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On-Demand: Estate Planning in a Year of Change

EisnerAmper's estate planning experts presented a timely trust and estate presentation highlighting a few areas covered at the 55th Annual Heckerling Institute on Estate Planning Virtual Conference.


Karen Goldberg:Good afternoon, everyone. This webinar is intended to cover the highlights of the 55th Annual Heckerling Institute on Estate Planning that took place during the first week in May, May 3rd. And for the first time, the conference was held virtually, and it went off without a hitch. As is customary for Heckerling on the first day of the Institute, there's a fairly lengthy recent developments presentation. And this year, that presentation was made by Steve Akers, Sam Donaldson, and Sarah Johnson.

I am going to cover the high points of that. But considering the presentation was more than three hours and I have less than 15 minutes, I'm going to focus on the discussion surrounding the recent proposals in the trust and estate area. They spent a great deal of time during the first half of this seminar discussing them. So I figured I would spend a few minutes that I have with respect to their presentation discussing those same items.

The presenters started off by talking about Senator Bernie Sanders proposal. The 99.5 Percent Act that he submitted on March 25th, 2021. As part of that Act, the top estate and gift tax rate that is currently 40% would be increased. 45% for transfers during life and a death to the extent they exceed three and a half million up to 10 million. 50% for transfers from 10 million to 50 million and 55% for transfers from 50 million to 1 billion. And any transfers over 1 billion would be at 65%. This doesn't even include any state estate taxes that might be due.

As part of this Act, there'd be a reduction in the historically high basic exclusion amount of 11.7 million that's being indexed for inflation. And the basic exclusion would be reduced to 3.5 million for estate tax purposes and 1 million for gift tax purposes with no provision for indexing for inflation. The GST exemption would be 3.5 million, and the GST tax rate would be the top estate and gift tax rate of 65%. This Act would be applicable to transfers during life and at death after December 31, 2021. So it  would not be retroactive to January 1, 2021.

Other provisions included in that Act is a provision that provides that there's no step-up in basis for assets in grantor trusts that are not includible in the grantor's estate. But I think that's what most practitioners believe is the correct answer. There are a few  practitioners out there who take what I view as an aggressive position and have concluded that assets in an intentionally defective grantor trust perhaps get a step up at the grantor's death.

The Act, like other Acts, has proposed elimination of gift and estate tax valuation discounts. The provision in this Act is pretty much all-encompassing. It says that non-business assets held by an entity will not be entitled to an entity-level discount. So let's say a client creates a limited partnership, funds it with cash and marketable securities, and transfers a limited partnership interest to a child or a trust for his children. There'd be no discount because the partnership, only holds marketable securities and cash. The Act also includes a provision that does away with the minority interest and lack of marketability discounts for transfers of family-owned or controlled entities. And there's no exception for an active trade or business. This means if a client owned a business and he wanted to give away a non-controlling interest to a child or a trust for the child, minority interest and lack of marketability discounts would not be available when valuing that interest.

Like a lot of other proposals out there, there's a proposal to limit in effect the efficiency or the effectiveness of a grantor retained annuity trust by providing that grantor retained annuity trust have a minimum term of 10 years.

The term of the GRAT can't be longer than the grantor's life expectancy plus 10 years. And the value of the remainder interest or the value of the gift on setting up the GRAT must be at least 25% of the value of the GRAT assets. The value of the assets on the date they're contributed to the GRAT or $500,000, whichever is greater.

So when setting up a GRAT, it'd be a minimum $500,000 taxable gift that could be conceivably sheltered by the donor’s three and a half million dollar exclusion under the Sanders Act. And this 99.5 Percent Act also wants to in effect, eliminate the planning strategies that are available with respect to intentionally defective grantor trusts. It provides that a grantor trust will be includible in a grantor's estate. Distributions from the grantor trust to a beneficiary will be treated as a gift. If grantor trust status is turned off while a grantor is living, the grantor will be deemed to make a gift of the trust assets.

So the gift in these cases would be reduced by any gift amount that was reported on a gift tax return when the initial property was transferred to the trust. This does not apply to a trust that is otherwise includible in the grantor's estate. What I mean by this, is that these rules don't apply to revocable trusts. This provision would apply to trust created on or after the date of enactment, any gift to existing trusts after the date of enactment, and any existing trust if a sale or exchange occurs on or after the date of enactment. So essentially, this is an attempt to shut down sales to defective grantor trusts.

As part of the Act, there's also an attempt to shut down dynasty trusts that are exempt from the generation-skipping transfer tax. So a trust that lasts longer than 50 years will have a generation-skipping transfer tax inclusion ratio of one, which means that if a trust lasts longer than 50 years, any distributions to grandchildren or more remote descendants will be subject to the generation-skipping transfer tax. And this, again, applies to trusts created after the date of enactment or in the case of a trust created before the date of enactment with an inclusion ratio of less than one, it can retain that inclusion ratio for just 50 years after the date of enactment.

The Act wants to basically clamp down on the amount of annual exclusions available when an individual makes a gift to a trust. So what it provides is that a gift to a trust is eligible for a $30,000 annual exclusion, regardless of whether any of the beneficiaries have a present interest via, let's say, a Crummey Power. So what would this mean?

