On-Demand: Highlights from the 54th Annual Heckerling Institute on Estate Planning

Karen Goldberg:

Good afternoon, everyone. M. Read Moore of McDermott Will & Emery presented on planning for the GST tax on non-exempt trust. What's a non-exempt trust? He talked about what a non-exempt trust ... it's a trust that has an inclusion ratio between zero and one, which means that the trust is either partially or fully subject to the GST tax when a distribution is made to a skip person, someone who's two or more generations below the grantor transferor. For example, in most cases, it's a grandchild or remote descendant. Mr. Moore noted that in past presentations at Heckerling, that no one has really discussed how the GST tax applies to non-exempt trust. Past speakers have spoken about how to protect the grandfather status of a GST exempt trust, how to make a late allocation, how to fix an allocation, where you should allocate GST exemption, but no one has really spoken about what happens when there's a GST event via a trust.

And, practitioners may feel that they're well equipped to deal with this, been practicing in estate and trust area for many years. Rules should be pretty similar, but the estate and gift tax has been around for more than 100 years. There's lots of code sections, regulations and case law on it, but GST? Well, that's only been around for 35 years. Yes, there are code sections but there are very few regulations and almost case law in this area. I have to tell you as a practitioner for 25 years working in this area, the first time this past year I was involved in the preparation of eight GST type returns. Prior in my career, maybe two. So, it's becoming much more relevant for practitioners to deal with.

And, I have to say when I was doing this, I realized how little there was out there on how the GST tax works. Mr. Moore, as part of his presentation, actually went through the mechanics of when the GST tax applies to trust, taxable terminations and taxable distributions, and then this tax can be quite large. What's the source of the payment and financing the tax? Then finally, he talked about strategies to minimize and reduce this potential GST tax, which can be quite large.

He started off by talking about the taxable termination. This is an event that triggers GST tax when it occurs in the case of a trust. What is a taxable termination? Well, it typically occurs when you have a trust that has beneficiaries that are both skip person and non-skip persons. When a non-skip person's beneficial interest in the trust terminates, and there are no other non-skip persons remaining, there's a GST event that occurs, but it only occurs if the trust is in otherwise subject to an estate or gift tax. It's basically when the last non-skip person dies, that's when you have a taxable termination. Dies or otherwise their beneficial interested is termination. Most cases, it's the death of a non-skip person.

Let me give you an example of a typical taxable termination. A grantor sets up a trust for his child for their lifetime, and then upon the child's death, the property goes to grandchildren. When the child dies, the child is the only non-skip beneficiary, upon his death, a taxable termination occurs. So, what's the GST tax that's paid at this point in time? Well, it's based on the value of the trust property on the date of the termination. Interesting. If you look at the GST rules, there is nothing that defines value for this purpose, but it makes sense to look to the same rules that apply for estate and gift tax purposes for value. This value, the value of the property in the trust, it's subject to a tax, the GST tax, which is at the top estate and gift tax rate when the termination applies.

So, currently the rate is 40%. You look at the value of the property, you multiply it by 40%. It seems pretty easy. But, what if the trust has a mixed inclusion ratio? So, some of the trust is exempt from GST tax and some is not. The tax is multiplied by the inclusion ratio, so it reduces it. It's something less than 40% depending on how much of the trust is exposed to the GST tax. Interesting is the taxable termination occurs by reason of the death of a non-skip person. There's an option to use alternative values for purposes of determining the value of the trust property. Just like for estate tax purposes, the alternate value is permitted if the taxable termination occurs by reasons of the death of the non-skip person.

Who pays the tax? The trust pays the tax. They're responsible to pay the tax and file the return. Interesting, when value the property in this trust, the Chapter 14 rules don't apply. And, deductions. I said that the value of the trust property is subject to the GST tax, but deductions are allowed, and the only guidance that we have with respect to what deductions are allowed is the reference in regulations that say those similar to those permitted under Section 2053 of the Code, which are the estate administration expenses allowed on an estate tax return.

The other kind of GST event that could happen with respect to a partially exempt or non-exempt trust is when a distribution, called a taxable distribution, is made to a skip person. Essentially, a taxable distribution is any other distribution to a skip person that's not a taxable termination or subject to estate or gift tax. If there's a trust, and it's for the benefit of the grantor's children and grandchildren, and a distribution is made to a grandchild, it's not a taxable termination because it's still a non-skip person who's a beneficiary of the trust. A distribution is made to that skip person. There's a GST tax at that point. But you know what? There's an exception if funds for the trust are used to pay the medical or educational expenses of that skip person instead of being paid directly to that skip person, those distributions are not subject to the GST tax.

Even though it's still deemed a distribution to the skip person. Mr. Moore also pointed out that there's no guidance if let's say the trust makes a loan to a skip person. Could that be deemed a taxable distribution? How about if you circumvent the GST rules by instead of distributing a home to a skip person, you allow a beneficiary who's a skip person to use the home while it's held by the trust so there's no distribution? Is that an end run around these taxable distribution rules? It seems to be okay.

The GST tax on a taxable distribution is, again, subject to the top estate and gift tax rate. That's the GST tax rate of 40% multiplied by the inclusion ratio if the trust is not entirely subject to the GST tax, such that it has an inclusion ratio of one. So, the GST tax is computed on the value of the distribution less deductions. Those are deductions for any expense incurred with connection with the determination, collection or refund of the tax. I've dealt with this. Basically, you're looking at tax preparation fees to prepare the GST return for the beneficiary. The GST tax is paid by the trust beneficiary, and if the trust pays the tax, it's deemed an additional taxable distribution to that skip person.

There's another interesting implication with respect to a taxable distribution or taxable termination for income tax purposes. Well, the general rule is that when in kind property is distributed to a skip person, a taxable distribution, or ends up in the hands of skip people in the case of a taxable termination, the basis of the property subject to the GST tax is stepped up to the extent that the GST tax is attributable to the unrealized appreciation in the property. If the GST event occurs because of a taxable termination by reason of death ... Again, a taxable termination by reason of death ... the property subject to the GST tax is permitted a basis adjustment to fair market value at the date of death of that non-skip person that caused the taxable termination.

Or, if alternate value is used in determining the value of the property for taxable termination purposes, that's what the basis adjustment is permitted, up to or down to that amount.

