New Estate Plans – Revisit and Revise

January 16, 2023

By Charlie Friedman

At the 57th Annual Heckerling Institute on Estate Planning, Carol Harrington gave a presentation entitled “Watch Your Steps—Don’t Abuse Substance in Transfer Tax Transactions.”  There is an old saying, “the best laid plans of mice and men often go awry,” which sometimes applies to estate planning.   Developing an estate plan with qualified professionals in an effort to minimize transfer taxes and achieve the desired disposition of assets involves more than just drafting documents.

This session covered various situations where an estate plan can fail.  It covered the reciprocal trust doctrine, indirect or conduit transfers, sales in exchange for notes, loans, retained interests and entity discounts. To have a successful estate plan, there are numerous behaviors that must be adhered to after the documents are signed.  Below are a couple of examples of bad behavior that threaten an estate plan.

In recent years, wealth has passed to the next generation via low-interest loans.  Children would borrow money at extremely low rates and then invest the funds at a high rate of return.  Bad behavior can occur when the client forgives the loan every year, and no interest or principal payments were ever intended to be made by the children.  There must be evidence that there is a reasonable expectation that the loan can and will be repaid.  That could be in the form of a repayment schedule with evidence of some interest (and principal) payments, or a securitized note.  If there was never an intent to repay the loan, the IRS could deem the loan a gift at inception which could trigger an unintended gift tax liability. This does not preclude loan forgiveness each year using the annual gift tax exclusion.  There just should be some loan payments.

Another example of a situation that should be avoided is a taxpayer creating and funding an irrevocable trust with virtually all of his assets, without leaving enough funds outside the trust to support his lifestyle.  When the client is desperate for money, he takes funds from the trust.  When the client created the trust, he relinquished all rights, control, and beneficial enjoyment with respect to the trust assets.  By withdrawing funds, the client violates the trust terms.  In such cases, the IRS can wreck the client’s estate plan by including the trust assets in his taxable estate.  If the trust assets significantly appreciated, this could be a costly error on the part of the taxpayer.  The lesson to be learned is for the client to retain money/assets outside the trust sufficient to support his lifestyle.

There is a litany of cases where an estate plan was wrecked through both bad behavior and inadequate drafting.  The gist of the presentation was that creating an estate plan is a commitment that must be constantly monitored for proper adherence and law changes.

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