Currently, when an individual sets up a trust, and let's say there are five beneficiaries, and they each have Crummey Powers equal to $15,000, and a client makes a gift of $75,000 to the trust, there would be no taxable gift. The entire gift would be covered by the annual exclusion amount. But let's say, the donor does it when the rules of this Act are in place. A  transfer  of $75,000 to a trust with five beneficiaries who have Crummey Powers,  would result in a $45,000 taxable  gift, 75000 less the $30,000 annual exclusion.

Also, with respect to gifts of interests in passthrough entities, interests subject to a sale prohibition, and other property that can't be immediately liquidated to individuals in any one given year, the donor would be limited to a $30,000 annual exclusion for all gifts. All the gifts of these entities would be totaled, and a $30,000 annual exclusion would be subtracted.

So let me give you an example. An individual makes a gift of his interest in his closely held business to his five children children. The value of the interest given to each child is $15,000, $75,000 in the aggregate. There would be  a $30,000 annual exclusion and $45,000 taxable gift. In today's world, there'd be no taxable gift because there'd be a $15,000 annual gift tax exclusion for each gift to each child.

The Act eliminates the annual exclusion for gifts to minor's trust. That's a trust set up for a child that terminates when he attains the age of 21. If he dies before attaining the age of 21, the trust is includible in his or her estate. No more annual exclusion for this type of trust. However, the annual exclusion rules as they are in place today would apply for gifts of cash and marketable securities made outright to individuals.

A short time after the introduction of the Act by Sanders a couple of his colleagues introduced two other proposals they're called the Deemed Realization Proposals. And they were introduced by Representative Bill Pascrell and Senator Chris Van Hollen. And both of these proposals provide that property transferred by gift or at death will be treated as sold for income tax purposes at their fair market value and so income tax would be required to be paid.

Past appreciation, not just appreciation following the date of enactment, would be taxed. There are some exceptions. Tangible personal property, transfers of property held in connection with a trade or business would not be subject to this rule. Transfers to a decedent's spouse if the spouse is a U.S. citizen, would be exempt from this rule, and transfers to charity would be exempt from this rule.

In the case of property held in a long-term trust, a dynasty trust, the property will be deemed to be sold at specified intervals. 30 years in the case of one proposal, for every 30 years, there would be a deemed sale event. 21 years in another proposal. So every 21 years, the property in the trust would be deemed to be sold and income tax paid on the capital gain.

There are some exclusions, annual exclusion gifts in one proposal would not be subject to this deemed gainor deemed realization rule, and up to $1 million of net capital gain at death would not be subject to this rule, and the $1 million would be indexed for inflation. This is the case in H.R. 2286. And then in the other proposal, the STEP Act, there would be a lifetime exclusion of $100,000 for capital gain. And at death there would be a $1 million exclusion for capital gain realized at death but it would be reduced by the amount of the $100,000 lifetime gain exclusion that had been used. Both the $1 million gain exclusion and $100,000 exclusion would be indexed for inflation. The deemed sale at death could be offset by the deemed losses at death.

At the time that I created this slide, and at the time of the Heckerling conference, there wasn't much known about how Biden's American Families Plan would impact the estate and gift tax. There wasn't much talk about it, and I didn't really have that much information. But as of Friday, the green book was released as most of you know, and there's much more detail with respect to Biden's plan. It’s just like those other proposals by Pascrelll and Van Hollen; he wants there to be gain realization when a gift is made and when individuals die.So gain would be realized on appreciated property when gifted and at death when bequeathed.

There would be some exclusions, like gift and bequests to a surviving spouse. Gifts to charity, and transfers of personal property would be exempted. Every individual would have a $1 million exemption. So a married couple would have $2 million, and it would portable from one spouse to the other, to the extent it isn't used. These exemptions would be increased for inflation.

Having said that, they'll still be an estate tax imposed at the top estate and gift tax at rate of  40%. And the basic exclusion amount will still be 11.7 million indexed for inflation. And as we all know, that is scheduled to go down in 2026 to a much lower amount, $5 million-plus some indexed amount. So potentially, there could be an income tax and estate tax when someone passes away. But in the Biden proposal, there would be an estate tax deduction for the income tax paid on the capital gain incurred at death.

But remember under his plan also, capital gains and qualified dividends would be taxed at ordinary income tax rates for certain high-income taxpayers, which means that capital gains at death may be taxed at a 39.6% rate, which would be perhaps the ordinary income tax rate rather than the current much lower capital gains rate of 20%. Biden's proposal is to be effective for gifts and bequests after December 31, 2021. So there's no plan to make it retroactive.

Karen Goldberg:Great. I hope the no is, the correct is what happens because it'd be an administrative nightmare to calculate capital gain and some of these assets. And now I'm going to hand it over to my colleague, Lisa Herzer. She's going to discuss planning in light of these proposals.

Lisa Herzer:Good afternoon, everyone. I will be covering some of the highlights of the May 4th presentation titled Strategic Estate Planning for Another Year of Change. 2021: What's in store? It appears 2021 will be another year where estate planning will be challenging. On Tuesday, May 4th, Diana Zeydel, and Todd Angkatavanich presented Strategic Estate Planning for Another Year of Change. Todd set the stage by discussing how a lot of clients took advantage in 2020 of the $11.58 million estate and gift exclusion anticipating that the large exclusion available in 2020 would be reduced in coming years with the change in administration.

Those that did take advantage of breathing a sigh of relief with all the current proposals out there, those that did not pull the trigger, however, are concerns about retroactive legislation in 2021. It should be noted that most of the proposals, however, do not contain retroactive provisions.