So, this GST tax. 40%. When is it due? It's due on April 15th following the year in which the taxable termination or the taxable distribution happens. The tax is payable on April 15th. The tax return is due then, but you can get an extension for six months to file the return just like an individual income tax return because tax can be pretty hefty. So, what if the property that triggered the tax is a closely held business? Can you get a deferral? As similar to that, allowed for state tax purposes, a 6166 deferral? No. There can be permitted a six month extension to pay the GST tax for reasonable cause. That's available. That's permitted for estate tax returns as well.

There's another extension permitted in the case of estate tax. One year extensions for up to 10 years for undue hardship. That's only available for GST tax payable by reason of a taxable termination that was caused by the death of a non-skip person. So, your clients really need to plan for the payment of the GST tax. In my particular case where I had it, and the client was paying millions of dollars in GST tax, luckily they had the liquidity to pay it. Interesting, when you file a GST return, there's no closing letter. You don't know when the IRS is going to come in and open the door and look at this audit. It's not like with an estate tax return when you get the closing letter and you know you're safe to distribute the assets. There's no real safety net with the GST tax. You really need to wait the three years.

So, the trustees, when they're paying the tax in the case of a taxable termination, need to plan for this and potentially hold back cash in case there is an audit and additional tax is imposed by the IRS. Although, I've never seen one of these audited, but then again, I haven't seen a lot of these GST returns filed.

Planning strategy. Mr. Moore talked about some interesting planning strategies to minimize or reduce the potential GST tax. Now, there are three parties that are involved when there's a GST tax because the funds are inside a trust. There's the grantor who created the trust. The beneficiary who's the recipient of the trust property, and the trustee, who's managing the trust property. So, there are different planning strategies that are available to each of them. Well, the transferor can make a late allocation of GST exemption using the new increased exemption that's available to trusts existing currently that don't have their inclusion ratio.

He could choose to make actually a timely allocation of GST exemption at the end of ETIP period using the increased GST exemption now available. He could ask for 9100 relief to retroactively allocate GST exemption to a non-exempt trust. What about a beneficiary? What options are available to them to minimize the tax? Well, if a beneficiary has a limited power of appointment, they would exercise that in favor of a non-skip person, or exercise that in a way to lengthen the term of the trust so that the GST event doesn't occur until a later point in time. Or, maybe the beneficiary could exercise some power that would cause the trust property to be includable in their estate or be deemed a gift by them such that the trust wouldn't be subject to GST tax. But, you'd only want to do that if the estate or gift tax that would be imposed if the beneficiary was subject to it is less than the GST tax.

So, what could the trustee do to reduce or eliminate the GST tax? Well, make distributions to the trust only to non-skip persons. Use the funds in the trust to pay the medical and education expenses of the skip person, only those expenses. Permit the skip persons to use trust property instead of distributing. If there's a house in there, let them use it rather than distributing it to them. Decant the trust to eliminate or postpone the GST tax, like you decant to eliminate beneficiaries skip persons, or possible lengthen the trust term. Maybe there's some discount planning and freeze transactions they could enter into with the trust property to reduce the value of the trust property, so when it's distributed or becomes payable to a skip person, the GST tax imposed is much less because the value of the property is much less.

Now, we've come to a polling question.

Moderator:

Yes, so you have polling question number one. 

Who is responsible for paying the GST tax in the case of a non-exempt trust? Is it A, trustee, B, beneficiary, or C, it depends. I just want to remind everyone that in order to receive your CPE certificate, you must remain logged on for at least 75 minutes and respond to at least five polling questions. All right, just a few more seconds. All right, I'm going to share the results.

Karen Goldberg:

Okay, the correct answer is it depends. If it's a taxable termination, the trustee pays the tax. If it's a taxable distribution, the beneficiary pays the tax. So, 46% of you got the answer correct.

Scott Testa:

Thanks, Karen. As you mentioned, you don't see a lot of the GST tax being paid. I've actually only seen that form once in my career, and the IRS actually returned a check back. They didn't know what to do with it. We actually got it straightened out. If you've never been to the Heckerling Conference and you work in the trust and estate area, it is definitely worth checking out. You get to meet some of the speakers, and some of them are like celebrities in the estate planning community. Jonathon Blattmachr is one of them, so if you ever get the chance to hear him speak, you should. He always covers the most interesting and innovative topics, so when he spoke at a general session and then a breakout session as a part of a panel, I chose that topic as I what I wanted to cover in this webinar.

In the sessions, they discussed tax and other implications of individuals changing domicile, and discussed the 2019 US Supreme Court case that addressed the state's ability to tax trust. I mean, we don't get too many US Supreme Court cases in that area. Then, highlighted planning opportunities for using non-grantor trust for state and federal income tax savings. That's what I'm going to cover, or try to cover in the next 15 minutes.

People change their residence, and do so for a variety of reasons. They might change jobs, retire, want to reduce the cost of living, live close to the family, or maybe away from family, or for a big reason, taxes. They may anticipate a big gain on stock, sell the business for a large dividend, or they might want to move out of a state that has estate tax.

Here are the steps needed to change domicile. Regarding days spent, Mr. Blattmachr suggested you spend twice as many days in your new state than the old state. Also, it would be helpful if you bought a substantially larger home in the new state and sell your old residence, or at least downsize. These are the factors that states will look at to determine if you have in fact changed your residency or domicile, and no one factor is determinative nor do they necessarily have the same weight. Also note that residency may be different for income taxes than for estate taxes. For estate taxes, it is purely domicile, your one true home.

For income taxes, you could be a statutory resident where you'll be taxed as a resident in the state if you have a permanent place of abode there and spend more than 183 days there. I'm not suggesting changing your residence solely for income tax reasons, although it's a great tax planning move. You have to live where you want to live, you really need to live in the other state. You can't just change a few factors and claim you're no longer a resident there. You need to prove a change in domicile by clear and convincing evidence.

Fortunately, there may be some ways to avoid state income tax without changing residence, and that is through the use of non-grantor trusts. First, I want to discuss the US Supreme Court case North Carolina Department of Revenue versus Kimberly Rice Kaestner 1992 Family Trust that limited the state's ability to tax trust based solely on residency of a beneficiary. Then, I want to talk about planning with non-grantor trust.

