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Ms. Zeydel also discussed the psychological aspects of lifetime gifting, stating that many clients link their balance sheet to their identities. As a result, another possible fact pattern presented relied on portability with creation of two irrevocable grantor trusts by the survivor (one using the survivor’s exclusion and another using the exclusion ported). Although, in the aggregate the presenters noted that using the entire exclusion today is still the most favorable outcome for GST planning purposes based on the numerical analysis. Further on in the presentation, the presenters noted that an even better outcome results from “topping up” your trust each year with the annual inflation-adjustment to the exclusion amount.
The conversation shifted focus to the expected time between the deaths of two spouses. Although many strategies require an over life, Ms. Zeydel pointed out that this type of planning remains important because even a 70 year old client still has 9.01 average over life. She further provided that an overlife as high as 15 years might be used in financial projections for some high net worth clients due to their propensity to live longer as a result of their access to better healthcare. Also noting that the closer the dates of death, the less efficient the strategies.
The final scenario presented involved a couple with $100 million in assets. The presenters reminded the audience that very wealthy clients might have large fixed costs, requiring quite a bit of income to maintain their lifestyle. In this fact pattern, the presenters introduced a potential sale of assets to the trusts. Further noting that, in the alternative, allocating GST exemption to a GRAT may be more complicated when weighed against any concerns regarding the use of an installment sale.
In conclusion, the presenters opened the floor to questions, and addressed the balanced portfolio assumption as well as concerns regarding the purchase of assets by the grantor using a note.
Session I-B Planning with SCINs and Private Annuities – Seizing Opportunities While Navigating Complications (Financial Assets Series, Focus Series) Steve R. Akers, N. Todd Angkatavanich, Melissa J. Willms SCINs and private annuities offer tremendous potential opportunities, in light of taxpayers’ ability to “self-select” when to use these strategies and various planning flexibilities. But these strategies also involve a host of complicated tax rules and requirements through which the planner must navigate. The panel will focus on practical planning issues and strategies.
SCINs and private annuities offer tremendous potential opportunities, in light of taxpayers’ ability to “self-select” when to use these strategies and various planning flexibilities. But these strategies also involve a host of complicated tax rules and requirements through which the planner must navigate. The panel focused on practical planning issues and strategies. This special session builds on the general session on the same subject that was presented by Steve Akers.
The panel began by reviewing why wealth transfer “freeze” planning, such as self-canceling installment notes (SCINs), grantor retained annuity trusts (GRATs), private annuities, or installment sales to grantor trusts, is attractive to clients. Properly done, these techniques contain the value of assets in the grantor’s taxable estate, transfer future appreciation to the beneficiaries, and provide cash flow to the grantor (and possibly the grantor’s spouse).
SCINs and private annuities have the potential for superior wealth transfer results if the seller’s health is not good, causing a reduced chance of surviving to life expectancy. Because the seller may survive past life expectancy, SCINs and private annuities create the risk that the payments made will increase the value of the seller’s estate, a “reverse freeze.” Mr. Akers noted that many people may not have done a SCIN or private annuity. These strategies have a lot of complexity and moving parts. In their basics, they are very similar to a GRAT or an installment sale. The only difference between a SCIN and an installment sale is the terms of the note.
With SCINs and private annuities, there is a valuation risk involved on both sides of the transaction – the value of the asset being sold and the value of the note. We don’t have any guidance on how to determine the risk premium that the seller may not receive full value for the asset sold. The examples in their presentation used the section 7520 rate but they are not saying it’s the proper rate to use.
Ms. Willms reviewed the guidance and cases involving SCINs and private annuities, noting that the IRS position continues to evolve. Many pre-date the enactment of section 7520, raising the question of how much weight to give them.
Mr. Angkatavanich discussed the valuation rules. Section 7520 requires that the value of any annuity, interest for life, term of years, remainder interest, and/or reversionary interest be determined using IRS tables and an interest rate equal to 120% of the midterm AFR. An exception exists if the seller is terminally ill, as defined in the regulations.
Practitioners thought the section 7520 regulations could be used for SCINs and private annuities. Commercial software such as NumberCruncher/Estate Planning Tools and Tiger Tables use the section 7520 regulations in their computations.
CCA 201330033 and the IRS position in the Davidson case call this into question. The CCA states the IRS litigating position in Davidson. The IRS said that the actuarial tables under section 7520 and “terminally ill” test did not apply to SCINs. Instead, SCINs must be valued under a willing buyer/willing seller standard and that the parties in an arms-length transaction would use actual life expectancy, rather than the section 7520 tables. The seller’s actual life expectancy would be based on their medical history.
The Davidson case may be settled. If it is, it leaves the IRS in best of all worlds: they have the chilling effect of the CCA and no court decision providing guidance.
The panel offered the following planning considerations for SCINs:
· Expect IRS scrutiny if the seller dies early. The IRS views SCINs with a jaundiced eye, particularly if the seller has health issues and/or dies soon.
· “Backloading” SCIN payments are a “red flag.” · The ability of the buyer to repay the SCIN is critical in evaluating whether it is valid debt.
· A large principal risk premium creates heightened concern. The note may exceed the value of the asset sold.
Securing the SCIN by additional assets will increase the expectation of repayment.
The important thing when evaluating any of these transactions is to “run the numbers.” The panel reviewed a hypothetical situation.
The bottom line is that there are more issues with SCINs than we thought.
The panel then turned to a discussion of private annuities. They may be more attractive than SCINs due to certainty in determining the value of private annuities for gift tax purposes. Private annuities have significant 2036 issues, however.
Private annuities can be a good opportunity for someone who isn’t in the best of health but is not terminally ill. For someone terminally ill, there are valuation risks on the buyer’s side as well because you can’t use the section 7520 tables.
