The Strings that Bind
Presented by
Steve Hartnett
Associate Director of Education
American Academy of
Estate Planning Attorneys
The Strings that Bind
 Grantor Issues – Gift Tax
– Gift Completion
• “parted with dominion and control”
– Treas. Reg. 25.2511-2(b)
• If grantor retains rights
– Incomplete to that extent
– If permissible beneficiary
» Depends if creditors can reach
» Paolozzi v. Comm’r
» PLR 9837007 (Alaska Trust)
The Strings that Bind
 Grantor Issues – Gift Tax
– Gift Completion
• If grantor has no interest, see if
grantor retained control
– Sprinkling power
– Add or remove beneficiaries
– Power to accumulate (if that might
shift assets to different beneficiary)
The Strings that Bind
 Grantor Issues – Gift Tax
– Powers not “dominion and control”
IF
• Exercisable only w/ adverse party
• Subject to ascertainable standard
– Question is whether creates
enforceable rights in beneficiary
under state law – so can differ
• Power to affect time and manner only
– Power to accumulate if will
eventually go to that beneficiary
The Strings that Bind
 Grantor Issues – Gift Tax
– Powers not “dominion and control”
• Any power subject to contingency if
– Beyond grantor control
– Not yet occurred
The Strings that Bind
 Grantor Issues – Imputation
• Estate of Grace reciprocal trust
– A sets up trust for B, B sets up trust
for A. A is deemed grantor of trust
for A, causing 2036 inclusion.
– Consider if anyone else could be the
deemed grantor
The Strings that Bind
 Grantor Issues – imputation
– Trustee removal
• If can replace w/ self, attribution
• If can replace w/ someone not
related/subordinate, not a problem for
2036/2038.
– At first Service allowed, then not,
then lost in court, now ok. Rev. Rul.
95-88.
– Unclear if 2042 issue --old TAM relied
on revk’d RR, but said no
The Strings that Bind
 Grantor Issues – Imputation
– Initial naming of even related party not a
problem
• So can name kids or spouse as ttee
– Service argued in the past that close
relationship is de facto control
• Courts: no control
– Trustee has independent fiduciary
duty, i.e. someone can file suit
The Strings that Bind
 Grantor Issues – 2036
– Estate includes property if
• Transfer +
– Retained possession, enjoyment,
right to income
– AND
– Period is
» D’s life
» Not in fact end before D’s death
» Ascertainable by ref. to D’s death
The Strings that Bind
 Grantor Issues – 2036
– Right to receive income or property
• Could be implied agreement
– Example: John transfers 99% of
assets to an Alaska Trust and trustee
always distributes upon request
• Transfer of residence
– No problem if transfer to spouse
– Risk if anyone else
The Strings that Bind
 Grantor Issues – 2036
– Transfer of house
• Could give fractional interest and
thereby retain right to live there
• Note sale/leaseback does not per se
avoid 2036 even if for FMV according
to Service.
– If creditors can reach, it’s included
– If distributions satisfy D’s legal
obligation of support—inclusion
The Strings that Bind
 Grantor Issues – 2038
– Transfer (except FMV sale) AND
• D had at death
• Power to alter amend revoke
terminate enjoyment of property
• Power alone or in conjunction of
anyone that’s not adverse
The Strings that Bind
 Grantor Issues – 2038
– Powers causing inclusion
• Shift income or principal
• Add beneficiaries
– (independent significance doesn’t
count, like power to adopt a child)
• Power to accumulate
– Alters enjoyment even if doesn’t
shift to other beneficiaries
– So, completed gift but included
The Strings that Bind
 Grantor Issues – 2038
– If grantor plus others
• Still inclusion
– If grantor incapacitated
• Still inclusion
– Exception
• Ascertainable standard
The Strings that Bind
 Grantor Issues – 2038
– Ascertainable standard
• Ok- HEMS
– Sickness or other emergency
– Standard of living in style to which
s/he has become accustomed
• Not ok
–
–
–
–
For best interests
The circumstances so require
Special emergency
pleasure
The Strings that Bind
 Grantor Issues
– Management powers 2036/2038
• If can exercise in non-fiduciary
capacity it’s a problem
• If in fiduciary capacity
–
–
–
–
Power to allocate income ok
Investment discretion ok
Power to substitute assets ok
Power to vote stock not ok
» 2036(b) and 2036(a)(2)/Strangi
The Strings that Bind
 Grantor Issues – 2042
– Any incident of ownership causes
inclusion
• Right to change beneficiary
designation, surrender policy, etc.
