Heckerling Institute on Estate Planning: 2015 Conference Highlights
1. Income Tax Basis
With recent tax law changes, income tax planning has become an important issue for estate planners. Basis has become a more complex concept with the use of such planning techniques as intentional grantor trusts, contingent power of appointments and private annuities. The rules of basis and its increased importance in estate planning was discussed in great deal. We suggest that our clients review their current estate plan as it relates to income tax basis and call us with any questions.
2. Adequate Disclosure
As it pertains to gift tax returns, adequate disclosure is extremely important because if the IRS determines that the standards of the regulations have not been met, no statute of limitation applies. The gift return is open for audit until the issue is corrected. There can be serious consequences if this incomplete gift tax return is found upon audit of the donor’s estate and significant tax is now owed by the estate or beneficiaries. To assure adequate disclosure on a gift tax return, the transfer needs to be reported in a way that the IRS can determine the nature of the gift and methodology for the value reported. There are five elements that are required to achieve adequate disclosure:
- A description of the transferred property and any consideration received by the recipient.
- The name of and the relationship between the transferor and transferee.
- Any property transferred in trust must also report the trust EIN and either a description of the trust terms or a copy of the trust.
- A “Qualified Appraisal” if required under the Treasury Regulations or, if not required, a detailed description of the method used to determine FMV.
- A statement describing any position taken on the gift returns that is contrary to any proposed, temporary or final regulations published at time of gift.
Corrective measures should be taken as soon as a possible lack of adequate disclosure is discovered.
3. Self-Cancelling Installment Notes (“SCINs”) and Private Annuities
These techniques are typically used to transfer wealth to younger family members at no gift or estate tax cost. They are most successful if the senior family member dies prematurely. Therefore, the ideal candidate is someone in poor health, whose death is imminent. With a SCIN, a parent sells property to a child in exchange for a note that is cancelled if the parent dies prior to the expiration of the note term. As a result, the remaining note payments that would have been payable had the parent lived are not includible in the parent’s estate. SCINs do have their inherent uncertainties. Because of the mortality risk, the seller must be compensated for the note’s potential cancellation at death by either a higher purchase price or a higher interest rate. In addition, if the SCIN’s term equals or exceeds the seller’s life expectancy, the SCIN might be characterized as a private annuity. With a private annuity, a parent typically transfers property to a child in exchange for fixed annual payments for the remainder of his lifetime. If the parent dies before his anticipated life expectancy, he would not receive payments equal to the value of the property transferred, thereby reducing his estate. A potential risk is that if the annuitant outlives his life expectancy, he will receive “too much” for the transferred property.
4. Trust Design
With the ever-changing world of estate and gift tax planning, it is important to build a smart, flexible trust agreement that can adjust over time as the people, assets and society will all change in ways that we can’t predict. The various ways to make a trust flexible as well as the often overlooked provisions that should be in every trust agreement were reviewed in detail during the presentation. The trust should define support and maintenance, advancements and the importance of including a grantor statement in the trust to advise the trustee in making distributions. 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 the beneficiaries. Children should be thoroughly defined in the agreement, and adoption needs to be covered in the trust as state law should not be relied upon. The most useful clause in the trust is the single signatory clause. All the trustees should consent to the action, but just one trustee needs to sign the specific form to take the action.
5. Portability
Portability is the estate tax provision that allows a surviving spouse to inherit his or her predeceased spouse’s unused estate tax exclusion (“DSUE”). There are several benefits and drawbacks as well as potential planning strategies relating to portability. One advantage is that spouses can leave their property outright to each other without having to fund a credit shelter trust to preserve the estate tax exclusion of the first spouse to die. Another advantage is that assets passing outright to the surviving spouse, rather than to a credit shelter trust, receive a second step-up in basis when the surviving spouse dies. A potential drawback of portability is that the unused generation-skipping transfer tax (“GST”) exemption of the first spouse to die could be lost because the GST exemption is not portable. Nevertheless, this risk can be overcome and the benefits of portability preserved if, upon the first spouse’s death, that spouse’s GST exemption amount passes to a Qualified Terminable Interest Property (“QTIP”) trust for the surviving spouse. The QTIP trust is eligible for the marital deduction and therefore does not affect the portable amount. Furthermore, because the QTIP assets are includible in the surviving spouse’s estate, they are subject to a second basis step-up at the surviving spouse’s death. One of the several planning techniques that can be considered included how the surviving spouse can use portability to leverage the predeceased spouse’s DSUE by making a lifetime gift of the DSUE amount to a grantor trust for descendants. The assets in such a trust, rather than a testamentary credit shelter trust, can grow tax-free because the surviving spouse is responsible for paying the income tax on the trust income.
