfer tax exemptions), to intermediate (using the donor’s applicable exclusion amount as a credit shelter vehicle while potentially achieving creditor protection), to advanced (minority interest planning and as an integral part of the defined value transaction). Interplay between Inter-Vivos QTIP Trusts in leveraging the DSUE Amount and “locking in” the use of the DSUE Amount. Practical planning implications, such as subsequent transfers of Inter-Vivos QTIP Trust interests, use of powers of appointment and divorce concerns.Requirements.A QTIP must give the done spouse a qualifying income interest for life.Gift tax definition of qualifying income interest IRC Sec. 2523(f)(3) applies the estate tax definition referencing IRC Sec. 2056 (b)((7)(B)(ii).Donee spouse must be entitled to all income for life. No person can appoint any trust property to anyone other than done spouse.Must continue for life. Reg. Sec. 25.2523(f)-1(c)(2). Cannot use a floating souse clause as that would constitute a limitation on the income interest of the initial donee spouse.All trust accounting income must be paid to the done spouse at least annually. IRC Sec. 643.QTIP can hold non-income producing assets and personal use assets without being disqualified but donee spouse should have the right to require that the trust produce a reasonable amount of income.The amount of income the done spouse should be entitled to what a beneficiary who is unqualifiedly designated as the life beneficiary of a trust would receive. The trust should produce such income as is consistent with the value of the trust corpus and its preservation. Reg. Sec. 25.2523(e)-1(f)(1).A QTIP election must be made. IRC Sec. 2523(f)(2).QTIP election must be made on a timely filed gift tax return. IRC Sec. 2523(f)(4)(A).IRS does not have discretion to grant extension beyond six month automatic extension. PLR 200314012; PLR 9641023.Rev. Proc. 2001-38 gave executor relief when an unnecessary estate tax QTIP election were filed. The Rev. Proc. Only applies to estate tax and will not affect a gift tax QTIP election.IRC Sec. 2519 Disposition.If the donee spouse gifts any of her income interest in the QTIP it will be deemed a gift of the entire principal value of the QTIP.The transfer that created the inter-vivos QTIP was protected from tax by the gift tax marital exemption. But if the donee spouse gives up some of her income interest to a third party that is fundamentally inconsistent with the theory of the marital deduction.The amount of the gift triggered is the full FMV of the QTIP corpus less the value of any income interest the donee spouse retains, if any.What constitutes a disposition triggering 2519?Investment of QTIP assets into an FLP was not a disposal of the income interest under 2519 although it could have worked as a limitation on the spouse’s right to income. FSA 199920016.The loan of QTIP funds to three children was not deemed a disposition for 2519. PLR 9418013.Income Tax.QTIP is a grantor trust for income tax purposes because the donor spouse is treated as the owner for income tax purposes of any portion of a trust if the income is or may be distributed to the grantor or the grantor’s spouse, or which his accumulated for the benefit of either. IRC Sec. 677(a).This will not assure that the trust is wholly grantor as to the donor spouse as to principal. This can be achieved by permitting the trustee to make discretionary distributions of principal to the donee spouse.If the trust is made wholly grantor (i.e., as to income and principal) it can qualify to hold S corporation stock as a grantor trust. IRC Sec. 1361(c)(2)(A)(i). If not wholly grantor it could elect ESBT status (it won’t qualify as a QSST).QDOT.Intervivos QTIP planning won’t have the same planning consequences when a QDOT is created for a non-citizen spouse because the QDOT assets are taxed in the donor spouse’s estate.Basis Adjustment Under IRC Sec. 1014.General rule is that income tax basis of property acquired from the decedent is FMV of property at date of death (or alternate valuation date).Assets in an intervivos QTIP are treated as included in the estate of the donee spouse under IRC Sec. 2044 and is treated as having passed from the donee spouse under IRC Sec. 1014(b)(10).What if the donee spouse dies within one year? The exception of IRC Sec. 1014(e) may apply to prevent a basis step up. Some argue that property passing in trust and not outright to the spouse is not subject to this exception.Uses of Inter-Vivos QTIPs.Fund Testamentary Use of Donee Spouse’s Exemption.H sets