Some of the techniques discussed that I will go into detail about were sale to an existing grantor trust, setting up shelf GRATs, planning with preferred partnerships, funding up-generation gifting, and SPACs.

The first planning idea discussed is the sale to an existing Grantor Trust. As Karen just discussed, the Sanders bill contains language that will require post-effective date Grantor Trusts to be brought back into the grantor's estate. Therefore, if you have existing Grantor Trusts, you may want to consider doing sale transactions with the trust. The bill only requires new contributions to be brought back into the grantor's estate. There was no mention of sale transactions being painted.

This planning technique is accomplished by selling assets to the Grantor Trust for fair market value. The sale could be an exchange for a promissory note with the current low AFR. Repayment of the loan over time allows the assets to grow in the trust at a greater rate, hopefully than the note AFR.

Another idea is setting up shelf GRATs. This would require putting together a series of zeroed-out GRATs with varying terms funded with cash. These GRATs would be grandfathered since they were set up before the effective date of any legislation. You could then, down the line, swap growth assets into the trust and take back the cash. It is critical that it is a fair market value exchange.

Preferred partnerships, sometimes refer to as freeze partnerships, effectively freeze the return of one class of partnership interests at a fixed rate. That class of partnership interests do not participate in the upside growth of the partnership as all the future appreciation in excess of the preferred coupon and liquidation preference belongs to the common growth class of partnership interests held by the younger generation.

The preferred interests are typically held by the senior generation family member. There are various issues that must be considered in connection with the formation of a preferred partnership that are beyond the scope of this presentation, including avoiding section 2701 deemed gift issues.

The next set of planning techniques focus on funding up-generation gifting. This planning idea is based on utilizing grandparents' gift and GST exemptions. When significant family wealth has been generated at the current generation, the grandparents may have asset levels that would not enable them to make full use of their current combined gift tax exemptions. However, there are certain opportunities to shift asset value by way of appreciation to the up-generation, which may provide an opportunity for them to build up wealth in their states. So as to use some or potentially all of the current valuable gift estate and our GST exemptions.

One way is to use short-term pop loans. You loan funds to the generation above at the low AFR. They then invest that money, makes significantly more than the AFR hopefully, they back the loan and now cumulated assets to be able to utilize some of their exemption and to pass down those assets to grandchildren. It is important that the loan be respected as bonafide debt, however, there needs to be strict compliance with loan terms.

Another way to utilize up-gen planning is to use the zeroed out GRAT where the grandparent is the beneficiary. You have to be careful, though, not to overshoot the mark with any of these techniques and put too much in the grandparents' estate, thereby creating a taxable estate.

Tax have been in the media a lot lately, often referred to as blank check companies because they are created before their acquisition target has been identified. As observed, the planning with SPACs have some similarities to carried interest transfer planning, but in other ways are very different. Whenever you have an asset that has that potential for stratospheric growth, it makes it a good candidate for estate planning. Due to the complex nature of SPACs is important to get a team of professional involved. Here at EisnerAmper, Nina Kelleher is leading a team of EA professionals specializing in SPACs. We have another team dedicated solely to real estate SPACs I believe Lisa Knee is leading that one.

So as Diana quite rightly pointed out in her presentation, 2021 should be about moving planning forward without doing any harm. Though 2021 may bring uncertainties and challenges, there are still plenty of opportunities for planning, even in these uncertain times.

Lisa Herzer:Most of you got it right. That's right. Both A and B. And I believe Scott Testa is up next with GST Planning.

Scott Testa:Yes. Hi, thank you. On a Wednesday morning session, we went beyond the basics of GST with Julie Miraglia Kwon, Ms. Kwon frequent speaker at Heckerling on generation-skipping transfer tax, gave us some key points there's on GST. This assumes a basic knowledge of gift and GST, and we'll get technical. In this class, we got into a number of technical GST issues, and today I'm going to highlight a few of the more common issues that were discussed.

Well, not exclusively a GST concept. The first issue I want to cover is gift splitting. If gift splitting is elected, all gifts made that year must be split, except those that can't. And that each spouse is deemed to be the transfer of half of that gift. If spouse is elected to split gifts, the same election applies for GST purposes. In other words, if a gift splitting election is made under section 2513, each spouse is treated as a transfer of half of the gift for GST purposes. You can elect the split gifts for gift tax and not GST. Gifts that can't be split include a gift one spouse makes to the other spouse either outright or in trust.

So let's go over when a gift to a trust can be split when you have a gift to the trust where the grantor's spouse is a beneficiary. Treasury Reg 25.2513-1(b)(4) says that if a donor transfers property in part to his spouse and impart to third parties, the gift can be split only to the extent the spouse's interest is both ascertainable at the time of the gift and severable from the interest transferred.

In the case where a spouse is a discretionary beneficiary of a trust, and his or her interest is not limited, it's tough to argue the spouse's interest is ascertainable. The spouse's interest is limited, say to the ascertainable standard, and the spouse has adequate assets outside the trust. So it's likely none of those trust assets would be needed that maybe can argue her interest is negligible. Anything in between, try valuing that interest.

This rule typically applies in the case of a spousal lifetime access trust or SLAT. In most cases, the spouse's interest is completely discretionary is therefore not ascertainable because the gift to the trust cannot be split. The allocation of the GST exemption also cannot be split. The spouse who is the grantor is treated as a transferor for GST purposes and should allocate GST exemption to the full amount of the gift. The allocation of GST exemption to be split, the portion of the gift must be split for gift tax purposes. The point here is that the gift split election must actually be effective for gift tax purposes to be treated as split for GST purposes.