Here are the facts of the Kaestner case. It was a New York trust created by a New York settlor governed by New York law. The trustee was a resident of Connecticut. The custodians of the assets were in Massachusetts. The primary beneficiary had moved to North Carolina, and under the terms of the trust, the beneficiary had no right to trust assets or income except in the complete discretion of the trustee. In fact, no distributions were ever made to the North Carolina beneficiary. The Supreme Court ruled in favor of the trustee. North Carolina tried to tax the undistributed income in the trust. The US Supreme Court held that the North Carolina law of taxing the trust income based solely on the residency of the beneficiary that could have received a distribution but didn't was unconstitutional.

This was based on the Due Process Clause of the 14th Amendment that requires some definitive link, some minimum connection between a state, the person, property or transaction it seeks to tax. The Kaestner case highlights that states needs sufficient nexus to tax it in that state. The Holding written by Justice Sotomayor was limited to the specific facts presented. She said we do not imply approval or disapproval of trust taxes that are premised on the residence of beneficiaries whose relationships to trust assets differs from that of the beneficiaries here. So, if this case is so narrow, why's it so important?

First of all, it reminds us that there are ways that a non-grantor trust that is set up in one state can be taxed in another state. Our clients may tell us when they move, but they don't necessarily always tell us when their children move or when a trustee moves. This is important to know because there's still some states that attempt to tax a trust, at least in part, based on the residency of the beneficiary. If you have a trust with a beneficiary in North Carolina, or one of the other states that impose taxes based on residency of a beneficiary like California, Georgia, North Dakota, Tennessee, you may want to file a protective claim.

Other states tax a trust on where it is administered or where a trustee resides, like California or South Carolina for example. Before you pick your out-of-state trustee, you need to review the laws of the state where the trustee lives. Finally, this case also reminds us that there's a great planning opportunity here for the right client. There's a way to avoid income tax in a trust residence state, and if done right, not pay any state tax at all. We'll get to that right after the next polling question.

Moderator:

All right, so we have polling question number two. In Kaestner, the US Supreme Court struck down a NC law on the taxation of trust based on A, Marbury vs. Madison, B, IRC Section 1041, C, Due Process Clause 5th Amendment or D, Due Process Clause 14th Amendment. Just as a reminder once again to everyone, please remain logged on for 75 minutes and respond to at least five polling questions in order to receive your CPE certificate.

Okay, 10 more seconds. All right, I'm going to close the poll now and share the results.

Scott Testa:

Most of you got this correct. It is the Due Process Clause of the 14th Amendment that says no person shall be deprived of life, liberty or property without due process of law. Okay, for those of us in New York and New Jersey, we weren't really all that excited about the Kaestner case. Maybe I'm speaking for myself. Why? Because our states recognize that there will be situations where estate can be resident in that state, and have resident beneficiaries and still not have enough nexus to tax it there. So, let's get into the definition of how these states define a resident trust.

A trust is a resident trust basically if the settlor was a resident of that state on the day he or she set it up, or died, or become irrevocable. However, and this is the nexus issue, if all trustees and all assets are out of outside of the state and there is no state sourced income, it will not be taxed in that state. There's no mention of the residency of the beneficiary. This is the Resident Exempt trust. To me, this is huge. It's an easy move that allows for some significant income tax savings. Again, it's right in the forms in the instructions. You still have to file a return to report its exempt status.

Just to show you, I want to take a look at New York Form IT-205-C, and note the facts that you need to be resident exempt. One, are all trustees domiciled in a state other than New York? Two, is the entire corpus including real and tangible property outside of New York. Intangibles don't count. Are all income and gains outside of New York? On the New York sourced income, New York will take the position that any dollar of income would cause the trust to fail this test. The rules in New Jersey may not be as harsh. There's one case that held that a resident exempt trust of New Jersey sourced income from a flow-through entity only subjected that income to tax in New Jersey.

In any case, if there's a possibility that the trust can have state sourced income in that state, for example, through an investment or public traded partnership, then put that in a separate trust. Let's take a look at the next two questions. Is the trust an incomplete, non-grantor trust? That's because New York taxes them as grantor trusts, and I'll get to that in a little bit. Did the trust make an accumulation distribution to a New York beneficiary. New York has a throwback tax. New York will tax a later distribution to a New York resident beneficiary, but these rules only apply to accounting income, not capital gains, so keep that in mind. And, note also that New Jersey has a filing requirement. They want you to file a New Jersey 1041 and attach a statement certifying the trust exempt status.

This is a great planning move for a client that lives in a high tax state. You can create a non-grantor trust that is resident exempt, or convert a grantor trust to a non-grantor trust and remove all resident trustees and assets. Think of the potential income tax savings. If you had a million dollars unrealized gain in a stock that you wanted to sell and you were in a high state income tax bracket, you could easily save about $100,000 just by moving the stock to a non-grantor trust. However, for this to work the trust must be a non-grantor trust. That means it can't have any of these provisions that would make it a grantor trust. That's why you need to look at the definition of a grantor trust and see which provisions you can't have in the trust document if you want it to be a non-grantor trust.

Here are the powers in a trust document that would make it a grantor trust. A retained, reversionary interest, the power to revoke, the power to substitute assets, which is great for estate planning to pull assets to pull back into your estate. The grantor or spouse's right to income. The power to deal with trust assets for less than adequate consideration. The power to borrow without adequate security and the power to pay premiums on life insurance. Any of these powers would make it a grantor trust and tax the grantor, whether or not there are any distributions from the trust.

So, the trust has to be a non-grantor trust. It can't hold life insurance, it can't allow distribution to the grantor or the spouse. This severely limits the grantor's ability to access the assets in the trust, and you have to be okay with this. These are all the key provisions that you have to be willing to accept. Unlike the grantor trust, which is great for other reasons, you won't pay income tax on it and you can't take the money out. Well, there is an important exception. A non-grantor trust can allow for a distribution to the settlor's spouse but only with the consent of an adverse party.

An adverse party could be a trust beneficiary, such as an adult child who is a remainder beneficiary. You may have a friendly adverse party, and this could be used as a failsafe but better move is don't put too many assets in the trust, and don't really plan on taking any distributions from it.

Just real quick want to cover the disadvantages of the non-grantor trust. One, you lose a step up in basis for completed gifts. You also lose the tax burn available to grantor trusts, meaning the trust, not you, pays the tax on it. You can't substitute assets or sell assets in the trust without being a taxable burn. It's not an eligible S Corp shareholder, unless you make a QSST or ESBT election. Generally, it can't hold life insurance, and there's definitely some costs to setting them up and maintaining the trust.