6. Digital Assets
The Uniform Fiduciary Access to Digital Assets Act (“UFADAA”) is meant to give clients and fiduciaries the ability to plan for and manage digital assets. So many of our clients use online providers for banking, investments and asset management. Although there is no universal definition of digital assets, it has generally come to mean electronic records, which are accessed by tangible devices such as a computer, smartphone, tablet or a server. Many individuals own digital music, client lists, financial institution accounts, business records, frequent flyer and rewards programs, social media accounts and more. Some service providers have explicit policies on what will happen when an individual dies, but most do not. Digital assets are generally governed by contracts known as Terms of Service Agreements (“TOSAs”) which control the relationship between the account holder and the custodian, and include terms of use, end-user license agreements and privacy policies. Many of these agreements do not authorize fiduciaries to have access to the decedent’s digital assets. Fiduciaries need to access digital assets in order to prevent identify theft. Fiduciaries are obligated to preserve the assets of the estate they are managing. When an individual is unable to continue to monitor his/her online accounts, it becomes much easier for criminals to hack these accounts, open new credit cards, apply for jobs, obtain identification cards, etc. Thus, a fiduciary needs to monitor and protect these accounts as part of his/her fiduciary responsibilities. Further, the fiduciary must marshal and collect assets, and this is becoming increasingly difficult to do in today’s internet environment. The UFFADAA was drafted by a committee appointed by the Uniform Law Commission for the purposes of creating a uniform act to vest fiduciaries with the authority to access, manage and distribute digital assets. UFADAA aims to resolve many of these impediments to fiduciary access, so that they can carry out their duties. The owner of valuable digital assets should take steps to ensure that those assets are disposed of according to his or her wishes. Though the laws continue to evolve toward allowing greater levels of authorization for the fiduciary, the owner who fails to plan is likely to make the fiduciary’s task more difficult and time consuming.
7. Curing Estate Plans that No Longer Make Sense
With the increase in the federal gift and estate tax increase and the portability rules, taxpayers are finding that transactions they entered into may no longer be appropriate or needed. Only 15 years ago, the estate tax exemption was $675,000 ($1,030,000 for GST)’ the top estate tax rate was 55% and any unused exemption amount was lost by the surviving spouse. Fast forward to 2015, and as a result of ATRA, the current estate tax exemption is $5,430,000 (same for GST), the top estate tax rate is 40% and we have portability. While the estate tax burden has decreased, the income tax burden for individuals and trusts has significantly increased. The top income tax rate on ordinary income has gone from 35% to 39.6%, long-term gains from 15% to 20% and we have a new 3.8% Medicare tax on net investment income. There are several new estate planning strategies post ATRA. One of the concepts discussed was to think about avoiding valuation discounts on assets. While in past years, estate planners put much effort into setting up ownership structures that would permit a valuation discount due to: (1) fractional interest, (2) lack of control or (3) restrictions on outright sale, the post ATRA world could make these structures detrimental to the overall tax burden of a family. The estate tax value of an asset is what determines basis for income tax purposes of the inherited property. If the decedent’s total assets do not exceed the current estate tax exemption ($5.34M), a reduced fair market value will produce no federal estate tax savings AND will increase the capital gain that will have to be recognized on the eventual sale of the property by the beneficiary. Other strategies that clients should pursue post-ATRA include: causing inclusion of trust assets in the settlor’s estate; causing inclusion of trust assets in a beneficiary’s estate; causing inclusion of trust assets in a third party’s estate; causing inclusion of gifted assets (not in trust) in the donor’s estate; changing ownership of spousal assets to achieve a new income tax basis for appreciated assets and to preserve the income tax basis of “loss assets”; avoiding imposition of the 3.8% net investment income tax (“NIIT”); addressing life insurance policies and life insurance trusts that are no longer needed; swapping high basis assets with appreciated property in a grantor trust; and turning off grantor trust status to avoid unnecessary wealth shifts and to facilitate income tax planning.
8. Trust Protector
The trust protector has different roles and the U.S. law governing their powers has evolved over the years. A trust protector can maximize flexibility of a trust and help carry out the grantor’s intent. There are essential terms to include in a trust when providing for a trust protector. Also, the person who will be named should be consulted prior to agreeing to serve as a trust protector to make sure he or she is aware of the grantor’s wishes and the role he will play in the trust administration. Clients typically do not understand that a trust protector can re-write a trust if given both broad administrative (add beneficiaries to amend the various trust provisions) and technical (tax) powers. 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. 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. Changing certain administrative provisions (changing scrivener errors and changing the name of the trust) may be better than giving the trust protector broad authority.
Top drafting considerations regarding the trust protector are as follows:
- Trust protectors are not necessary or desirable for all trusts.
