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Estate of Aragona v. Commissioner involved when a trust materially participates in a business. This was originally a concern under the section 469 passive activity loss rules. It has become important for estate planners because the passive loss rules are used to determine if certain activities are investment income/loss for purposes of the 3.8% net investment income tax. The IRS has taken the position in litigation that only a trustee’s actions as trustee count in determining the trust’s material participation. The passive activity loss regulations have reserved the section dealing with material participation by a trust. The Tax Court held that without guidance, it will take the position that a trustee’s activities as employees count. Prof. Donaldson disagrees with the IRS position that trustee’s actions as employee don’t count. He said you can’t remove the fiduciary hat in anything you do. Since trustees materially participated as employees, the trust should be considered to materially participate.. Until we get regulations that codify the IRS litigation position, we can rely on Aragona. Mr. Belcher said that the IRS is concerned about the use of trusts as tax shelter but he expects it will be several years before we see any guidance. PAL is probably bigger issue than NIIT.
SEC v. Wyly is an SEC disgorgement case where the defendants were ordered to disgorge almost $620 million due to securities violations arising from tax planning using offshore trusts. The panel said we care about the case because it the judge who decided it is a federal district judge who might decide tax issues. He concluded that trusts were grantor trusts. The degree of control grantors exercised over the trust created de facto control and implicated section 674 making the trust a grantor trust. The panel thought that a similar conclusion would be reached under sections 2036 and 2038. Mr. Belcher said that this case shows egregious facts make bad law. Legal fees for handling SEC complaint and lawsuit was $100m.
Tuesday, January 13 9:00 - 9:50 Trust Design: The Most Important Part of the Estate Plan David A. Handler Trusts into which assets are transferred during life or at death will govern the administration, investment and disposition of the assets for one or possibly several generations. It is critical to build a smart, flexible trust agreement that can adjust over time, as the people, assets and society will all change in unforeseeable ways during the life of the trust. This session will discuss ways to make a trust flexible, and oft-overlooked provisions that should be in every trust agreement.
Reporter: Michael Sneeringer Esq.
Mr. Handler combined humor and real world experience to explain to the audience why trust design is just as important as taxes in estate planning.
Mr. Handler’s remarks followed his session outline in order. However, he expounded upon the outline beyond what was in the materials; ordering the session in audio format, if interested in the topic, would be recommended. He began by explaining why trust design is important: once the trust becomes irrevocable, the trust provisions control everything for X number of years (where X is the number of years of the rule against perpetuities prescribed under the trust’s governing state law).
The first main topic was building flexibility into trusts. Mr. Handler began by recommending how estate planning practitioners should draft their clients’ trustee provisions. He covered who should be trustee and how to change the list of successor trustees (appointment and removal power). Mr. Handler touched on a few specific topics with regards to trustee selection such as having different roles for different trustees, age restrictions for the trustees, requirements for certain trustees experienced in one field versus another, and having spouses as trustees. Mr.
Handler mentioned that estate planning practitioners should consult Revenue Ruling 95-53 for trustee removal and appointment powers by grantors. He also provided guidance on trustee provisions when beneficiaries are trustees of their own trusts.
Mr. Handler then discussed Trust Protectors. He highlighted that clients do not understand that a trust protector can re-write a trust if given both broad administrative (add beneficiaries; amend the various trust provisions) and technical (tax) powers. His comparison was that the trustee is often picked first and is the most “trusted” person, leaving the follow-up client discussion to who would be the client’s choice as the “smartest” person… the smartest person is then picked as the trust protector. He stressed that once clients are aware that a trust protector can amend the trust provisions, the client will want to modify the terms of the previously created irrevocable trust as often as if he or she were changing the terms of a revocable trust (opening the door a crack). He added that changing certain administrative provisions (changing scrivener errors, changing the name of the trust) may be better than giving the trust protector broad authority.
Mr. Handler discussed powers of appointment and described them using the reference to the “stick”; parents’ say “I brought you into this world, I can take you out of the trust.” He stressed that estate planning practitioners should be mindful in crafting who assets may be appointed to and what the provisions say.
Mr. Handler’s best comments were in the middle of his presentation in describing why trust assets should be
divided into subtrust amongst each beneficiary (as opposed to being held in one pot trust for all of the children):
David’s Proverb, share toys, not money! He stressed that estate planning practitioners need to approach this subject with some common sense. He also related a recent client story in explaining withdrawal rights to the audience: why Crummey… unfortunately (or fortunately for clients) that is the name of a family.
The next main topic was incentive provisions versus trustee guidance. Mr. Handler briefly touched on defining support and maintenance, advancements, and the importance of including a grantor statement in the trust to advise the trustee in making distributions. His main point in this portion of his presentation was that the grantor should help guide the trustee by providing in the trust certain principles for the trustee to consult (requests but not requirements) when making discretionary distributions to beneficiaries.
The final topic was important but overlooked clauses to include in trusts. Mr. Handler quickly spoke three or four sentences on each of the twenty-six subtopics. He noted that hard and fast rules in drafting divorce clauses in trusts lead to unexpected consequences. He stressed though that clauses should be included to address income tax consequences that occur upon divorce and trustee provisions that change following divorce.
Mr. Handler noted that children should be thoroughly defined, and that adoption needs to be covered in the trust as estate planning practitioners should not rely on state law.
He pointed out that provisions should be included to address portability, the disposition of individual retirement account assets, and how changing the trust’s governing law effects the rule against perpetuities governing the trust.