Now let's look at another example. This time with Crummey Powers. Husbands sets up a trust for the benefit of his wife and descendants. The wife has a $5,000 withdrawal right, and their two children have withdrawal right up to the annual exclusion or twice that if gift splitting is elected. The husband transfers $1 million to the trust and wants to allocate GST exemption to the gifts. Gift splinting is elected on the gift tax return.

The trustee has discretionary power to distribute income and principal to the spouse and descendants. And it's not limited to an ascertainable standard. In this case, the gift to the trust above the annual exclusion cannot be split. For gift tax purposes, only the gift subject to the children's withdraw power can be split. The deemed gifts to the wife of 5,000, the excess over the withdrawal powers cannot be split.

So in reporting the gifts, the husband reports gifts of $970,000 for gift tax purposes, the $935,000 access, plus the 5,000 withdrawal power to the spouse. Plus, the Crummey Power gifts to the children after the split, and the spouse reports gifts of 30,000 for gift tax purposes. The key, though, is that for GST purposes, because part of the gift is split, each spouse is treated transferor of one-half of the entire gift. Therefore, each would allocate $500,000 of GST exemption. So here, there's a big disconnect between the gift and GST exemption reported. To me, it just doesn't look right on a gift tax return, but it can be alleviated through proper planning if this is not what was intended.

Another important concept is the timing of the gift split election. Gift splitting election may be filed on a late-filed gift tax return, as long as it is the first file return for the year. Gift splitting is effective retroactively to the date of the gift. The example is in 2019 husband makes the gift of $2 million to an indirect skip GST trust. Obviously what married to his wife, and it is now 2021, and a 2019 gift tax return has not yet been filed. What happens? If no gift tax returns are ever filed, $2 million of the husband's GST exemption is automatically allocated to the gift. But hold on in 2021, husband and wife can now go and file the 2019 gift tax returns reporting the gifts to the trust and elect to split the gifts. The gifts splitting election is effective for both gift and GST purposes. As a result, husband and wife each use $1 million of the gift tax and GST exemptions.

Next up is annual exclusions for GST transfers to trust. Gifts made to trust that qualifies for the gift tax annual exclusion do not automatically qualify for the annual exclusion for GST purposes. To qualify for the annual exclusion for GST purposes, first, the gift to the trust must be eligible for gift tax annual exclusion. In other words, it's got to be Crummey Powers in the trust or 2503(C) trust gifts for minors, trust for minors. Then the trust must be a qualified trust on the 2642(C).

A qualified trust under this section is a trust exclusively for the benefit of skip person during his or her life. And includable in such beneficiaries gross estate if death occurs before the trust terminates. Example: T makes a gift of $90,000 to a trust for the benefit of her descendants, which currently includes two children and four grandchildren. It's a single trust with discretionary distributions permitted to any of the descendants who are both skip and non-skip persons. If not distributed, assets remain in the trust for future generations, each beneficiary has the right to withdraw up to the annual exclusion amount.

In this case, the trust is not a qualified trust under the 2642(C). So even though there are no taxable gifts for gift tax purposes due to the annual exclusion, $90,000 of GST exemption must be allocated to this trust for it to be fully exempt from GST. In other words, to maintain an inclusion ratio of zero.

In this case, I recommend that you file a gift tax return, affirmatively allocate GST exemption to the trust. Now, if you're planning for doing a lot of planning for 2021 or last year you were doing a lot of planning, you get the question, how many gifts do I have left to give? How many gifts does a client have left to give? Make sure you review not only the gift tax exclusion but the GST exemption as well because it is possible that there could be less that the GST exemption remaining could be less than the gift tax exemption. You don't want to tell a client you can make a gift, and it makes it to a GST trust, and then go over the remaining GST exemption.

Now a quick word on GRATs and GST. With a gift to a GRAT, especially zeroed-out GRATs, gift splitting, and allocating the GST exemption, are not often considered. The role is GRATs are not good vehicles for GST planning, but be aware of these state tax inclusion periods and know that GRATs can be considered GST trusts too, especially when you have a GRAT where the remainder will pull over into a trust for children and descendants. In this case election out of the GST exemption on the date of the gift to the GRAT should be made if GST exemption is not intended to be allocated for that GRAT.

In this session at Heckerling, there are few instances where Ms. Kwon recommended some best practices when preparing gift tax returns, these are things not necessarily seen in the internal revenue code but practices she recommends based on experience.

One of the recommendations is towards affirmatively elect in or out of the automatic allocation of the GST exemption on the first gift tax return filed for a gifts to a trust. The GST rules on indirect skips under section 2632(C) are not always clear, and whether trust is the GST trust or not, it's sometimes open to interpretation. As a quick review, remember that there are two types of trusts during life that qualify for the automatic allocation of GST exemption, direct skips, outright or direct skip trust, and indirect skips.

If an indirect skip occurs during the transferor's lifetime, any unused portion of the transferor's GST exemption will be automatically allocated to the transfer to the extent necessary to make the inclusion ratio zero. An indirect skip defined as any transfer property other than a direct skip subject to gift tax made to a GST trust. A GST trust is defined as any trust that could have a generation-skipping transfer.