But despite the potentially valuable benefits of using non-grantor trusts, most client's estate plans will likely include a blend of grantor and non-grantor trusts. If the trust is a completed gift trust, then you are using your gift in estate tax exemption to put those assets in the trust. High exemptions, however, like we have now make completed gifts less important, especially with the loss of step up in basis. Avoiding income taxes become even more important, so unless you live in New York, you may want to consider an incomplete gift non-grantor trust.

What is an ING? I have limited time, I don't want to get into too many details but let's just say an ING is not a grantor trust for income tax purposes, even though you may have some access to it. This is done by giving a distribution committee made up of adverse parties the power to distribute to the grantor or spouse. And, it is not a completed gift for gift tax purposes based on certain retained powers. You can get the best of both worlds. You can transfer assets to a trust, not use your gift tax exemption, get a step up in basis at that, and not pay state income tax on it. Further, you don't have to give up your interest in the trust as the property in the ING can come back to the grantor or the grantor's spouse.

That is unless you live in New York. As I mentioned, New York treats ING's differently. New York has passed anti-ING legislation that taxes ING's as grantor trusts. However, the anti-ING statute does not apply to completed gift trusts, so if you live in New York, it may be beneficial to use the taxpayer's gift tax exemptions with a completed gift trust.

Finally, although this was discussed in a different session, I just want to quickly mention that there's some federal income tax savings opportunities for non-grantor trusts. First, you can shift income to a beneficiary in a lower tax bracket. Next, you can get the extra $10,000 state and local tax deduction for property taxes in the trust, or income taxes. Let's say if you have state sourced income, if you don't otherwise itemize, you can set up a trust that allows for charitable contributions to get the charitable deduction. Another big benefit under TCJ is the 199A deduction. If you have a business that is a specified series trader business, you can use a trust to take advantage of the 20% deduction under 199A.

If the trust income is below the threshold amount of $157,500, you get the 20% 199A deduction regardless of meeting the other qualifications. So, it doesn't have to be qualified business income. Finally, there are some deductions allowed for trusts not allowed to individuals, one of them being tax prep fees. This way, we don't feel too bad when we bill more to the trust than the individuals. Anyway, as you can see the non-grantor trust is a powerful tool in both income and state tax planning, but we will get to the next polling question.

Moderator:

All right, polling question number three. Which of the following powers would not cause a trust to be treated as a grantor trust for income tax purposes. A, power to substitute trust property. B, grantor's right to borrow without adequate security. C, power to use income to pay life insurance premiums, or D, adverse party's power to distribute to spouse.

All right, just a few more seconds. Okay, I'm going to close the poll, and now we see our results.

Scott Testa:

All right, it looks like more than half of you got this correct. Just keep these powers in mind when reviewing your trust documents.

Brent Lipschultz:

Next we're going to go around the world in 90 minutes with the session speakers Gideon Rothchild, Amy Kanyuk and Daniel Rubin. When I signed up for this course, I thought we were actually going to go around the world in 90 minutes and talk about different laws in different countries and what's changed, but in actuality what we did was we were talking about asset protection trusts. Now, there's 19 states, and I repeat, 19 states have enacted Domestic Asset Protection Trusts, and Florida has enacted quasi asset protection legislation using the inter-vivos QTIP trust.

Estate planning, as we all know, has become an exercise in form shopping. We talked about form shopping. Scott talked about form shopping a few minutes ago, and what we're doing is we're looking what statute has the most modern trust design, income tax efficiency, perpetuatory periods, conflict of law, all important considerations. What we're really going to focus on throughout the presentation is will an asset protection trust jurisdiction's trust law protect a non-resident who desires to create a trust in his non-home state?

For example, if I wanted to go to South Dakota, which is a very popular domestic asset protection state, and I'm a resident of New York, could I set up a trust in South Dakota prior to any litigation that may or may not be down in my horizon? Would South Dakota give me the effect of its legislation, and we'll find out that different states have different rules. Who sets these things up? In our practice, we typically see doctors, financial services folks and real estate investors. Anybody where there's sufficient risk, and perhaps people that may be going through divorces or see divorce in their future.

I think the key to this whole presentation was to tell you that offshore jurisdictions are as popular as onshore jurisdictions, and they remain popular to avoid political strife, exchange controls, forced heirship is a big provision especially in France or any of the civil jurisdiction, and to obtain favorable tax benefits. Leveraging against a private creditor is the most common use. Keep in mind, though, with the offshore jurisdictions, offshore trusts, we have all that complicated foreign trust reporting that we have to deal with.

So, what's important? Certain offshore trust jurisdictions have repealed the prohibition against self-settled spendthrift trusts. Now, there are states in the United States that have also done that, and with these trusts, the settlor essentially names himself as a discretionary beneficiary while at the same time protecting trust corpus from future creditor claims. As I said before, there are states ... I believe Alaska, Delaware were the first asset protection statutes adopted.

How do we select the appropriate state trusts if we're dealing with an asset protection in the United States? You want to look at the culture of the state, the quality of fiduciary, what are the fees in that particular jurisdiction? Review state legal statutes, the time it takes to set up and not all of these asset protection trusts are equivalent. No one size essentially fits all, and you really have to take a look at certain charts to really see the differences. The speakers pointed out that the ACTEC chart is most reliable as it does not essentially rank the states, but it actually gives detailed breakdown of these different areas that you got to look for in doing planning. Typically, our firm at EisnerAmper, we don't get necessarily involved with the legal aspects of asset protection trusts.

What we get involved with is the compliance associated with them, and any sort of affidavits of solvency that are required. What we look at is when you're talking to somebody about asset protection, the first thing that comes to mind is due diligence. And, the reason I say that is because if you set up an asset protection trust, and you know that there's a company going to sue you, then that could be a fraudulent conveyance. So, you really have to understand who the client is, what the financial state is. And, I know it's only required in 50% of the states, this affidavit, but we recommend ... The speakers recommend as best practice to do it with all jurisdictions.

Who can serve as trustee of these? 15 states require the resident of that state to serve, including corporate or individual. Alaska, New Hampshire statues do not require resident trustees, and a co-trustee can serve in many jurisdictions but is not recommended by the panel to have a co-trustee. In finality, you got to balance the control versus the protective nature of these statutes. The speakers recommended not having an out-of-state trustee for income tax residency issues or a family member serve in these asset protection trusts.

