Estate and Trust October 2013

Estate and Trust October 2013

DOMA Decision Gives Rise To

Tax Savings and Wealth Transferring

For Same-Sex Married Couples

[author-style]By Mary Ellen Meara, CPA, Senior Manager[/author-style]

Mary Ellen Meara
[email protected]

However, some of these new opportunities may come with an expiration date. Married same-sex couples should consider filing amended estate, gift and income tax returns, but only those that were filed within the past three years, to reflect changes in their marital status. The IRS is not requiring same-sex married couples to file amended returns, but tax savings opportunities may exist. Additionally, same-sex couples who are in civil unions and are living in “battleground” states, such as New Jersey, Illinois and Hawaii, should especially consider filing protective refund claims on previously filed tax returns filed within the past three years, in order to avoid being barred by the statute of limitations.

IMPACT ON INDIVIDUALS IN CIVIL UNIONS

To date, thirteen states and the District of Columbia have legalized same-sex marriage (CA, CT, DE, IA, ME, MD, MA, MN, NH, NY, RI, VT, and WA); four states have legalized civil unions (CO, HI, IL, and NJ); and thirty-five states have banned same-sex marriage by constitutional amendment or state law. In states that have legalized same-sex marriage (like New York), same-sex married couples will now be subject to more than 1,000 federal laws and programs and will start to receive the federal benefits of marriage.

However, in states allowing civil unions (like New Jersey), the impact of DOMA remains uncertain. For example, New Jersey has no laws banning or allowing same-sex marriage. In 2006, the New Jersey Supreme Court ruled that the state had to extend same-sex couples the same benefits as heterosexual couples. The Legislature responded by passing a bill recognizing civil unions. However, a State Commission found that civil unions did not provide equal benefits, and gay rights advocates went back to court in 2010. The groups are asking the court to speed up its ruling following the DOMA decision. Finally, the federal benefits afforded to same-sex married couples living in states that have a ban on same-sex marriages (like Pennsylvania) will vary by agency.

THE (FEDERAL) BENEFITS OF THE DOMA DECISION

A sampling of the federal benefits the DOMA decision affords same-sex married couples are listed below.
THE UNLIMITED MARITAL DEDUCTION AND DSUE: Under federal estate tax law, spouses can make unlimited transfers of assets to each other (during life and at the death of the first to die) without incurring any federal gift tax or estate tax. The surviving spouse can also inherit the deceased spouse’s unused estate (DSUE) and gift tax exemption. In other words, the deceased spouse’s DSUE is “portable” to the surviving spouse, which enables the surviving spouse to shield up to an additional $5.25 million in assets during their life or at death, which is currently indexed for inflation.

RETIREMENT PLANS: A surviving spouse in a same-sex marriage can rollover their deceased spouse’s IRA or other qualified retirement plan into their own retirement account. A same-sex spouse may also contribute to a spousal IRA, subject to AGI limitations.

GIFT SPLITTING: Same-sex married couples may split gifts. In 2013, each person has a $14,000 gift annual exclusion amount. If a spouse would like to make a $20,000 gift and avoid having to pay gift tax, the spouses may “split” the gift – meaning, the gift will be treated as a $10,000 gift from each spouse.

SIMPLER FEDERAL INCOME TAX RETURNS: Same-sex married couples will be required to use married filing joint or married filing separate filing status for federal income tax returns filed after September 16, 2013. This includes 2012 returns on extension.

CITIZENSHIP: A U.S. citizen spouse may sponsor a non-citizen same- sex spouse for legal permanent resident status.

MILITARY BENEFITS AND BURIAL RIGHTS: Same-sex spouses in the military will be eligible for benefits (such as health coverage and housing allowances). They will also have the right to be buried together in military cemeteries.

EMPLOYEE BENEFITS: Same-sex spouses will now be able to enjoy their spouse’s health care benefits and share in their spouse’s COBRA coverage, if necessary.

ALIMONY: Married same-sex couples who later divorce should be able to take a deduction for alimony paid, which would be included in the recipient spouse’s income.