The Kite case involved private annuities with the first payment deferred for 10 years but within the seller’s life expectancy. A letter from her doctor stated that she wasn’t “terminally ill”. The IRS attempted to depart from the section 7520 tables, claiming it was foreseeable that she wouldn't live for five years. The court held that the deferred annuity was adequate consideration for the transfer of family partnership interests. It said the fact she had home health care didn’t show she was terminally ill. She was wealthy and spent her money to provide the type of care she wanted.
This was a good victory for the taxpayer but doubling down with 10-year deferral can get the IRS’s attention.
Proposed regulations on the taxation of annuity payments would make significant changes to the income taxation of private annuities. Historically, a private annuity results in the seller reporting gain ratably over the annuity term.
If finalized, the regulations would be retroactive to October 18, 2006. They require the seller to recognize gain at the time the assets are transferred. Mr. Akers said he won’t do private annuities to individuals or non-grantor trusts, just with grantor trusts.
Ms. Willms discussed a second part of the 2006 regulations that affects private annuity sales to grantor trusts: the “exhaustion test.” It applies if a life annuity is paid from a trust or other limited fund. In that situation, there is an additional gift if the fund is insufficient to pay the annuity to the annuitant’s age 110.
She recommended that unless you are an actuary or a glutton for punishment, use commercial software to make the calculation. Even if you do it yourself, she recommended checking your result against commercial software.
Strategies to consider to avoid the additional gift if the trust would fail the exhaustion test include using a substantial pre-existing trust, personal guarantees, or a combination. In Trombetta, Judge Cohen refused to give effect to personal guarantees.
A Private Annuity for the Shorter of Annuitant’s Life or Stated Term (“PAST”) can help with the exhaustion test. If the annuity can’t last to age 110, the exhaustion should be inapplicable. The stated term should be longer than the seller’s life expectancy. Under GCM 39503, if the stated term exceeds the annuitant’s life expectancy, the annuity is taxed under the annuity rules of section 72 rather than as an installment sale.
If the sale is to a grantor trust, you can have section 2036 issues, especially if the annuity stream looks to be close to income from asset. The materials include cases where the taxpayer won on section 2036 issues. The panel standard the best practice is not to have annuity payments equal or close to the income from the asset.
The materials include other suggestions on how to use private annuities for maximum benefit for clients. The panel agreed that the uncertainties associated with SCINs make private annuities to grantor trusts a safer alternative.
Session I-C Review of the Past Year’s Significant, Curious, or Downright Fascinating Fiduciary Cases (Litigation Series) Dana G.
Fitzsimons, Jr., Gerard G. Brew Recent cases will be reviewed to assist fiduciaries and their advisors in identifying and managing contemporary fiduciary challenges, including: investments, business interests in trusts, disclosure and privileges, surcharge and defenses, trust modification, and more. Gerard Drew could not participate so Dana Fitzsimons covered all topics.
Reporter: Joanne Hindel Esq.
He explained that he looks at cases each day to determine what is going on in litigation.
He started with cases involving Investments:
Kastner v. Inrust Bank Claims against trustee were dismissed where beneficiary is not a qualified beneficiary and for failure of proof of any economic harm. Knowledge of trust law and knowledge of how to put on a case are very different skills.
Greenberg v. JP Morgan Chase Bank Two trustees – there was a contractual delegation of investment management to the corporate co-trustee.
Individual co-trustee then sued corporate co-trustee for downturn in market value of assets and for continued investment in proprietary funds. Court refused to dismiss claims for investment losses during economic downturn where bank rejected individual co-trustee’s request to reallocate portfolio despite existence of contractual delegation.
Matter of Littleton This case involved a concentration of Corning Glass stock. Trust had an exculpatory clause but court refused to dismiss suit based upon the exculpatory clause. Allegations were that trustee had never met with the beneficiaries or talked with them. Dana pointed out that some exculpatory clauses will be upheld but better practice is to act in a prudent and fiduciary manner to increase chance that a court will uphold the exculpatory clause.
Cavagnaro v. Sapone Court held that trustee did not breach duties by selling residential property to save expenses and better support widow, regardless of the fact that the remainder beneficiary resided there.
Matter of Gill, 2014 NY App. Lexis 7828 Suit against a bank as trustee for breach of duties by investment in mutual funds. Dismissed as a matter of law by appellate division – statutes authorize corporate trustees to invest in their own mutual funds and allegation that investments decreased in value is not sufficient. Test is prudence not performance.
Newcomer v. NCB 2014 Ohio case Pre-UTC claims that expired prior to enactment of longer period under UTC will not be revived. Standard of proof for breach of fiduciary duty is clear and convincing evidence. Court addressed reckless indifference versus willful neglect. Plaintiffs tried to assert that multiple actions of the trustee could rise to the level of a breach of the fiduciary duty when aggregated – court rejected this.
Damages & Remedies
Miller v. Bank of America Trustee breached duties by investing in nonproductive commercial real estate and borrowing from an affiliate to generate phantom income to distribute to the beneficiaries and measure of damages should include both inflation adjustments and prejudgment interest without reduction for the phantom interest distributed to the beneficiaries.
Attorney’s fees and costs
Regions Bank v. Lowrey If you sue a trustee and lose, the trustee has a lien against the trust for the attorney’s fees. Alabama Supreme Court reversed lower court ruling for improperly reducing the trustee’s reasonable reimbursement of attorney’s fees and costs of successful defense against surcharge claims. Court also held that trustee can get the fees it incurs in seeking its fees.
Larkin v. Wells Fargo Bank Lone beneficiary that continues litigation following completed settlement, arbitration and judicial resolution of claims is responsible for attorneys’ fees incurred by trustee and other beneficiaries incurred in responding to his actions.