Some states have trust protectors, or non-fiduciary participants. Trust protectors are essentially those folks that are outside of the purview of a trustee. They guard. I look at these folks as guarding the trust property, able to move the trust assets should something happen, remove trustees, et cetera. What can these people do either in a fiduciary or non-fiduciary capacity? You got to be very careful in drafting the clarity of what these folks can do in order to preserve the asset protective nature of these trusts. I didn't realize this, but all states require irrevocable agreements except Oklahoma, and Oklahoma permits a revocable trust under certain circumstances.

Obviously, a revocable trust should be avoided because the creditors obviously can appear and say revocable trust. State law should be cited in the instruments, and we see most trust instruments citing state law, so that seems to be a very obvious. And, some real estate may not get asset protection. They have the properties outside of that asset protection state. Some states will allow settlors to occupy the real property, but it's interesting. You could use an LLC or QPRT to hold real estate and get that same asset protection. There's no exception creditors in the offshore arena. Exception creditors being child support, alimony and so forth. No exception creditors in the offshore arena.

Gift tax issues, we went through this with Scott's presentation. Complete or incomplete gifts. Typically, asset protection trusts are drafted, so the transferring of the property to the trust by the settlor constitutes an incomplete gift. We know that there's certain planning suggestions that may say we want a complete gift, but that's how these are typically structured. There were several drafting examples I encourage you to look at if you are able to obtain the Heckerling material. Placing a residence in a DAPT, you could put a residence in a QPRT and obtain a mortgage as an asset protection tool as an alternative to a typical asset protection trust. It could be structured as a qualified personal residence trust, and a qualified personal residence trust, we don't see that used too much in planning today. Why? Because, interest rates are so low and you're not really leveraging the unified credit, the lifetime exemption very well.

But, QPRT's do serve a purpose. We got to also look at the fraudulent transfer statutes. Some statutes have a four year, meaning that if you transfer property within a four year period of time and there's a litigation matter that comes up, those could be pierced by creditors. You could use an asset protection trust as an alternative to a pre-nup. Some folks don't want to use pre-nup, but this could be an alternative to those who don't favor a prenuptial. Civil law foundations, we see a lot of those in offshore. It's equivalent to a trust in a company, but it's not equivalent to a private foundation. Whenever you see the word foundation, that's another name for a foundation. It's not equivalent to what we view as a private foundation.

Usually entity owns assets. There's usually no shareholders. It's set up for private purposes as opposed to serving public charities. The self-settled trust doctrine does not apply where you're essentially setting up a trust to benefit yourself with creditor protection. That doesn't apply, and there's a case, the Swan case, came out that a foundation at issue should be treated as a revocable trust. So again, when you're dealing with a compliance issue of these offshore accounts they're likely viewed as trusts.

New Hampshire, this one's new to me. I didn't realize this. New Hampshire is the first state that has adopted the Civil Law Foundation. That's a fairly recent phenomena. Foreign asset protection laws. Why foreign asset protection trusts are prevalent and why it should be looked at is there's a local trustee off shore, rarely requires a trust instrument. There's no requirement for that affidavit of solvency, but I'll tell you that certain cases have come up, I think in the jurisdiction of Florida, where somebody set one of these up and it came back to bite them because they didn't do an affidavit of solvency. There's no exception creditors and they never recommend for local assets, so if there's an asset in that local jurisdiction, it's not recommended to put that into that trust.

Again, the main theme of this presentation despite going around the world in 90 minutes, or 60 minutes, is that the offshore trust is generally better. The speakers cited Cook and Belize having a shorter statute of limitations period meaning that's the period of time that a creditor could pierce the trust. Standard of proof to prove fraudulent transfer is higher there. English Rule of attorney's fees and costs apply, so in other words the losing party typically pays. Some jurisdictions such as Nevis require a bond. Lawyers do not work on contingency fees offshore. Full faith and credit clause, international comity do not typically apply here in the international context.

And then, foreign trust considerations, again, you got the definition under the Internal Revenue Code of what is a foreign trust? You got to meet the court and control test, but most importantly, typically when you set these asset protection trusts up, they're foreign grantor trusts so you got to consider filing the 3520A, which is ... By the way, the 3520A is due in March as opposed to the 3520 and the FBAR, which are due on April 15th. You can get extensions for all this but in practice, if you've got a foreign grantor trust, the 3520A, I find is the often missed form and there's significant, significant penalties for that.

The last case I wanted to deal with is this matter of Cleopatra Cameron. It's a recent asset protection case. It was in 2019. California trusts were established for the benefit of Cleopatra Cameron by her father. As part of her divorce action, the court granted full custody of the minor child to the husband and ordered Cleopatra to pay child support. Under California law, the spendthrift trust could be compelled to make distributions to third-parties to fund child support and spousal support consideration. So, going to Cleopatra's lawyer, they obviously thought of the South Dakota trust company, and they went to South Dakota to establish a South Dakota asset protection trust, and then obviously exercised the right under the trust instrument to move the trust situs to South Dakota, and then petitioned the circuit court for a declaratory judgment that the trust, the South Dakota trust, would be prohibited from making payments directly to the husband.

Because, under the South Dakota statute, it disavowed any exceptional creditors to spendthrift trusts. The taxpayer, Cleopatra, won at the lower court level and the husband appealed. The question here is whether California's order was entitled to full faith and credit under the US Constitution. The South Dakota Supreme Court held that although the order for child support would be enforceable against Cleopatra in South Dakota under the Full Faith and Credit Clause, the order against the trust would not be enforceable in South Dakota since the law of South Dakota prevents enforcements of judgements against spendthrift trusts. The California order was held not enforceable against the South Dakota trust.

Why is this case significant? May have argued whether the Full Faith and Credit Clause would require enforcement of a judgment against an out-of-state trust. In this case, the argument is that the asset protection state where the trust was located could be compelled to enforce the non-DAPT state court order under the Full Faith and Credit, and this case is the one Supreme Court case that held otherwise. So, this could be a trend going forward.

Moderator:

All right, that brings us to polling question number four. How many asset protection jurisdictions are there in the US? A, none. B, two. C, 13. D, 19, or E, none of the above.

Please remember that in order to receive your CPE certificate, you must remain logged on for at least 75 minutes and respond to at least five polling questions. Okay, about 10 more seconds. Okay, I'm going to close the poll and there are the results.

Brent Lipschultz:

The answer for those paying attention ... My colleague Marie is laughing at me ... is 19. D.

