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Ms. Zeydel commented that the potential loss of DSUE amount is intellectually blocking estate planners. The discussion included several facts and figures highlighting the relatively low probability of the surviving spouse remarrying. In the alternative, an advantage to the surviving spouse remarrying is the potential to “stack” DSUEs through lifetime gifting. Ms. Zeydel commented that we should be advocating for a change in the law to omit the potential loss of the DSUE amount.
In traditional planning, a “credit shelter trust” is funded using some, or all, of the DSUE amount, also benefiting from the allocation of the deceased spouse’s unused GST exemption. Alternatively, if the client prefers to use disclaimer planning and preserve the ability to elect portability, the estate of the first decedent may pass into a “QTIP trust,” also benefiting from the allocation of the deceased spouse’s unused GST exemption. Ms. Zeydel noted as a practitioner tip that you always start with the trust with greater benefits and disclaim into the trust with lesser benefits, often requiring the surviving spouse to give up a power of appointment of the trust. As an advocate for using independent fiduciaries, Ms. Zeydel also noted that an independent fiduciary should be appointed to shift benefits from one beneficiary to another. Similar to a disclaimer plan, partial QTIP elections and Clayton provisions can defer the decision to use the first decedent’s exemption.
The discussion then turned to the idea of a “Supercharged Credit Shelter Trust,” providing for the creation of a lifetime QTIP trust by one spouse for the benefit of another spouse, or an inter-vivos QTIP. As stated in the materials, “[b]y the terms of the lifetime QTIP trust or pursuant to the exercise of a special power of appointment by the beneficiary spouse, the lifetime QTIP trust will become a Credit Shelter Trust using the unified credit (estate tax exemption) of the first spouse who was the beneficiary of the lifetime QTIP trust and in whose gross estate the QTIP trust is included.” The regulations provide the key elements that make this type of planning work, and although others have expressed concern regarding navigation of the reciprocal trust doctrine, Ms. Zeydel does not believe the application of this doctrine is a concern due to the fact that the trust is includable in the grantor‘s spouse’s gross estate. The discussion also included an analysis of the interpretation of Treasury Regulation 1.671e)(5), providing that the first spouse may not be granted, or exercise, a general power of appointment in the lifetime QTIP. The materials also mention that “[i]ssues regarding self-settled trusts are determined under state law, and although there is no issue under Florida law, there may be issues in other states.” Unless both spouses are creating a lifetime QTIP trust, the spouse expected to survive should create the trust. If each spouse is creating such a trust, practitioners should avoid creating these trusts at the same time, with the same assets, and under the same provisions. In addition, Ms. Zeydel mentioned that the potential for leaking income is not as large a concern as it was in the past, especially for clients with a balanced portfolio. Ms. Zeydel further expressed that out of all the planning with portability, the “Supercharged Credit Shelter Trust” is the easiest.
The discussion closed with the review of several projections using JP Morgan’s proprietary MAPS projection system.
For more information regarding the numerical analysis on the use of portability, please refer to the review of the materials and discussion related to the Special Session mentioned above, which is scheduled for Wednesday.
10:55 -11:45 Planning for the 0.2% as if They Were Part of the 99.8%: Some of the Best Planning Strategies We See that Reduce Both Income Taxes and Estate Taxes (Financial Assets Series, Focus Series) S. Stacy Eastland The presentation will focus on planning strategies that lower the taxpayer’s potential transfer taxes and reduce the net tax effect a sale of any assets subject to estate planning may have, including: various borrowing, location, disregarded entity, grantor trust, QSST, DSUE, mixing bowl and charitable planning strategies. The presentation will also explore various strategies that reduce a complex trust’s income taxes, indirectly benefit grantor GST trusts with a Roth IRA conversion, and enhance the basis of a surviving spouse’s assets.
Reporter: Beth Anderson Esq.