So that the definition of GST trust sounds simple, except that in reality, it is quite technical and there are six exceptions. The main exception is that where more than 25% of trust corpus is likely to go to non-skip persons before age 46, then the trust is not a GST trust. I look at it anytime a grandchild could take the trust should be analyzed for GST consequences because the ultimate beneficiary is when deciding whether or not to allocate GST exemption.

The bottom line is, don't rely on anyone else's interpretation if you are allocating to GST exemption. And again, you'll discuss this with the client, the attorney, and anyone on the estate planning team, then make the affirmative election to treat the trust as a GST trust and elect into the automatic allocation rules for current and future transfers. If it's a GST trust, it might be clear on its face, but it couldn't hurt to make this election. And if you are allocating out of the GST exemption, then you definitely have to make the election. For example, you might have a trust that is technically a GST trust that terms say that assets can be held in trust for future generations, but it's not what the client intended. He was a trustee rather intends to distribute the assets to his children.

Another example is the life insurance trust payable outright to children upon death of the grantor, which could be after they reach age 46. We just might have a better use of the GST exemption, especially if the GST exemption and the gift tax exemption decreases. Proper allocation of the GST exemption is key to good estate planning.

In either case, in or out best practice is to document this, have the client or the attorney sign off on this via email, and even consider including such language in the filing instructions.

Another good practice is set up a profile with the trust document trust synopsis, including any elections in or out and GST consequences.

To his children. Another example is the life insurance trust payable outright to children upon death of the grantor, which could be after they reach age 46. We just might have a better use of the GST exemption, especially if the GST exemption and the gift tax exemption decrease. Proper allocation of the GST exemption is key to good estate planning. In either case, in or out best practice is to document this, have the client or the attorney sign off on this via email, and even consider including such language in the filing instructions.

Another good practice is set up a profile with the trust document and trust synopsis, including any elections in or out and GST consequences. What I'd like to do in subsequent years on gift tax returns is include a footnote on the return of a prior election out of the automatic allocation rules, if that's the case, but this is the gift tax return software and carry it forward every year. So then you always have your answer to the question why you're not allocating GST exemption if you elect out.

Final key point I want to highlight is don't elect out of the automatic allocation rules just to elect back in. I first started this a few years ago at Heckerling when Carol Harrington stayed at the same position. I was happy to hear her say it because in the past I've when preparing gift tax returns, I've had attorneys who wary of the automatic allocation rules or want to do a formula allocation one-elect attitude GST only to prepare a notice of allocation to elect back in. Why do this? I'd say, "That's the thing about the automatic allocation rules. They're automatic." To me, these rules are taxpayer-friendly. The IRS is not out to get anyone over these rules. If the value of the gift tax should change on audit. For example, then the GST allocation also automatically changes.

Furthermore, these rules are designed to protect the taxpayer in case of a misdirection. If you miss allocating GST exemption to a trust, you can always fall back on the automatic allocation rules and go back and allocate GST exemption. That is unless you have a pre-2001 trust and needs to go back to before the automatic allocation rules applied. As long as you never elected out, the allocation was automatic, and can go back and fix it or adjust the exemption. Trouble arises when should I say, your predecessor elected out to automatic allocation rules and don't properly elect back in. So why mess with those rules?

Scott Testa:Okay. Let's see. It looks like most of you got this right. Although the trust technically satisfies the qualifications of a GST trust, the transfer to the trust is not an indirect skip because the transfer to the trust is direct skip. The transfer to a trust whose beneficiaries are only skipped persons. Therefore the gift should be reported on schedule A part two as a direct skip.

Now, in this example, I didn't say anything about Crummey's Powers or whether the annual exclusion applied. If the trust did have Crummey Powers and was eligible for gift tax exclusion, even though it meets the first prong of the 2642 (C) trust test, it's still not eligible for the GST in an annual exclusion because it doesn't say it ends on the grandchild's death.

The last word of advice is, don't wait until October to start those gift tax returns. And that's true, especially if you need to have an attorney or a GST specialist in your office review the returns. Now's a good time to work on them, and good luck this summer and enjoy the rest of the webinar. Next step, Kurt.

Kurt Peterson:Hello everyone. Thank you for attending our seminar. And I will be discussing the recently adopted SECURE Act related to the federal income taxation of deferred retirement plans, which was a presentation provided by the always very popular Natalie Choate at this year's Heckerling Conference.

Assets in a retirement plan consisting of traditional IRAs, 401(k), and 403(b) plans, et cetera, are taxed at federal ordinary income tax rates when the retirement plan benefits are withdrawn by the owner. When a retirement plan is inherited upon the death of the retirement plan owner, income from the retirement plan is referred to as income in respect of a decedent or IRD. It does not receive a step-up in basis as would other assets that are held directly by a decedent outside of a retirement plan, such as stocks, bonds and real estate. Therefore the income in a retirement account is still taxed at federal ordinary income tax rates when the retirement plan benefits are distributed to the beneficiaries of the retirement plan.

An exception is when the retirement plan owner has made after-tax contributions to the retirement plan. After-tax contributions create a tax basis in the retirement plan and will not be taxed when they are withdrawn by the retirement plan owner.

Additionally, the after-tax contributions or basis in the retirement plan can also be inherited by the beneficiary upon the passing of the retirement plan owner. So, therefore, the after-tax contributions are also not taxed when they are distributed to the beneficiary.