Onofrio Cirianni:

Thank you, Brent. Good afternoon, everyone. This is Onofrio Cirianni. I am covering a special session, which was titled Can You Roll Over in Your Grave? What Executors, Trustees and Beneficiaries Must Know About Inherited Retirement Benefits. The speaker was Natalie Choate from Nutter McClennen & Fish. Natalie is one of the most respected authorities in the area of IRA's, qualified plans, has a ton of knowledge and actually is a great entertaining speaker.

Today, I'm going to cover and highlight ... I'll give you an overview in regards to the presentation and retirement plans. How existing clients versus new clients should approach strategies, post-death required minimum distributions, planning for eligible designated beneficiaries. I will cover the Secure Act pre-2020 deaths and then I will conclude and give some tips and summarize some of the options.

So, every so often a new piece of legislation is passed, and in this case in late December, the Secure Act was passed, which had advisors, clients, as always, scrambling to learn and determine what this means to them and their particular situations. There was quite a buzz at Heckerling, and I'm sure many on this call see their inbox filling with a lot of information about the Secure Act. I'm going to highlight some of the key points Natalie covered and as a result of the topic, her original information and material was really thrown out the window. So, some new material was created and covered in a special session and then the originally scheduled session really became a Q&A because so much of the material was really new.

The Secure Act affected a lot of areas. Employers sponsored plans, as example. How it may enhance choices for participants in those plans with particular products. Also, 529 plans. My focus here today and most of the presentation that the speaker covered is really in the area of IRA's and qualified plans from a wealth transfer and an estate planning context.

The Secure Act was passed. Secure stands for Setting Every Community Up for Retirement Enhancement Act. It was signed into law on December 20, 2019. The biggest impact with the Secure Act as highlighted here is Stretch IRA's. For over 30 years, the go-to estate plan for owners of tax-favored retirement plans has been the Stretch IRA. Under the Stretch IRA, the IRA or the retirement plan is payable to a designated beneficiary who can leave the plan in its tax deferred status for years after the individual's death. The beneficiary is able to withdraw the benefits gradually by taking annual distributions over his or her life expectancy. Secure eliminated the life expectancy payout and replaces it with a maximum 10 year post-death payout period for most retirement benefits.

As you can imagine, this was timely after we've just gone through almost 11 consecutive years of a rising market and retirement plans appreciating, some of which are multi figures in regards to the account balances. There were some other IRA enhancements as well in regards to the ability to continue to contribute to traditional IRA's post 70 1/2, IRA required minimum distribution age has been delayed from 70 1/2 to age 72. But in exchange, and may believe not an equal exchange, this is a pretty drastic change eliminating the Stretch. There's been a lot of questions and really some push back already.

There happens to be a new bill already up on Capitol Hill, which there are proposals to either pushback required minimum distributions to age 75 and then another bill actually eliminating required minimum distribution age. So, this acceleration of requirement, as you can imagine, is going to accelerate income taxes paid to beneficiaries who in many cases just based on life expectancy, many of those beneficiaries are in their 40s and 50s, most likely in their peak earning years and in the highest tax brackets.

So, how do we approach existing clients versus new clients, and how are they affected? Natalie did a pretty good job ... Again, there's a lot of data and information and it was pretty much broken down into three general categories. The ones that are most affected, and probably should be looking at the planning they've done as soon as possible ... Like, an emergency ... grandchildren that are beneficiaries of these large IRA's. The 10 year only applies to children of the IRA owner and non-designated beneficiaries or non-related beneficiaries, the five year rule applies. So, there will be a quicker acceleration of those distributions required.

Somewhere in the moderate to potentially severe changes with designated beneficiaries, first is really looking at who are those direct beneficiaries? Two techniques and approaches many practitioners have utilized over the years are conduit trusts, also known as see-through trusts, which look to the beneficiary of the trust. It's a trust that passes IRA distributions through to the beneficiary and in most cases will be distributed in 10 years and potentially expose those assets to creditors, potentially a divorcing spouse of a beneficiary who could also be in many cases a child. Also, accumulation trusts, which also could be a see-through trust. As the name implies, it can accumulate plan distributions in the trust and there are some exceptions to that 10 year rule, as well.

Then, the least affected, someone that may not have much in regards to qualified retirement assets as a part of their overall balance sheet, the ultra-wealthy that they may have a large qualified plan, but there may be intentions and plans to have that all go to a charity upon their passing. And then, there's potentially some enhancements to eligible designated beneficiaries, and those five eligible beneficiaries are a surviving spouse, a minor child, a disabled person, a chronically ill child or a beneficiary that's less than 10 years younger than the IRA or qualified plan owner. We'll cover eligible designated beneficiaries in a bit in more detail.

So, when planning in terms of considerations now on a going forward basis as a result of the Secure Act, we really want to look at this from several points of view. Number one, the IRA owner but also the beneficiaries and contingent beneficiaries. That could be generation two or generation three in terms of multi-generational planning. We definitely want to review overall balance sheet, the size of the estate, looking at the cash flow based on the lifestyle of those parties I just mentioned. What percentage of the overall balance sheet are qualified plan assets? The age of the IRA owner and spouse. Is it a first marriage, second marriage, potentially third marriage, et cetera? Who are the beneficiaries of this estate? Children, grandchildren, are there non-related persons? Are any beneficiaries eligible designated beneficiaries? The health of the IRA owner as well as the health of the beneficiaries.

And, is the client charitably inclined? There may be opportunities. Many variables above, which will definitely have the need to involve multiple advisors, both CPA's, trust and estate lawyers, financial advisors, et cetera, where one might be tugging and pulling in regards to pros and cons, having a team will definitely make this a more effective approach.

So, there are some post-death required minimum distribution rules. I'm going to highlight quickly just to understand the old rules before we get into the new rules. The old rules, there was general two categories of beneficiaries. You had a designated beneficiary and upon the death of the retirement plan participant, the balance of his or her retirement account would be distributed in annual installments over his or her life expectancy. If it's not left to a designated beneficiary, the inheritor had to withdraw the benefits within five years after the participant's death, if the participant died before his or her required beginning date.

A designated beneficiary was, and still is, defined as an individual named as a beneficiary by the participant or by the plan. The trust so named as beneficiary of the trust meets the requirements of the IRS requirements to be considered a see-through trust. In which this case, the life expectancy of the oldest trust beneficiary was the applicable distribution period. There are various rules on how to calculate life expectancy. And, just keeping in mind, these RMD rules have been in effect since 2001. So, as you can imagine, we see it in our practice a lot of planning and work has been done over a long period of time that would need to be reviewed.