The Strings that Bind
 Income Tax Issues
– Grantor trust status
• If grantor is substantial owner
– All income/deductions on grantor’s
1040
– Allows trust assets to grow tax-free
» Grantor pays the tax
» Special co-trustee could toggle
grantor trust triggers
The Strings that Bind
 Income Tax Issues
– Grantor trust status
• Alter ego of grantor
– Transactions between trust/grantor
ignored
– Look through to grantor for S
shareholder issues
– Section 121
The Strings that Bind
 Grantor Trust Status Triggers
– IRC 673 reversionary interest 5%
– IRC 674 beneficial enjoyment power
• Held by grantor OR non-adverse
• Unless subject to contingency
– Power re charitable beneficiaries
– Trustee power over corpus subject
to HEMS
– Power affects income and HEMS,
benef will get eventually, benef LPOA
over it, or fixed pattern for what was
accumulated
The Strings that Bind
 Grantor Trust Status Triggers
– IRC 674
• Power to add beneficiaries
• LPOA over trust assets
• If non-adverse is trustee
– Not grantor trust under 674 if at least
½ trustees are not subservient
(presumed if related or subordinate)
to the grantor
The Strings that Bind
 Grantor Trust Triggers
– Section 674- administrative powers
• Power for grantor to borrow w/o
adequate security or interest
– Even if exercisable by non-adverse
party—even if only w/ approval of
adverse
• Loan outstanding to grantor / spouse
• Investment decisions in non-fiduc
The Strings that Bind
 Grantor Trust Triggers
– IRC 675
• Power of substitution in non-fiduc
– If held by grantor, not 100% clear
2036 not problem. Jordahl dealt w/
power in a fiduciary capacity.
– Could be held by any non-fiduc
person– but “reacquire”
– IRC 676 power to revoke
The Strings that Bind
 Grantor Trust Triggers
– IRC 677 Income for benefit of grantor
• If income can be used for benefit of
– Grantor or grantor’s spouse
– Discretion of grantor or non-adverse
party
» Alaska trust would be grantor trust
» Spouse beneficiary would trigger
– May use income to pay premiums on
life insurance on grantor or spouse.
Power not enough, unless insurance.
Actual payment does it
The Strings that Bind
 Beneficiary Issues
– Gift Tax Issues
• GPOA [IRC 2514]
– Exceptions
» Ascertainable standard
» Exercise in conjunction w/ grantor
» Exercise in conjunction w/ adverse
party, i.e. at least 5% interest
The Strings that Bind
 Beneficiary Issues
– GPOA problem can be hidden
• Example: Pebbles is trustee and
remainder beneficiary. Pebbles
makes discretionary distribution to
lifetime beneficiary
• Could be problem even if holder’s
interest is subject to HEMS
– Question is whether distribution may
reasonable diminish availability for
distributions
The Strings that Bind
 Beneficiary Issues
– Non-enforcement of rights is a gift
• Dickman v. Comm’r
• Example: Oliver sets up trust for Eb,
Sam, and Mr. Haney. Sam is trustee.
HEMS standard. Sam goes back to
school and doesn’t distribute for it.
Gift upon expiration of statute of
limitations.
The Strings that Bind
 Beneficiary Issues
– Watch for reciprocity causing GPOA
• 2 trusts and cross-trustees
– Watch whenever beneficiary is trustee
– If GPOA contingent and not occurred as
of death, no inclusion.
– If holder lacks capacity, still included
The Strings that Bind
 Beneficiary Issues
– If client beneficiary has GPOA issue
• Maybe rectify with slow lapse
– Not release unless over $5k/5%
– Beneficiary can disclaim if w/in 9 mos of
creation of the power
– If beneficiary is co-trustee, problems
persist
• Unless co-trustee is someone w/
adverse interest b/c of GPOA rules
The Strings that Bind
 Beneficiary Issues
– Watch any power in non-fiduc capacity
– Can use independent trustee to avoid
GPOA issues
• More flexible b/c complete discretion
possible
– Allows better asset protection
– Beneficiary may be more vulnerable
The Strings that Bind
 Beneficiary Issues
– Income Taxes
• IRC 678 could be substantial owner
– If grantor not substantial owner
– Beneficiary has GPOA OR
– Beneficiary had GPOA and would be
treated as substantial owner if
he/she were grantor.
» Issue: beneficiary has power to
distribute to self based on HEMS is
this a “power solely by himself”?
DeBonchamps says no
The Strings that Bind
 Beneficiary Issues
– Creditor Protection
• Beneficiary creditors of 3rd party trust
– Some states allow attachment
» Child support
» Intentional torts
• If ascertainable standard
– Creditor can force
The Strings that Bind
 Beneficiary Issues
– Creditor Protection
• Possible Solution
– Child as trustee w/ ascertainable
standard
– If problems, child resigns and
independent trustee takes over
» Only discretionary distributions
» Sprinkle among benef and
kids/spouse