up intervivos QTIP for W and on W’s death the assets in the trust can utilize the donee spouse’s exemption.This enables H to control ultimate disposition of assets.Assets can be protected from donee spouse’s creditors.Fund Lifetime use of Donee Spouse’s Exemption.After funding the donee spouse could gift a portion or all of her income interest in the lifetime QTIP thereby using a portion or all of her exemption.Step transaction doctrine could be applied by IRS to argue that the disclaimer of the income interest was contemplated and the gift transfer should really be attributed to the donor spouse.Use Donee Spouse’s GST Exemption.A lifetime QTIP could be used to capture the done spouse’s GST exemption during her lifetime.Donor spouse cannot make a reverse QTIP election as to the lifetime QTIP trust so that the donee spouse can be the transferor for GST purposes.Grantor Bypass Trust.Supercharged Credit Shelter Trust.Donor spouse creates intervivos QTIP for donee spouse which on death of donee spouse creates a bypass and QTIP back to the donor spouse.Because the trust was included in donee spouse’s estate under IRC Sec. 2044 it will not be included in donor spouse’s estate under IRC 2036 or 2038. IRC Sec. 2041 can still present an issue if donor spouse’s creditors can reach assets.IRC Sec. 2041 – donor spouse remains donor of QTIP even after death of donee spouse. State law rules against self-settled trusts can permit creditors of donor spouse to reach assets in the bypass/QTIP back to the donor spouse following donee spouse’s death. If so donor’s creditors can reach and IRC Sec. 2041 would cause estate tax inclusion. Solution is to use as situs for the trust one of the 16 jurisdictions that permit self-settled trusts or one of the jurisdictions that has enacted inter vivos QTIP trust legislation (Arizona, Delaware, Florida, Kentucky, Maryland, Michigan, North Carolina, South Carolina, Tennessee, Texas, Virginia and Wyoming).Discount Planning.Use intervivos QTIP to create discounts. Entity interests owned by QTIP should not be aggregated with interests owned by spouse. H’s stock passed into QTIP for W. QTIP owned ab out 28% of stock and W owned (in a revocable trust) about 28%. IRS argued to aggregate and thus create a control premium since both QTIP and W’s interests were all included in W’s estate. Court held that the interests were not aggregated. Note that there was independent trustees over the QTIP. Neither spouse should be trustee of the QTIP in this type of ment: Does this suggest that the spouse could be named trustee if estate tax won’t apply and instead wish to cause aggregation to eliminate discounts or to perhaps create valuation control premium. In Nowell Est. v. Comr., TC Memo 1999-15 the court did not aggregate interests even though the decedent and a grandchild were co-trustees.Estate of Mellinger v. Comr., 112 T.C. 26 (1999), acq. 1999-35 IRB 314, corrected Ann. 99-116, 1999-52 IRB 763. The interests should be treated as separate blocks. Although the property is treated as passing from surviving spouse under IRC Sec. 2044 it does not actually pass from that spouse.Receptacle for Formula Valuation Clause.Use a lifetime QTIP as spillover for defined valuation mechanism. The excess value could pour into the QTIP.Est. of Petter v. Comm’r, 653 F.2d 1012 (9th Cir. 2011), aff’d TC Memo 2009-280 (Dec. 7, 2009) for the structure of the valuation formula. Petter did not utilize a QTIP as the receptacle but rather charity.A pay over to a QTIP should not be construed as a Procter reversion.Creditor Protection.An intervivos QTIP can provide protection from claimants if the transfer to the trust is not a fraudulent conveyance.Divorce Planning.Use an intervivos QTIP to provide for future ex-spouse while controlling asset. H owns 100% of LLC. Wants to provide for W post-divorce but does not wish W to have control over the entity. H creates lifetime QTIP and funds it with 49% of the entity. Post-divorce the ex-spouse donee/beneficiary will be taxed on the income from the inter vivos QTIP under IRC Sec. 682 which provides that such spouse shall include in income the amount of the income of any trust of which sous spouse is entitled to receive and which, but for this section, would be included in the gross income of the donor spouse.LISI?Estate?Planning Newsletter #2351?(October 5, 2015) at?? Copyright 2015 Leimberg Information Services, Inc. (LISI).?Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Written Permission.? ................
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