One other note to mention in regard to see-through trusts is to make sure the trust language is reviewed. It's key to make sure that it actually meets the requirements of a see-through trust, or it could potentially be subject to the five year distribution requirements. So, then we get to the new Secure Act categories of beneficiaries. We potentially can have a beneficiary who is not a designated beneficiary. Examples like an estate, a charity, or a trust that does not qualify as a see-through trust. You can have a designated beneficiary, which is an individual or does meet the requirements of a see-through trust, and the new category is this eligible designated beneficiary. It's a subgroup of designated beneficiaries that are still entitled to, or potentially a modified version of the life expectancy method.

So, planning for eligible designated beneficiaries. The new law does not apply, or at least the 10 year rule does not automatically apply to these five categories. These rules also apply for see-through trusts, and some planning ideas to consider in light of Secure for these five categories. Consider one of the five. Current estate plans that have one of the eligible designated beneficiaries, and it should still work. There may be just some tweaks that may have to be done here. Eliminating other discretionary beneficiaries, as an example, from benefiting from the plan. Also, looking at when there is a minor eligible designated beneficiary. One note here, however, the provision only applies until the child reaches majority. At that time, the 10 year rule will apply. There was some conversation going back and forth in regards to determining a child's majority. It may actually be a little tricky given that it's often based on the education status of the child. We'll see.

Also, looking at if there's a disabled or chronically ill beneficiary as well. There are some special breaks in applicable multi-beneficiary trusts, as an example, where there's a trust that has more than one beneficiary. All the beneficiaries are treated as designated beneficiaries, and at least one is an eligible designated beneficiary as well. Secure Act pre-20 deaths, as Natalie noted, the rules for pre-2020 deaths provide for a partial exemption. She noted that the attempt to impose the rules on pre-2020 deaths cannot realistically be implemented except in the simplest of situations. There's definitely going to be more regulations and other guidance that's probably going to be in this area. For the most part, if someone passed and they were using the life expectancy method, if they passed in 2019 or prior, in most cases those rules will apply.

But, under Section 401(a)(9)(H), please note once that beneficiary does pass in 2020 or later, the expectancy payout 10 year rule will kick in. There was a subparagraph I, Natalie noted, that seems to suggest there's some opposite interpretation or questions, which will probably take some time. One example she gave, which she felt is a big unknown, is when there's multiple beneficiaries and the example was where there's three minor children that are beneficiaries of the same conduit trust. Should they be treated the same or do you start the 10 year rule when the oldest reaches age of majority?

So, to wrap up in terms of some key points, summaries and some tips here. First and foremost, everybody really should be looking at their beneficiaries of their IRA's, 401k's, qualified plans. It's good practice to do that every year as family situations change as well. Potentially leaving traditional retirement benefits to a charitable remainder trust could be an effective approach. In this plan, the income tax on the IRA itself is basically eliminated and provides an annual payout to individuals replacing what may have been the lost life expectancy payout. At the end of the charitable remainder trust term, the remainder of the CRT goes to a charity. Obviously, one note, the participant would probably like to have some philanthropic intent.

One other approach are Roth IRA's. They are also affected by Secure. Roth IRA's may not have income taxes paid on those distributions, but the 10 year rule applies, so loss of tax deferral. If the owner is in a lower tax bracket than her expected beneficiaries, the IRA owner may consider doing a Roth conversion during her lifetime. This results potentially in lower income taxes on an overall basis and in most cases, often correctly if the beneficiary was a trust. If the current estate plan leaves retirement benefits for a conduit trust, this might still work fine under Secure if the conduit trust is for less than 10 years, a younger beneficiary. However, many conduit trust provisions force the trustee to distribute the entire retirement plan to the beneficiary within 10 years, and this may have not been the desirable result.

Accumulation trusts will still work under Secure. Again, could face a substantial income tax bill. Also, potentially consider life insurance as a tool to replace the lost wealth due to the accelerated income tax under the 10 year payout. Use accelerated distributions from that IRA to fund premium, consider using an irrevocable trust where we get the asset out of the estate. Also, can be combined with some of those CRT strategies I mentioned above for generation two or three.

Really, take a step back and review the overall estate and asset disposition strategy since IRA assets may be limited to the stretch for more than 10 years, really consider remaining non-retirement assets in the estate to be held longer in the trust. And, another note worth maybe mentioning here is if the time horizon of these assets and these retirement plans are going to be shortened is really looking at the overall investment strategy and the allocation of those assets. So, as you can see, really the final takeaway is really taking a look at your overall estate plan and specific attention to the IRA assets.

Moderator:

All right, that brings us to polling question number five. Which of these are not an eligible designated beneficiary? A, the surviving spouse of the participant. B, minor child of the plan owner (payout allowed until majority). C, disabled beneficiary or D, charitable remainder trust. All right, just a few more seconds. I'm going to go ahead and close the poll. So, here are our results.

Onofrio Cirianni:

72% of you answered the question correctly. Charitable remainder trusts are not an eligible designated beneficiary. Thank you for your time.

Marie Arrigo:

Hi, everyone. It's Marie Arrigo again, and now we're up to our final topic for our webcast this afternoon, which is Back to the Future: The Central Role of Family Governance in Today's Estate Planning. Thomas C. Rogerson presented this topic. His talk focused on that old saying of family's shirtsleeves to shirtsleeves, where most families really actually don't survive past the third generation. He described that the first generation is what you call creation. You have entrepreneurs, real estate developers, CEO's creating the wealth. Assimilation is the second generation, and those people have professional services such as attorney, accountants and investment advisors.

The third generation was referred to as enjoyment, so their careers were fun things like being actors and musicians and park rangers and ski patrol. And, then the fourth was lamination. The whole issue is how do you break this paradigm when in fact 70% of all wealth transfers fail in one generation, 97% of all multi-generational wealth transfers fail within three generations. Many families recognize the importance of leaving values and life lessons of inheritance, and yet, 90% of families say, "Well, our plan doesn't deal with our goals, our wants, our desires, our objectives." 46% of Heckerling attendees say family conflict was the biggest threat to estate planning, not communicating the plan, blended family issues were key.