Another exception is distributions from a Roth IRA. Contributions to Roth IRAs are not tax deductible when the assets are deposited into a Roth IRA account. Therefore the distributions from the Roth IRA, including the earnings on the assets when they are held within the Roth IRA, are generally not taxable when they are distributed to either the original Roth IRA owner during his or her lifetime or to a beneficiary that inherits the Roth IRA.

There are rules as to when the deferred income in a retirement plan must be distributed, which are called the required minimum distribution rules or RMD, which are under internal revenue code section 401(a)9. The RMD rules were significantly changed by the SECURE Act, which was legislation that was passed during late December of 2019 and took effect for deaths that occurred after the 2019 tax year.

Roth IRAs are not subject to the required minimum distribution rules during the life of the retirement plan owner. The rules prior to the SECURE Act generally allowed retirement plans that were inherited by individual beneficiaries to spread those distributions over a period of a life expectancy, or, in the case of a retirement plan that was left to a see-through trust to distribute the retirement income over the life expectancy of the oldest beneficiary of the trust. With a few exceptions, the SECURE Act has effectively reduced the ability to stretch out the length of time to recognize the deferred income tax liability that is inherent in these inherited retirement plans.

The RMD rules are generally separated into two sets of rules when the retirement plan required minimum distributions must be made. The first set of rules dictate when the RMDs must be made during the retirement plan owner's lifetime, which we'll discuss on this current slide. And the second set of rules determine when the RMDs must be made after the retirement plan owner's death, which we'll discuss over the next two slides after this one.

The RMD rules under the SECURE Act dictate that for all types of traditional IRAs, the required minimum distributions must begin at age 72, and the IRA owner must begin distributions on or before the date of April 1st after the tax year that the IRA owner turns 72. The old rule prior to the SECURE Act required RMDs to begin when the IRA owner reached the age of 70 and a half. And as previously mentioned, Roth IRAs do not have an RMD during the lifetime of the Roth IRA owner. A Roth IRA owner can defer distributions to basically any age that they wish.

The RMD rules for qualified plans, such as 401(k) and 403(b) plans, depend upon whether the employee has retired before the age of 72.  For an employee who doesn't own more than a 5% interest in their employer, if the qualified retirement plan owner retires before the age of 72, then the required minimum distributions must begin on or before that April 1st date following the tax year that the retirement plan owner became age 72. If the employee continues to work beyond the age of 72, then the RMDs must begin on or before April 1st of the tax year following the year that that employee, in fact, retires.

The RMD rules under the SECURE Act for retirement plans inherited after the retirement plan owner's death depends upon whether the retirement plan owner died before or after the date that they were required to start taking their RMDs. The SECURE Act separates the status of beneficiaries that inherit retirement plans into three different classes.

The first class is the non-designated beneficiary, which happen to be treated the worst under the SECURE Act. The second class is a regular designated beneficiary who are individuals or a see-through trust named or nominated by the completion of one of those designated beneficiary forms. And the third is the new class of "eligible" designated beneficiary, which are actually treated the best under the SECURE Act.

So a non-designated beneficiary would include a trust that does not qualify as a see-through trust or the decedent's estate, such as when the retirement plan owner neglects to complete their designated beneficiary form. If a non-designated beneficiary inherits the retirement plan prior to the date that the deceased IRA owner had to start withdrawing their RMDs, then the entire retirement plan must be distributed within the end of the fifth full year following the retirement plan owners' death. This five-year rule is consistent with the old pre-SECURE Act rules and did not change with the adoption of the SECURE Act.

The regular beneficiary that is not an eligible designated beneficiary, which we'll define shortly, which inherits the retirement plan prior to the date that the retirement plan owner was required to start their RMDs would have until the end of the 10th year to withdraw the entire retirement plan under the SECURE Act. As with the old five-year rule, there are no annual required minimum distributions until the entire retirement plan must be withdrawn by the end of that 10th year.

An eligible designated beneficiary includes the retirement plan owner’s surviving spouse, minor children, disabled and chronically ill individuals, which are defined in separate sections of the internal revenue code, and beneficiaries that are not more than 10 years younger than the deceased retirement plan owner, and in fact, those beneficiaries could be older than the retirement plan owner.

An eligible designated beneficiary under the SECURE Act who inherits the retirement plan prior to the retirement plan owner's required date to start taking their RMDs could still use the life expectancy tables, or rather can elect to use the previously mentioned ten-year rule that applies to regular designated beneficiaries.

A decedents that died after the date that they had to start taking their required minimum distributions: The non-designated beneficiary, which again is the decedent's estate or a trust that does not qualify as a see-through trust, would be able to continue to take their RMDs from the retirement plan based upon the retirement plan owner's life expectancy. This has become to be known as the ghost life expectancy, or to pretend that the retirement plan owner is still there, even though they really aren't. There would be no five-year rule in this situation as that ended when the retirement plan owner survived the date that they were required to start taking their RMDs.

A regular designated beneficiary under the SECURE Act would be required to withdraw the entire balance of the retirement plan prior to the end of the new 10-year rule following the retirement plan owner's death, no matter whether the retirement plan owner died either before or after the required start date of their RMDs.

The eligible designated beneficiary would be allowed to elect the longer of the eligible designated beneficiary's life expectancy or the ghost life expectancy, which again is the deceased retirement plan owner's life expectancy as if they still had survived.

