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The Heckerling Institute focused on income tax and estate planning techniques, basic exclusions against the gift tax and non-reciprocal trusts.

Having Your Cake and Eating It Too

Gideon Rothschild of Moses & Singer LLP, Barry Nelson of Nelson & Nelson, P.A. and Jocelyn Margolin Borowsky of Duane Morris LLP presented a session focused on estate and income tax planning techniques for modestly wealthy clients, defined as taxpayers that have a net worth between $11 million and $100 million. Implementation of these techniques may avail these individuals of their increased basic exclusions against the estate and gift tax while retaining access to their assets should an unforeseen financial need arise in the future. The current utilization of the basic exclusions is prudent as the current law is scheduled to sunset after 2025 or possibly sooner if the political environment changes in Washington D.C. Another benefit of utilizing the basic exclusions currently is that the assets transferred by completed gift could appreciate in excess of the basic exclusion amount outside of the taxpayer’s gross estate.

Mr. Nelson developed a questionnaire designed to identify individuals that are candidates to make current gifts of their basic exclusions and attempt to match the client to the appropriate estate planning technique. The questions included in the questionnaire, in summary, are as follows:

To save future transfer taxes….

  • Would you be willing to make gifts of your gift tax basic exclusion, which during 2019 is $11.4 million if single or $22.8 million if married, provided that neither you nor your spouse would have access to those funds regardless of any negative reversal to your financial position?
  • Would you be willing to make gifts into a trust where your spouse, and possibly your children, would receive the benefit of the distributions but, upon the death of your spouse, the trust’s assets would be held exclusively for your children and not pass back to you?
  • Would you be willing to make gifts into a trust where your spouse and your children would receive discretionary distributions to be determined by an independent trustee? Furthermore, your spouse can decide whether, upon his or her death, all or a portion of the assets would revert to you in a new trust that he/she would create for your benefit.
  • Would you be willing to make gifts into a trust designating your spouse and children as discretionary beneficiaries but provide that upon a pre-determined future date the assets are distributed either outright or in trust for your children if your net worth outside the trust is at least a specified amount determined as of the creation of the trust that you believe you and your spouse would need for the rest of your lives?
  • Would you be willing to accept the complications of using a self-settled trust jurisdiction, where you, your spouse and possibly your children are potential beneficiaries, to reduce the likelihood that the IRS would prevail in the event they took the position that, due to you being a potential trust beneficiary, the assets of the trust would be includible in your estate? Would you be willing to set up a self-settled trust in a domestic asset protection situs (e.g., Alaska, Delaware, South Dakota or Nevada)? Would you be willing to set up a self-settled trust in a foreign asset protection situs?

If the above questions determined that the taxpayer is a candidate to make large lifetime gifts, Ms. Borowsky explained that completed gifts to self-settled trusts could utilize the taxpayer’s basic exclusion amount, keep the assets out of the taxpayer’s gross estate, and allow the taxpayer to have some access to the trust assets, and not require the taxpayer to be married. However, the taxpayer cannot take regular distributions (nor have an implied agreement between the taxpayer and the trustee to make distributions to the taxpayer) from the self-settled trust and the trust must be established under the laws of a state jurisdiction that has a domestic assets protection trust (“DAPT”) statute. If the self-settled trust is not established under the laws of a DAPT-statute state, the taxpayer’s creditors can access the trust assets to the maximum extent that the trustee can distribute the trust assets back to the trust settlor. Also, if the trust is not established in a DAPT statute jurisdiction, the trust’s assets would be subject to the claims of the taxpayer’s creditors, and the taxpayer will not be able to make a completed gift pursuant to IRC Section 2511. Additionally, if the taxpayer’s creditors can claim access to the assets of the trust because the self-settled trust is not established in a DAPT-statute jurisdiction, the taxpayer will have a retained interest in the trust assets under IRC Sections 2036 & 2038 or will possibly possess a general power of appointment under IRC Section 2041 and the assets of the trust would be includible in the taxpayer’s gross estate.

Mr. Rothschild explained that there is uncertainty whether a self-settled trust established by a taxpayer residing outside of a DAPT-statute jurisdiction will stand up as being governed by the laws of a DAPT-statute state. With respect to taxpayers that do not reside in a DAPT-statute state, self-settled trusts established to be governed by a DAPT-statute state that contain intangible assets (e.g., portfolio of securities) generally will be governed by the laws of the jurisdiction stated in the trust agreement. Self-settled trusts established to be governed by a DAPT-statute state that contain tangible assets (e.g., real estate) generally will be governed by the laws of the state where the tangible assets are located. Therefore, if the self-settled trust will be funded with real estate or other tangible assets located outside of a DAPT-statute state, the taxpayer should not transfer the real estate to the trust directly but rather wrap the real estate in a limited liability company or a partnership prior to transferring the asset in trust in order to convert the tangible asset to an intangible asset.

For married taxpayers, an estate planning technique where the grantor can make a completed gift, utilize his/her basic exclusion, retain access to the benefit of the assets transferred to trust through the grantor’s spouse and provide more comfort that the trust will not be challenged by the IRS to be includible in the gross estate of the grantor, is the spousal limited access trust (“SLAT”). The grantor’s spouse, and possibly also the children, will be discretionary beneficiaries of the SLAT, whereas unlike the self-settled trust, the grantor will not be a discretionary beneficiary. Upon the death of the grantor’s spouse, if he/she should be the first to die, the spouse can decide whether all or a portion of the assets in the trust revert into a new trust created by the deceased spouse for the benefit of the grantor. An independent trustee would then determine the extent of the distributions from the new trust that would be made to the surviving grantor of the original SLAT.

Another estate planning technique for either married or unmarried taxpayers to currently utilize the gift tax basic exclusions while receiving a benefit in trust is a non-reciprocal trust. This technique attempts to avoid the reciprocal trust rule or principle that states that if one person makes a transfer-in-trust for the benefit of another person and that other person makes a reciprocal transfer-in-trust for the benefit of the first donor, the trusts can be uncrossed and be effectively includible in the respective estates of both donors under IRC Section 2036. The reciprocal trust rule can be avoided if trusts that are non-reciprocal trusts that are created on different dates, funded with different amounts and types of assets, and contain different distributive provisions and trustee appointments within each of the respective trust agreements. The creation of a SLAT and a non-reciprocal trust by married taxpayers may also require the creation of a post-nuptial agreement by the spouses who each need to be represented by different legal counsel to protect the interests of both spouses in the case of a divorce.

Additional estate planning techniques for married taxpayers to utilize some or all of their basic exclusions during the lifetime of the taxpayers are inter-vivos qualified terminable interest property (QTIP) trusts. However, the QTIP technique will only work if the QTIP trust beneficiary spouse is a United States citizen. Upon the passing of married taxpayers, additional estate planning techniques to fully utilize the estate tax basic exclusion of the first-to-die spouse are testamentary QTIP trusts and portability planning.

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Kurt Peterson Tax Director provides a wide range of tax services including financial planning, income tax planning, estate planning, complex estate plan structures, retirement planning, and risk management insurance.

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