Mr. Eastland opened his presentation with a useful observance in that the only difference between the extremely wealthy and us is that their assets have really appreciated a lot. This lecture is a teaser for the special session II-A on Wednesday afternoon in which Mr. Eastland joins Steven B. Gorin and Ellen K. Harrison in a more in depth discussion on planning strategies that reduce income and estate taxes. Mr. Eastland’s outline is 155 pages of written text and another 183 pages of example financial schedules and projections, and as a result Mr. Eastland ran through his outline rather quickly but effectively highlighted strategies to reduce the income taxes for clients with highly appreciated assets.
The first topic of discussion was the use of estate/gift to mitigate income issues. Rev Rul 85-13 sales to grantor trust and the trust is not capable of being a separate tax payer if it violates the grantor trust rules. Therefore a sale with a low basis Promissory Note doesn’t cause any income tax issues. What about buying assets back from the trust with a Note with FMV interest rate (higher than the AFR) to give your Note more basis. Mr. Eastland did point out that there is no authority as to what is the trust’s basis in the note, and there is a risk that as the Note is paid down the trust could have capital gains.
Mr. Eastland discussed the importance of asset classes and the ability to have passive investments – equities vs hedge funds, private bonds. Consider taxes effect asset allocations because Congress has subsidized investing in equities by lower long term cap gains and timing of when a taxpayer wants to incur those gains. The taxpayer can chose to not be taxed by holding onto until death or gift to charity. This is not true with high yield bond (turn over).
Practitioners are in the investment business because allocation and location of assets affect the client’s estate plan.
For example, compare a 200% turnover hedge fund to a 5% Portfolio Index Fund and determine the rate of return necessary in order to double the asset value over 10 without using a grantor trust. The 5% index fund needs a rate of 12.21% to double while the hedge fund needs to earn 21.03%. If both funds are subject to estate taxes, to match the index fund, the hedge fund must improve by 72.34% annually pre-tax. If you put the hedge fund in a grantor trust using estate/gift tax to subsidize, the gap improves significantly and the hedge fund needs to improve by only 12.49%.
The next topic of discussion was low basis assets and whether to hold them or let them go. He did point out that it is a rare asset that the client wants to hold onto but the beneficiaries want to get rid of immediately upon death.
However, if there is an asset that no one wants to sell then even if it’s low basis it’s ok to gift it. The planning has focused to not using exemption until death, but getting appreciated assets out by sales or other types of transactions such as rolling GRATs; cascading sales to Grantor Trusts; Leveraged Sales as used in the Hendricks and McCord cases with the excess contributions to a GRAT or charity or QTIP. Worried about deemed contribution or selling to the wrong thing then have a disregarded entity as signal member LLC (which can have two members the client and his grantor trust) and contribute the non-voting units to the GRAT.
§385 of the corporate tax code provides guidance on leveraged transactions and debt v. equity in enterprises. Using the same concepts we can have leveraged LLC, and transfer the non-voting units (after they are old/cold) to a GRAT. Hard to value assets – double discounted – but if the assets are inside the GRAT when the value is challenged by the Service the only thing that can happen is the annuity amount is increased, but no gift tax surprise. Further appreciation is not needed to make the plan work because there is a discounted asset going into the GRAT with modest yield and undiscounted cash coming out. No need for re-valuations because not distributing hard to value property, and shouldn't be a deemed contribution or commutation. Better than rolling GRATS because the annuity amount is relativity small, and even if die in two year period the amount included in the estate is the annuity divided by the then 7520 rate. Some growth still escapes.
Wealthy are almost always self-made. They started from modest circumstances and usually want to take care of their parents. Why not create a grantor trust for elder parent with a gift of cash (high basis) and a subsequent sale of low basis assets to trust. The trust also provides that the parent has a general power of appointment over the trust assets. The difference between note and the assets will be included in the parent’s estate, and if structured properly all the trust assets included. Wealthy child gets a step-up in basis for helping out the parent. Good planning for fully depreciated assets and the trust is a grantor trust so pay off note with high basis assets and gets to restart depreciation. §1014(e) doesn’t apply because when made the gift it was cash – not highly appreciated asset – and if after the parent dies the assets go to a trust of which the client/donor isn’t a beneficiary then there are even less concerns.