Now in an estate plan, a means to possibly minimize the income tax consequences of the inherited retirement plan is when a retirement plan owner has someone that they wish to benefit that would qualify as one of these new eligible designated beneficiaries. They can then name one of those individuals like a disabled relative or siblings who would qualify for the RMD payouts utilizing their life expectancy as an eligible designated beneficiary of the retirement plan. Then they can leave the other assets, those non-retirement plan assets, to non-eligible designated beneficiaries, such as their adult children.

Other SECURE Act implications. The SECURE Act did not change the income tax preferential treatment of the surviving spouse that is nominated as a designated beneficiary of a retirement plan as was provided by the rules in effect before the SECURE Act. The surviving spouse, who is the designated beneficiary of a retirement plan, will have the choice to begin taking their RMDs based upon the life expectancy payout during the later of either option one, the year after the retirement plan owner's death, or option two, the year that the retirement plan owner would have turned age 72 had they survived.

Additionally, the surviving spouse's life expectancy payout from an inherited IRA is based upon an annual recalculation of the surviving spouse's life expectancy, which is an additional benefit. Upon the surviving spouse's death, the beneficiaries of the inherited IRA will have to withdraw the entire balance of their retirement plan under this new SECURE Act 10 year rule.

The other special rule that's available to a surviving spouse is that the surviving spouse has the option to perform a spousal rollover of the retirement plan to her own IRA. In most cases, this would be the best option for the surviving spouse and her designated beneficiaries, especially if the surviving spouse is much younger than the original retirement plan owner.

A see-through accumulation trust is a trust that names only individuals as both the life income beneficiaries and remainder beneficiaries of the trust and cannot include other types of entities, such as charitable organizations, as the beneficiary.

A see-through accumulation trust can keep the distributions received from a retirement plan and does not have to currently make the distributions in the same tax year that the retirement plan distributions are received by the trust. If a retirement plan owner does not want to nominate their surviving spouse as an outright beneficiary for whatever reason, but would rather have one of the see-through trusts receive and control the distributions to the surviving spouse, the SECURE Act no longer allows the trust to qualify for life expectancy payout as would have been allowed under the old pre-SECURE Act rules.  When a retirement plan nominates a see-through accumulation trust for the benefit of the surviving spouse as a designated beneficiary, the trusts will have to take the full distribution of the retirement plan within the SECURE Act’s 10-year rule.

Under the SECURE Act, a minor child qualifies as an eligible designated beneficiary while the child is still under the age of majority, and the retirement plan can distribute to the guardian of the minor child based upon the life expectancy of the minor child.

However, once the minor child reaches the age of majority, the once minor child is no longer an eligible designated beneficiary, and the SECURE Act RMD rule will flip to the 10-year rule. As an example, if the age of majority in Pennsylvania is age 21, which it happens to be, the retirement plan will have to distribute the entire plan assets by the time the child reaches a young age of 31. Therefore, utilizing a see-through accumulation trust to receive and control the retirement plan distributions under the SECURE Act 10 year rule would probably make more sense than to attempt to take advantage of a rather short-term life expectancy payout period. The see-through accumulation trust can then hold on to and distribute the assets received from the retirement plan to the child at an older age, let's say like 45.

The SECURE Act also provides a special provision for see-through accumulation trusts for the sole benefit of a disabled or chronically ill individual. This SECURE Act provision was adopted to accommodate for supplemental special needs trusts for the benefit of a disabled or chronically ill beneficiary to qualify for that tax-advantageous life expectancy payout.

These are the only two types of eligible designated beneficiaries where the see-through accumulation trust can qualify for a life expectancy payout of the assets from a retirement plan. Upon the death of the disabled or chronically ill beneficiary, the trust must provide for the remaining assets of the trust to pass to individual beneficiaries in order for that trust to qualify as a see-through accumulation trust, which we mentioned earlier.

Lastly, I'd like to mention that when a see-through trust receives distributions from a retirement plan and that trustee does not distribute to the income beneficiary during that same tax year, the distributions from a retirement plan is ordinary income and is taxed for income tax purposes at the trust level where the trust actually pays the tax. The tax consequences are that trusts have very small graduated tax brackets and are taxed at the highest 37% tax rate above only about $13,000 of ordinary income that trusts do not pass out to the beneficiaries.

However, if the trust distributes its ordinary income from the retirement plan in the year received, the trust generally obtains a deduction for that distribution of its net income to the beneficiary and the income is not taxed at the trust level. Therefore, whenever possible, the trust agreement should provide that the trustee have appropriate flexibility and discretion, to distribute trust taxable income to beneficiaries who may be in lower ordinary income tax brackets on their individual tax returns.

Thank you very much for your time and attention. And now we'll pass the baton over to Pat Green to discuss charitable remainder trusts.

Patricia Green:Good afternoon. Thank you, Kurt. I'm going to share this summary of Christopher Hoyt's topic on: Can a CRT Stretch an Inherited IRA? So now that the SECURE Act has been issued, we have this planning to do to see if there's ways that we can stretch the IRA payment over more than 10 years. I will be discussing what a stretch IRA is, overview of charitable remainder trust, planning and legal hurdles, type of CRT to use, and who could benefit.

A stretch IRA, as Kurt mentioned, is an inherited retirement account where payments are gradually made over the beneficiaries' life expectancy. And this is done mainly for tax-deferred growth. If the money is not needed by the beneficiary, the longer you leave the money in the retirement plan, it can grow tax-deferred. So there'll be more wealth to pass on. Beginning in 2020, the general rule now is limited to a 10 year liquidation period with the exception that Kurt had mentioned. So the question is, can a CRT get a lifetime payout comparable to a stretch IRA?