Mr. Handler expanded upon the discussion of the trustee’s power to acquire closely-held business entities where the trustee has an interest by explaining to the audience that provisions need to point out that the trustee should be a family member, the beneficiaries should have an interest in the closely-held business too, and that the beneficiaries consent to the investment by the trustee.
Mr. Handler thought that the most useful clause in the trust is the single signatory clause: all the trustees consent to the action and just one trustee needs to sign the specific form to take the action!
Mr. Handler finished his presentation by briefly touching on the right to information and survivorship requirement provisions that should be included in a client’s trust.
9:50 - 10:40 Portability or No: Death of the Credit Shelter Trust? (Focus Series) Diana S.C. Zeydel This program will review the opportunities and pitfalls of estate planning under the new portability regime. More complicated than advertised, relying exclusively on portability may rarely be the right answer. Planning to maintain flexibility is critical, but may be difficult to achieve.
Understanding the rules and how the math works is key to giving clients the best advice. This program will apply simulation based analysis to quantify the financial consequences of a variety of estate planning strategies in light of portability. The results are eye opening and a “must-know” for every estate planner.
Reporter: Tiffany Walker Esq.
Ms. Zeydel began her presentation by assuring the audience that despite the foreseeable permanence of portability, estate planners need not automatically disregard traditional planning techniques (such as “Credit Shelter Trusts”). While the American Taxpayer Relief Act of 2012 (“ATRA”) made portability permanent, Ms. Zeydel mentioned that purely relying on portability might not be ideal under all circumstances. The printed materials for the presentation provide that the addition of the portability election, in application, requires analysis to determine the advantages of its use on a case-by-case basis. Although the 64 pages of materials provide a conceptual overview of the use of portability, Special Session I-A, entitled “Projecting the Financial Consequences of Planning or Not Planning with Portability,” will provide more detail regarding specific financial consequences of various estate planning strategies in light of portability.
Ms. Zeydel noted that the addition of portability has complicated rather than simplified planning. Portability is beneficial in that it may be used to provide the surviving spouse with an estate and gift tax shelter, as well as a double basis step-up for assets. However, concerns regarding the use of portability include the potential that portability may not really be permanent and not all tax benefits are covered by portability. More specifically, portability does not extend to state taxes or generation skipping transfer taxes.
The discussion skimmed the beginning of the materials, describing how to elect portability, and the use and computation of the deceased spousal unused exclusion (DSUE). Much to the dismay of many estate planners, the Internal Revenue Service has declined to provide a Form 706EZ for those who are not required to file an estate tax return but wish to elect portability. The reason for the Internal Revenue Service’s failure to provide a simplified form is likely due to their need for more detail in determining the amount ported to surviving spouse. Ms. Zeydel added that she was “sort of” sympathetic to the continued requirement for a completed estate tax return because without such a return it would be difficult for the Internal Revenue Service to contend with the computation of the amount ported.
As an overview, portability is elected in a timely filed estate tax return (within nine month of the decedent’s date of death plus any extensions granted). Ms. Zeydel further noted that in completing such a return, there is no box to check for a portability election and the election is automatic with a timely filed return. However, to elect out of portability, an affirmative statement “electing out” must be attached to the estate tax return, if any, when filed.
The discussion picked up at planning with portability. In application, if the surviving spouse does not have sufficient assets to fully use their applicable exclusion amount, then portability would be used to “port” the excess to the surviving spouse. The DSUE amount is computed using the surviving spouse’s last deceased spouse. Therefore, in the event of remarriage, Ms. Zeydel suggested placing a clause in the surviving spouse’s premarital agreement with a new spouse to guarantee compensation for DSUE amount lost or assurances that the new spouse will preserve at least as much DSUE as surrendered.
Ms. Zeydel mentioned that in situations where the majority or all of the client’s assets consist of a large homestead coupled with retirement assets, it might be beneficial to rely on portability. However, Ms. Zeydel went on to warn the audience that if portability is used on the wrong clients the outcome can be worse than with traditional preportability planning techniques. More specifically, on average for clients with a balanced portfolio the use of portability may not be ideal.
For a wealthier couple, if the surviving spouse is willing to immediately use the DSUE amount to fund a grantor trust for the benefit of descendants upon the first spouse’s death or follow a disclaimer plan, then Ms. Zeydel commented that the use of portability is not as concerning. However, Ms. Zeydel remarked that she has yet to have the task of convincing a surviving spouse to follow this sort of planning, and the surviving spouse could be hesitant at the idea of transferring assets to a grantor trust that is not for the surviving spouse’s benefit. In addition, the surviving spouse’s payment of the income tax on the trust may deplete their own assets too quickly, especially if the amount used to fund the trust is close to $5.43 million (the maximum applicable exclusion amount in 2015).
In summary, the disadvantages of portability discussed in comparison to the use of a “credit shelter trust” include the loss of the predeceasing spouse’s unused GST exemption and creditor protection, as well as the loss of trustee protection against improvident investments and family members taking advantage of the surviving spouse.
Additional disadvantages discussed further were the loss of tax credits and potential loss of DSUE amount due to remarriage. As mentioned above, provisions should be included in a pre-marital agreement to provide some protection against the loss of DSUE due to remarriage. Another potential solution to protect against the loss of DSUE is to have the spouses agree to trigger Section 2519 upon remarriage or deciding to make a taxable gift.