What if client doesn’t use a note, but goes to the bank and borrows money, then uses the cash to buy asset back.
Now client has basis and trust has cash, however, normal folks don’t like borrowing to third parties, so refinance the bank note by using the cash in the trust. Note to trust for cash and pays off the bank. Note for cash is better than note for low basis assets. Want to add another level of planning made the trust a complex trust instead of grantor trust.
Mr. Eastland turned next to post mortem strategies to avoid estate taxes. Testamentary charitable lead annuity trust – clients don’t like them because of “Prince Charles Syndrome” – waiting for the crown, but the solution is a leveraged buyout. There is probate exception to the self-dealing rules if certain restrictions are met (see Treas. Reg.
§53.4941(d)-2), but the Note must be equal to or greater than fair market value of the asset in the CLAT (ie the partnership interest/LLC units); and the Note must be more liquid than the asset. Perhaps a 20 year note balloon, interest only higher than AFR to zero out the CLAT, this is the “world’s best note” because there is never out of pocket principal and subsidized interest because of the estate tax charity deduction and income deduction for interest payments.
Mr. Eastland briefly talked about DSUE planning and simulated credit shelter trusts, noting that this plan requires a couple who is happily married, with low basis assets. For example 50 million in low basis assets at the death of the first spouse, assets get a step-up, are contributed to a single member LLC. The surviving spouse gifts part of nonvoting units to quasi credit shelter (the spouse is not a beneficiary of the trust) and sells the rest of the non-voting units for a Note. The Note coming back from the Trust gives the spouse greater rights (debt priority) than being a trust beneficiary and simulates a 46 million dollar credit shelter trust, way better than the usual $5, 430,000.
Discounts, Estate freezes and Grantor Trusts are the 3 pillars of Estate planning, but Grantor Trusts far exceed the benefits of the other two, and it’s very powerful when you can use all three.
Planning with GST and surviving spouse with creditor problems, enter subchapter S planning and the self-settled grantor trust. Suppose the client has an ancient trust with boiler plate (or you modify a not so ancient trust) to allow investments in sub Scorps and qualify the trust for Sub-S status. If the beneficiary makes the QSST election then the trust becomes a grantor trust, and the beneficiary can sell asset to the trust and escape cap gains. The surviving spouse could also make a leveraged sale of Scorp stock to the credit shelter trust. The trustee of the credit shelter invests in sub Scorp and the surviving spouse sells the non-voting stock to a trust of which the client is the beneficiary, the client gets natural step up in basis when first spouse dies. Under the Uniform Principal and Income Act a note that is secured by stock and its distributions is paid as creditor over beneficiaries this plan is similar to the DSUE plan mentioned above, but unlike DSUE this trust can be GST exempt and protected from creditors.
Next, Mr. Eastland touched on pre-death charitable techniques and having an entity create a CRT which cannot last for a lifetime but can last as long as 20 years with very dramatic benefits with the health care tax. No income tax deduction for cash to charity but if you give preferred partnership interest and sell the common interest to family, §2701 shouldn't apply and you get an income tax deduction for the gift of preferred as present value of fixed income component. It’s not taxed under 704(b), and if you put in highly appreciated asset and later the charity sells the asset without gain recognition. Granted the Service could challenge “entity theory” of the partnership, but the fix is to create a CLAT which is not taxed on the distribution for income or health care tax. The charity gets a coupon” and the client’s family gets the rest.
Trust planning to reduce the health care tax burden. Mr. Eastland discussed interesting ways to reduce the income in the trust and allocate it to a lower income tax bracket beneficiary in order reduce the 3.8% health care tax burden. For example, what if the trust beneficiary had a limited right to withdraw, that does not violate §2041, over the income of the trust, and the trustee made a discretionary distribution to cover the income taxes. Suppose further that the trust is purely discretionary, could the trustee exercise such discretion to grant the appropriate beneficiary the same limited withdrawal right.