BENEFICIARY DESIGNATIONS: Same-sex couples should review their beneficiary designation forms because the beneficiary on certain qualified plans must be the spouse (unless the spouse waives the right) under federal law.

THE BARE MINIMUM

The DOMA decision should motivate same-sex married couples to review their estate plan currently in place (Will, Power of Attorney and Health Care Directive). Right now, it remains unclear who would inherit a same-sex spouse’s assets if they die without a Will as a resident of a state that does not recognize same-sex marriages. If a same-sex spouse or partner dies without a Will, that deceased spouse’s or partner’s belongings could be inherited entirely by their blood-related family members.

NEW ESTATE PLANNING TECHNIQUES

Before the DOMA decision, same-sex couples had limited estate planning opportunities. Many couples gravitated toward grantor retained income trusts (GRITs), charitable lead trusts (CLTs) and family investment entities (such as family limited partnerships) for flexibility and to avoid gift tax exposure. Now that the unlimited marital deduction and federal exemption amount is available to same-sex married couples, an entire universe of wealth transferring techniques are available, including QTIPs and Dynasty Trusts, which utilize both the unlimited marital deduction amount and the federal gift, estate and generation skipping tax exemption amounts.

IRS GUIDANCE

Federal agencies, including the U.S. Treasury, will need to review and modify rules and regulations. Affected couples will need to review these new rules and policies with their tax and legal advisors and should consider updating their estate plans.

The Supreme Court’s ruling means that married same-sex couples are entitled to the same federal benefits as heterosexual couples, but it does not make estate planning any easier. It may take some time to fully implement the Supreme Court’s decision. Federal agencies, including the U.S. Treasury, will need to review and modify rules and regulations. Affected couples will need to review these new rules and policies with their tax and legal advisors and should consider updating their estate plans. As the U.S. Treasury and various states continue to work on post-DOMA guidance, the complete impact of the DOMA decision remains to be realized. We will continue to monitor these developments and keep you informed. In the meantime, if you would like to discuss this further, please contact a member of our estate and trust group.

Learn the Key Features of a Delaware Trust

[author-style]Ted Nappi, CPA/PFS, CSEP, Partner[/author-style]

Ted Nappi
[email protected]

On July 9, 1997, Delaware’s Qualified Dispositions in Trust Act (“Delaware Act”) was signed into law. Individuals, including non-Delaware residents, use the Delaware Act to save taxes, protect assets and achieve other purposes summarized below. This brief article highlights the key features of this specific type of Delaware trust.

Traditionally, an individual could not create a self-settled trust (i.e., an irrevocable trust from which he or she could benefit) and protect trust assets from claims by his or her creditors. Therefore, if an individual created an irrevocable trust and gave the trustee discretion to use the income and principal for the individual, the individual’s spouse and the individual’s children, the individual’s creditors could reach all trust assets. As American society became increasingly litigious, interest developed in a trust, often called an “asset-protection trust” (“APT”), in which the person creating the trust could retain some potential benefits that could not be reached by his or her creditors.

The Delaware Act gave birth to the Delaware APT. These types of trusts are created regularly, but the Delaware APT is not for everyone. It should be viewed as an option to consider along with other techniques for protecting assets.

There are several uses for Delaware APTs, including:

1. SAVE FEDERAL TAXES: An individual might be reluctant to give away assets to use part or all of his or her $5.25 million exemptions from the federal gift tax and the federal generation-skipping transfer tax (“GST exemption”) for fear that her or she will need the funds later in life. Although the tax treatment is less certain, one should consider using a Delaware APT for these tax benefits as an opportunity exists to possibly recoup these assets in an emergency.
2. AVOID STATE DEATH TAX: If an individual’s residency state has an estate or inheritance tax, one might be able to reduce that tax by making a gift before death. If the gift is made to a Delaware APT, funds could potentially be recovered in the event of need.
3. AVOID STATE INCOME TAX: If an individual willingly subjects distributions to the control of adverse parties, the individual might be able to avoid tax on undistributed ordinary income and capital gains of a trust, imposed by one of the 42 states (including NJ), that follow the federal grantor-trust rules. The IRS has ruled several times that APTs structured in this way may be nongrantor trusts. The individual possibly could receive tax-free distributions of the untaxed income in later years.
4. OBTAIN ASSET PROTECTION: Generally, if an individual owns substantial assets outright, he or she could fund a Delaware APT with some of the assets to get protection from future creditor claims and business reverses.
5. PROTECT YOUNG ADULTS’ ASSETS: To shield assets from future spouses and creditors, an individual should encourage his or her children to put assets that they receive (or may withdraw from a trust) at majority in a Delaware APT.
6. PROTECT OFFICERS AND DIRECTORS: Corporate officers or directors are receiving increased scrutiny for activities. In order to give additional protection to your assets, consideration should be given to shielding some of these through a Delaware APT.
7. PROTECT ESTATE-PLANNING VEHICLES: Several common estate-planning vehicles are self-settled trusts and therefore are vulnerable to creditor claims. These include charitable-remainder trusts (“CRTs”), grantor-retained annuity trusts (“GRATs”), and qualified personal-residence trusts (“QPRTs”). The Delaware Act extends protection to these arrangements.
8. PROVIDE OPTIONS FOR NRAS: Nonresident aliens of the United States (“NRA”) should consider a Delaware APT for two reasons. First, a Delaware APT is a viable estate-planning and asset-protection option for an NRA, whether or not an NRA has family members in the U.S.. Second, the individual is considering immigrating to the United States, he or she might want to create a Delaware APT beforehand to take advantage of the favorable tax treatment afforded lifetime gifts and to keep the ability to recover funds if a need arises.
9. PROVIDE PROTECTION FOR EXISTING TRUSTS: If an individual has created a foreign APT or a self-settled trust in a state where it does not have protection from creditors, he or she should explore moving it to Delaware.

To create a Delaware APT, one must establish an irrevocable trust that contains a spendthrift clause, provides that Delaware law governs the trust, and appoints at least one “Delaware trustee.” A “Delaware trustee” is an individual who lives in Delaware (except the trust owner) or a Delaware trust company that performs certain duties.

To create a Delaware APT, one must establish an irrevocable trust that contains a spendthrift clause, provides that Delaware law governs the trust, and appoints at least one “Delaware trustee.” A “Delaware trustee” is an individual who lives in Delaware (except the trust owner) or a Delaware trust company that performs certain duties. The trust may have non-Delaware cotrustees and Delaware or non-Delaware advisers.

The Delaware Act specifically permits an individual to have the power to:

1. Consent to or direct investment changes;
2. Veto distributions; and/or
3. Replace trustees or advisers.

The Delaware Act also expressly authorizes an individual to have one or more of the following:

1. The ability to receive income or principal pursuant to broad discretion or a standard;
2. The right to receive current income distributions;
3. An interest in a CRT or a QPRT;
4. Up to a 5% interest in a total-return unitrust or a GRAT;
5. A power, which one may exercise by his or her Will or another document, to appoint the principal in the trust at the individual’s time of death to or for anyone except his or herself, the estate, creditors, or the creditors of the estate;
6. The ability to be reimbursed for income taxes attributable to the trust on a mandatory or discretionary basis; or
7. The ability to provide for the payment of death taxes, debts, and expenses after an individual’s death.

DRAFTING ISSUES, UNAUTHORIZED PROVISIONS, AND UNWISE PROVISIONS

A Delaware APT should not:

1. Appoint the grantor, trustee or cotrustee;
2. Provide that the grantor will get trust assets back at a certain age or after a certain amount of time;
3. Authorize the trustee, adviser, protector, or committee to terminate the trust; or
4. Authorize the trustee to reimburse you for gift taxes.
5. Appoint a cotrustee in the state where the grantor lives or works; or
6. Give the grantor the power to replace the trustee.