Charitable Remainder Trusts are tax-exempt entities. A transfer at death from a retirement plan to a CRT is a tax-free transfer from one tax-exempt trust to another tax-exempt trust. The trust itself does not pay any income tax. The tax is paid when the beneficiary withdraws the money. When distributions are made to the beneficiary, the beneficiary is the one who pays the tax on that income. The CRT holds assets that generate, there's an exception to that rule. If the CRT holds assets that generate unrelated business taxable income, the CRT must pay tax of 100% of the full amount of the unit. So care must be taken in proper assets inside the CRT.

This does not apply to charitable lead annuity trusts. We are not talking about charitable lead annuity trust. They are not tax-exempt organizations, entities. They pay income tax. And they are the opposite of charitable remainder trusts where the charitable beneficiary is the remainder mint, and the income is distributed to non-charitable beneficiaries with a class, the income is distributed to charities, and the remainder goes to non-charitable beneficiaries. And this is a taxable trust that gets a charitable deduction for the payments to the charity.

A charitable remainder trust can be set up for a term of years or for life. So it could be for the life of one of our beneficiaries, or for a term of years not to exceed 20. And at the end of the term, the balance goes to charity. There's a four-tiered distribution system for the income that's passed out to the beneficiaries on their distributions. It first carries out income of ordinary income, then capital gains and tax-exempt income. And finally, once all that is depleted, then it distributes out corpus and suspends known as WIFO, worst in, first out.

Types of charitable remainder trusts. You'll have the typical charitable remainder annuity trust. This pays a fixed dollar payout of at least 5%, and no more than 50% of the value of property contributed. Then you have a charitable remainder unitrust, a standard CRUT. As a fixed payout percentage of the value of the trust assets, each year subject to the same, at least 5%, but no more than 50% of the value of the property contributed. So a charitable remainder trust the payment is fixed as the date the trust is created. With a unitrust, the payment is going to fluctuate each year, based on the percentage of the value of the assets in the trust each year.

Conversions of CRUT is a net income unitrust, which pays the lesser of the year's net income or fixed percentage of the value of the trust assets. This is sometimes used when there's still liquid assets that are not generating any income in the beginning of the term. And when we talk about this net income, it's really referring to trust accounting income, which is another topic to discuss another day.

That's very rarely used. What most people use is what we call a NIMCRUT, Net Income With Make-up Unitrust. Similar to the net income trust, except the trust can pay in excess of the stated payout percentage in order to make up for a shortfall from a prior year when the net income limitations cost the beneficiary to receive less than the stated payout. So in one year, the income such as accounting income was less than 5% of the fair market value of the previous year. So the income was limited that year. And the following year, if there was sufficient income to payout, you could pay out more than the fixed percentage to make up for the shortfall in the previous year.

The next kind is referred to a FLIPCRUT. This is similar, but it converts to a standard CRUT the year of a specified date or triggering event. So the trust might have an illiquid asset. And then, upon the sale of that asset, then it could convert over to a standard CRUT.

There are many planning options and hurdles that you have to overcome, which Chris mentioned in his presentation. One of them is the annual payouts must be between five and 50%. The biggest one is the charitable remainder interest must be at least 10% of the initial net fair market value of the property contributed computed under the Section 7520 rates.

This could happen if the stated payout rate was too high, projected term of the trust too long, or in this low-interest-rate environment, this will be very hard to meet with a charitable remainder annuity trust. As Kurt mentioned, the income of a retirement plan is what we call income in respect of the decedent. So the beneficiary receiving it pays ordinary income tax on it. Section 691 allows for an estate tax deduction. Estate tax was paid on the retirement, money in a taxable estate. For an individual, you would get an estate tax deduction. So if you received $100,000, you would get a deduction for 40,000, say the tax rate was 40%. The other hurdle is if the intention is to transfer as much wealth to the family, this is probably not going to be your soul.

Patricia Green:Okay. Well, it is exempt the trust of CRP is exempt from income tax, and it does benefit charity. 28% got it right. That if you're trying to pass as much wealth to family members, you would not use this technique. What works best? A charitable remainder annuity trust does not work well in this low-interest environment. It would have to be for a term of years. And from some of the calculations, Chris mentioned that it would have to be no longer than 19 years. I think I was able to get one for 20 years. But is that really an advantage? You're getting another 10 years after the 10-year limitation.

So the CRUT seems to work best with a 5% payout. So the CRUT assets can grow the same rate as the distribution. It seems to benefit the family's greatest if it's a long-term trust. Or it's probably not likely that a CRT can produce family wealth rather than just taking the distribution outright in the 10 years. And it would depend on the investment return and the tax rate, but it can happen with a long-term CRUT.

So who would benefit from this? This is very limited to the people that I think would benefit from this, but it would be somebody who is terribly inclined and wants to benefit family members for life, is not in the taxable estate, an anticipated long-term CRT with high-income tax rates imposed. And if this is something that is desirable, it might be the second to die, spouse. And he has two children with no grandchildren or anything and wants to make sure that whatever they don't use up during their lifetime, they go to charity. There's an important message that Chris stressed in his topic. If this is what they want, you have to make sure you have properly drafted documents and that the CRT is named as the beneficiary on the retirement plan.

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