- Do not rely on state law and try to avoid jurisdictions that provide mandatory statutory provisions for trust protectors.
- If the trust protector will hold powers beyond those inherently given to a trustee, will the trust protector act in a non-fiduciary capacity? Make that option available in the trust terms.
- Be very specific in trust terms as to what authority the trust protector has and whether or not the trust protector will act as a fiduciary. Make it clear whether the trust protector will monitor the actions of the trustee and be entitled to information about the trust.
- Make sure to use the terms trust protector and trust advisor appropriately and consistently.
- Give the trust protector discretionary, not mandatory, powers and provide guidance as to the exercise of those powers.
- Clearly articulate the duty of care with which the trust protector is to act.
- Remember that the trust protector needs protection as well.
- Grant the trust protector access to the trust information, but be careful not to increase the trust protector’s liability by giving access to information.
- Provide detail with respect to the manner in which the trust protector is to be compensated.
- Provide a mechanism to remove, replace and appoint trust protectors.
- Remember that the trust protector does not “protect” the trust.
9. Power of Appointment
The power of appoinment (“POA”) has many family, administrative and tax uses. The new Uniform Powers of Appointment Act has added new opportunities for clients and planners to incorporate the POA into their documents. The federal income, gift and estate tax consequences of holding and exercising powers were discussed in detail. POAs are not fiduciary powers like trust modifications or decanting powers. POAs are different in that they are non-fiduciary powers. The most common reason to include POAs is for a “second look,”so that a trust may be adjusted due to changed circumstances or tax laws revisions. Two questions to ask are: (1) Do you want someone to be able to make such changes? and (2) Who should do so and by what standards? Also, old trusts may have bad investment standards, obsolete provision, etc. POAs can be exercised to send trust assets to a new trust with better provisions. There are other ways to do this, such as by using trust protectors or decanting, but POAs may be simpler. The new trends that practitioners are seeing POAs being used for include getting a new basis in trust assets, avoiding GST issues and avoiding income tax by appointing to a trust in a jurisdiction that does not have state income tax. POAs are useful to add flexibility to estate plans, to potentially keep family members in line (by threatening to use it), but also to keep charities in line where they may have changed their focus (by not being in line with the grantor’s original intent). POAs can help when family dynamics change due to the beneficiaries’ ages, marital issues, creditor issues, divorce issues, etc.
10. Keeping It in the Family
Business succession planning for the closely-held and family-owned business has its own complex and unique planning concerns. There are various exit strategies and techniques to deal with liquidity issues. In considering succession planning, it is a process. The best time to consider it is at the startup phase, especially if there are multiple owners or sides of the family. The process should be implemented well in advance of the expected targeted transition date, whether that be retirement or some other event. Hopefully a plan is in place in the event of an unexpected death. Succession planning done correctly requires the consultation and involvement of multiple professionals and disciplines, accountant, financial adviser, business attorney, family attorney, business appraiser, banker, insurance professional,and,depending on the dynamics, possibly a business psychologist/consultant. Initial consideration: Is there an existing plan? In any event, what are family goals and individual family member goals? Often times, those are not in sync. Children do not necessarily agree to what the senior generation believes is appropriate. There should be a mission statement to help define family goals and business goals. Regular meetings should be considered as well as an outside person(s) to serve on an advisory board. Consider whether nonfamily members should be on the board of directors. Family goals will dictate approach: Is sale a consideration in the near term or not a consideration? If a business is to continue, who is to have ownership and control? Is ESOP a consideration? You will have to consider how senior family members desire to treat family especially if there are multiple children with differing interests.. Is equalization or getting assets to those who should have them a goal?, (i.e., Ownership to those who are active in the business with an attempt to provide for nonactive family members.) Consider recapitalization with voting and nonvoting interests, giving the nonvoting interests to nonactive family members. If senior family is attempting to equalize values and nonactive members are allocated business interests, grant the active members a right/option to acquire the business interest that was allocated to the nonactive family member. It is extremely important that whatever strategy or approach is implemented be conveyed to the family members.
As you can see from the above, there was a great deal of complex topics presented at the conference that should be considered in your estate and income tax planning. We highly recommend that you contact a member of WS+B’s Estate and Trust Services Group to discuss revisiting your estate plan in light of the ever-changing tax laws.
NEED MORE INFORMATION?
If you have any questions about this Tax Tip, please contact your WithumSmith+Brown professional, a member of WS+B’s National Tax Services Group or email us at [email protected].
Ted Nappi, CPA, PFS, CSEP, Partner
Co-Practice Leader, Estate & Trust Services Group
732.842.3113
[email protected]
Hal Terr, CPA, PFS, CFP, AEP, Partner
Co-Practice Leader, Estate & Trust Services Group
609.520.1188
[email protected]
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