FUNDING ISSUES

Generally, an individual should fund a Delaware APT with assets that are never expected for use. It is also recommended that Delaware APTs should be funded with no more than one-third to one-half of an individual’s surplus assets that are not already exempt from creditor claims after an analysis of existing and foreseeable assets and liabilities is performed. (See “Avoid Fraudulent Transfer” below.)

The best assets to put into a Delaware APT are cash, stocks, and bonds. Interests in a family limited partnership (“FLP”) or a limited-liability company (“LLC”) are good assets to put in a Delaware APT, provided that the individual is not the general partner or the manager and that the entity does not own real estate outside of Delaware. For legal reasons, real estate outside of Delaware should not be put into a Delaware APT.

CUSTODY / TRUSTEE

One of the most important decisions in creating an Asset Protection Trust is to select the appropriate trustee. Often the decision requires balancing of the grantor’s desire to retain control over the transferred assets with a desire to create an effective Asset Protection Trust (i.e., the greater the retained control, the greater the risk to effective asset protection). The Delaware Act requires at least one qualified trustee. One of the first questions that a grantor may ask is whether or not he may serve as a trustee. The Act is clear that a transferor is not considered a qualified trustee. Moreover, the transferor would also be prohibited from serving as a co-trustee.

Another question is whether a corporate or individual trustee should be selected. It seems clear that a higher level of creditor protection would be afforded by the use of an established and independent Delaware corporate trustee. The primary reason is that the use of an individual trustee could raise concerns of an implied understanding as to the grantor’s ability to access the assets at any time. However, a corporate trustee with an established method for determining discretionary distributions would reduce the risk of this line of attack.

Disadvantages of using a corporate trustee may include increased fees and a perceived loss of control over the transferred assets. Given the importance of administering the Trust in an appropriate manner, the use of an established corporate trustee is almost always preferred. However, even the use of a corporate trustee is not without risk of attack. Specifically, if the corporate trustee is a national trust company with operations in multiple states, a concern could arise that a local court would assert jurisdiction. Many Delaware trust companies are structured independently in such a manner so as to alleviate this concern.

In order to address the control issues, a grantor may request the use of an individual co-trustee to serve with a corporate qualified trustee. This raises several concerns that a grantor must carefully consider. First, if a co-trustee is located in the same jurisdiction as the grantor, a non-Delaware court may be more willing to assert jurisdiction over the Trust and there is the possibility that Delaware law might be determined to not govern the Trust. Further, the use of a spouse, friend or relative as a co-trustee could raise the implied understanding concern mentioned above. In general, an individual co-trustee is not recommended. One alternative to using a co-trustee is through the use of advisers, as permitted by general Delaware law.

The adviser may serve in a variety of capacities including, but not limited to, as an investment adviser or a distribution adviser (either on a consent or direction basis). The adviser could also have the power to remove and replace a trustee. A grantor may serve as an investment adviser or as an adviser who can veto distributions.

DISTRIBUTION ISSUES

For the trust to work, the grantor must give up control. One should request discretionary distributions of income or principal rarely, if ever, and should not expect to use the trust as a checking account or to get money whenever at any given time. The opportunity does exist to keep the right to get regular income or unitrust distributions along with the ability to get principal on a discretionary basis.

INCOME TAXES

Usually, a Delaware APT will be a grantor trust for federal income-tax purposes, which means that the grantor—not the trust—must pay all income taxes on interest and dividends that the trustee receives and on capital gains that the trust incurs. The trust may direct the trustee to pay (or reimburse the grantor for) those taxes.

TRANSFER TAXES

If the trust gives the trustee or someone else discretion to distribute trust funds to the grantor and if the grantor retains a power of appointment and a power to veto distributions, the grantor will not make a taxable gift when the Delaware APT is created. However, if the grantor relents those powers, a taxable gift will more than likely be made when the Delaware APT is created; and the trust probably will not be included in the gross estate. If the creation of a Delaware APT is a completed gift and if the trust is not includable in the gross estate, the grantor may allocate GST exemption at the creation of the trust.