So, why do most families fail? First of all, what is failure? You have the financial wealth is gone. The intangible assets are forgotten and lost. A loss of a definition of who are we as a family. A good test is well, who's in your cellphone contact list? 60% of failure is due to a lack of communication and trust within the family around group decision making, lack of education, a lack of governance. You have unprepared heirs. 10% of the failure is due to no clarity of family purpose and individual place, but less than 5% of failure is really due to failures in financial planning, taxes and investment.

So, clearly having a great plan is fine, but it may not be enough for this family to flourish. They also talked about independence versus interdependence. If your family members are independent, they'll drift away until completely independent. There's an avoidance of dealing with family measures. At the other spectrum, you can also have the explosion, the blow up that happens usually probably at the family gathering for the holidays. The thing that resolves conflict, things such as educating and motivating and managing conflict, coaching, working together, those are the items that could help and really people don't really practice.

The discussion also focused on family culture consisting of values and beliefs, and defining how the family behaves. You can't just ignore it. You can't just try to mask it with structures because at the end of the day, you have to deal with the underlying problem. Changing the family culture can happen, but it requires a lot of work and a better understanding of what the issues are. Normal estate planning solutions really don't foster a great culture. You have in essence a divide and conquer of funding independence almost to the point of estrangement, and trying to force interdependence by structure and assets may not in fact work.

So yes, you could have the family vacation home and the family foundation, the family enterprise, but unless you have the culture to support all of that, it may not work. In purely discretionary trusts where you're providing funds to beneficiaries, you're creating entitlement.

To succeed, the suggestions ... You should have family meetings. Prioritize, organize, create a process to getting to the decisions, and also creating the special places to build memories, to do team building, trust building, etc. Building and saving tangible and intangible wealth creating the consensus, creating the sense of trust among family members. You need a process to affect the family culture. It was also mentioned of something called FAST, which we'll talk about in a few minutes.

The discussion also talked about a six step process. The first step is assessment, setting the foundation. Where are you now? Is there improvement over time? The second step is education, creating a family curriculum, talking about topics like financial issues like budgeting and sustainable spend rate. The family office, a family bank, and philanthropy. Those are topics that help prepare family members for understanding their wealth and being able to deal with that. The third step is communication, developing a leadership style that creates safe transparent communication, and also managing the triggers. You don't want people being set off by saying the wrong thing.

Step four is values, mission, vision, history and future. Team building experiences, sharing values by meaningful experiences. Basically, creating connection. Step five is action, practice governance and leadership. Family entrepreneurial mindset, family philanthropy and a family bank. And, the sixth step is advancement. Endowing ongoing healthy family governance, investing your family members rather than distributing to them.

And, we just came across a polling question.

Moderator:

Yes, this is polling question number six. 97% of family wealth transfers fail within ... Is it A, one generation, B, two generations, three generations or D, four generations? Please remember to respond to at least five out of these six polling questions in order to receive your CPE certificate. Okay, just a few more seconds. And, I'm going to close the poll.

Marie Arrigo:

Ah, you were paying attention. So, the answer is C, three generations. Okay, so I want to spend some time discussing the Family Advancement Sustainability Trust as an idea that could help foster a family cohesiveness. The common law trust is one trustee. Generally, it's one trustee. It could be more than one trustee, but that trustee controls the investment and distribution decisions. Then, the trust beneficiaries are impacted but they don't have any say in the process, so to speak. The F.A.S.T., it provides funds for future generations to use to prepare heirs to be able to successfully manage an inheritance, a business, a family compound, et cetera. It really actually helps to keep the family together after the older generation dies, and perhaps encouraging other things such as family retreats and meetings, giving every family member a sense, a purpose and place.

And, it helps to train future generations on concepts like philanthropy, entrepreneurship and being responsible stewards. What the F.A.S.T. is basically a dynasty trust created an estate with directed trust laws, which allows decision making authority to be split up among separate co-trustees, advisors, and the trust protector. By doing that, you can have family members and trusted advisors directly participate in the governance of the trust. So, a typical example would be you'd have an administrative trustee, but that administrative trustee has no control over the investments and the distributions. The grantor appoints three committees. You can a distribution committee, which their mission is really to preserve and strengthen the family institution, not necessarily just distribute money out to the beneficiaries. The investment committee, which among their responsibilities is also to generate enough cash to fund activities such as the family meeting, et cetera and retreats.

And then, the trust protector committee ... I think Brent mentioned that earlier in his presentation ... plays the role of the grantor over such things like perhaps needing to remove a trustee, or maybe amending the trust, etc. Out of this, it creates a situation where everyone's participating and has a place and has a say, and creates a leadership structure that encourages all to work together. You basically have trustees and committees who, if you have outside people, which is also one of the recommendations, to really run the F.A.S.T. and be charged with the responsibility of carrying out these particular functions.

So, the key conclusions is again that most families historically have failed by the time you get to the third generation. The cause is not bad investment, management or tax planning. It is the lack of trust, communication around group decision making. Modern estate planning doesn't really address these issues, and in fact can contribute to the family erosion. The family culture is hard to change, but can be accomplished if you work at it and really create a sense of shared connection and identity. The key to changing this paradigm is through family meetings, creating opportunities where, again, people are connecting, consider using the F.A.S.T. structure, and hiring experienced facilitators and consultants to get the process started and keep it going.

And, we are up to the questions section. We just have a couple of minutes. Karen, I think you had a question.

Karen Goldberg:

Yes. Let's see. The question had to do with the alternate value, and with respect to GST, so I'll read the question. I'm just finding it right here at the top of the list. Is there an alternate valuation date available for GST tax as there is ... I'm sorry. Let me read the question. Is there an alternate valuation date available for GST tax as there is for an estate? As I explained in my presentation, if a taxable termination occurs because of the death of a non-skip person, then an alternate value election is available just like for estate tax purposes.

Marie Arrigo:

Okay, we do time for another question?

Moderator:

We have enough time for another question?

Scott Testa:

If you'd like. Yeah, I need to get on your microphone. Thank you. Is it possible to set up an ING in Nevada for a client in New Jersey if the assets consist of investments exclusively mutual funds and ETS? So, there's no New Jersey sourced income. Although some of the underlying holdings are based in New Jersey, yes, a New Jersey resident can set up an incomplete non-grantor trust. You can go to Nevada, set it up. New Jersey does not have anti-ING legislation so it works. You can also use a resident exempt trust, set it up in Nevada if you want to do a completed gift trust, so either does work.

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