MOVING TRUSTS TO DELAWARE

The Delaware Act provides for the move to Delaware of self-settled trusts created in other states or abroad The time that the trust existed before it is moved counts toward the four-year period during which a creditor may pursue a claim against the trust.

AVOID FRAUDULENT TRANSFER

If a transfer is made, whether by giving money to children, establishing a family partnership or creating a Delaware APT, and there are not enough assets to pay existing and foreseeable creditors, the transaction is then a fraudulent transfer and the transfer may be undone.

WHO MAY DEFEAT A DELAWARE APT

Under the U.S. Constitution, certain “super creditors,” such as the IRS, the SEC, the FTC and minor children seeking support, may reach the assets of any APT. Under the Delaware Act, the following four categories of creditors may reach the assets of a Delaware APT.

1. PRE-TRANSFER CLAIMS: If a creditor’s claim arises before the creation of a Delaware APT, that creditor must bring suit within four years after the trust is created or, if later, within one year after the creditor discovered (or should have discovered) the trust. The creditor also must prove the creation of the trust was a fraudulent transfer.
2. POST-TRANSFER CLAIMS: If a creditor’s claim arises after the creation of a Delaware APT, that creditor must bring suit within four years after the trust is created created and must prove that the creation of the trust was a fraudulent transfer as to that creditor.
3. FAMILY CLAIMS: A spouse, former spouse, or minor child who has a claim resulting from an agreement or court order for alimony, child support, or property division may reach the assets of a Delaware APT, but a spouse whom the grantor marries after the creation of a trust may not take advantage of this exception.
4. TORT CLAIMS: A person who suffers death, personal injury, or property damage for which the grantor is liable before establishing a Delaware APT may reach trust assets at any time.

DEFENDING DELAWARE APTS

Residents of Delaware and NRAs who have protected their assets through a Delaware APT should not fear creditors reaching these assets except in the situations mentioned above. U.S. residents who are non-residents of Delaware who have Delaware APTs should afford the same protection, however this cannot be guaranteed as certain issues under the U.S. Constitution can come into play. The danger is that a court outside of Delaware is able to apply its law—not Delaware law—and order the trustee to pay a creditor, even if the claim is not one that is recognized under the Delaware Act. However, there are several reasons why a trust should stand in these circumstances.

CONCLUSION

No court has yet considered how effectively a Delaware APT protects assets, which makes it not yet fail-safe. But, a properly designed and implemented Delaware APT will raise formidable obstacles for creditors. The Delaware APT also offers planning options that might be of great benefit to an individual and his or her family.

In the meantime, if you would like to discuss the Delaware APT option further, please contact a member of our Estate and Trust Group.

Meet The Players

Get To Know WS+B’s Core Experts On Our Estate & Trust Tax Services Team

Alfred J. La Rosa
CPA, MS, Partner
New York, NY
212.751.9100
[email protected]

A partner based out of WS+B’s New York office, Al has over 30 years of professional accounting experience. He specializes in trusts and estates and is a certified public accountant in the state of New York. Al helps clients plan their estates to facilitate a smooth transfer of wealth through the use of creative gifting techniques. He advises clients, attorneys, executors and trustees in the accounting, taxation and administration of trusts and estates. He also assists fiduciaries, beneficiaries and attorneys in various aspects of trust & estate litigation and beneficiary disputes. In addition, Al focuses on estate and gift tax planning and charitable planning through the use of private foundations, split-interest trusts and public charities.

Al received his BBA degree in accounting from Pace University and earned an MS degree in taxation from Baruch College. Al is a member of the American Institute of Certified Public Accountants (AICPA) and the New York State Society of Certified Public Accountants (NYSSCPA). He serves on the Estate Planning Committee and the Trust and Estate Administration Committee for the NYSSCPA. He is also a director of the Thomas and Jeanne Elmezzi Private Foundation and serves as an executor and trustee for estates and trusts.

In each issue, we’ll feature a different Estate and Trust team member so you get to know our core experts.

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