The Optimal Basis Increase and Income Tax Efficiency Trust
ExploitingOpportunitiestoMaximizeBasis,LessenIncomeTaxesandImproveAssetProtectionfor
MarriedCouplesafterATRA(or:whyyou’lllearntolovetheDelawareTaxTrap)
(thisversionupdatedJanuary2015)1
ByEdwinP.MorrowIII,J.D.,LL.M.(tax)
I.
Problems with Traditional AB Trust Design & the Lure of Portability…………...1
a.
b.
c.
II.
Using Marital Trusts – not as simple a solution as you think…………………... 9
a.
b.
c.
d.
e.
f.
g.
h.
III.
Introducing targeted General Power of Appointment (GPOA) concepts.……..... 20
Comparison of formula GPOA v. QTIP v. bypass trusts.……………………..…. 22
Capping the GPOA to avoid state and/or federal estate tax.………………..….. 24
Determining the appointive assets when the GPOA is capped……………..….. 24
Issues if spouse is sole trustee or investment advisor………………………..…. 28
Application to states with a separate estate or inheritance tax..……………..…..30
Drafting GPOAs to keep fidelity to the estate plan and asset protection……..…32
Testamentary GPOAs - subject to power holder’s estate’s creditors/spouse?....36
Exploiting the Delaware tax trap, §2041(a)(3)………………………………..……40
Drafting alternatives to curb the “PEG Power” yet still trigger §2041(a)(3)..…... 42
Amending or crafting Delaware tax trap savings clauses……………………..….43
Addressing concerns of potential attacks on formula GPOAs………….….….... 44
PLRs 9110054, 9527024– formula GPOAs based on powerholder’s estate…...45
Analyzing and addressing the Kurz cases………………………………………....48
Comparing use of LPOAs & Delaware tax trap v. use of formula GPOAs…..….53
Busting Disclaimer Myths – Using OBITs w/ Disclaimer Based Planning…. …59
a.
b.
1
Clayton QTIP v. disclaimer funded trusts…………………………………….….… 9
Variations of marital trusts - GPOA marital v. QTIP marital…………………...…11
The weak threat (and nifty loopholes) of Rev. Proc. 2001-38 for QTIPs……....12
The valuation advantage (for <1%), and pitfall (for >99%) of QTIPs..……….…13
How to adapt QTIPs for better “step up”.……………………………………….....14
Summarizing benefits and drawbacks endemic to all marital trusts ………...…14
Techniques to adapt ordinary bypass trusts to increase basis……………..…..14
Are trust protector powers to add GPOAs dangerous?...................................17
Why Optimal Basis Increase Trusts (OBITs) are Superior to AB Trusts…..….20
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
IV.
Responding to the portability threat – and opportunity………………….............. 2
What’s “wrong” with the traditional AB trust post-ATRA……………………….... 3
Thirteen reasons not to “skip the trust”………………………………………….… 4
How a spouse can retain LPOAs/GPOAs in trusts post-disclaimer………….…59
Keeping testamentary powers post-disclaimer in QTIPs – Lassiter case....…..61
Portions of this outline were presented at other CLEs 2011-2014 and were published in Trusts and Estates,
Leimberg LISI Estate Planning Newsletter or CCH Estate Planning Review. © 2011-2014 Edwin P. Morrow III –
Contact: [email protected], or [email protected]. See this website for further updates:
http://ssrn.com/abstract=2436964 or http://dx.doi.org/10.2139/ssrn.2436964
V.
Doubling or Increasing the Basis Step Up at First or Other Deaths…………...62
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
VI.
Asset Protection Strategies Opened Up by Increased Exclusion………….…...92
a.
b.
VII.
Changes to Trust Income Taxation Wrought by ATRA and ACA……………….105
IRC §678(a) – Using Mallinckrodt/beneficiary-defective grantor trusts…….…..110
IRC §678(a) – Seizing the $250,000 capital gains tax exclusion under §121….118
IRC §678(a) – Application to special needs trusts………………………………..119
IRC §678(a) – Application to QTIP trusts…………………………………………..120
IRC §678(a) - Transactions between beneficiaries and fully §678(a) trusts……121
Using §643 Regs to permit capital gains to pass out w/DNI on K-1…………….122
Comparing the three methods under §1.643(a)-3(b)……………………………..126
Problems with adapting irrevocable trusts with prior tax reporting history……..126
Impact of changing the capital gains tax burden on distributions……………….126
Using lifetime limited powers of appointment to spray income…………………..128
QTIPs are (probably) terrible for tax shifting - what can be done (maybe)……..129
IRC §642(c) – Seizing above the line charitable deductions in trusts..…………132
DINGs, NINGs, OINGs – not just for state income tax avoidance………………137
The DING-CRUT – federal tax deferral plus state income tax avoidance…......139
Summary…………………………………………………………………………….140
a.
X.
Using existing LPOAs to trigger §2041(a)(3) for basis increase………………….95
Tax Effect of Amending Irrevocable Trusts prior to power holder’s death……...96
Limiting amendments to keep fidelity to settlor’s intent…………………….……. 98
Gift tax effect of beneficiary procurement/consent to amendment………….…...99
Asset protection effect of beneficiary procurement/consent to amendment…...101
Amendments or modifications affecting GST exemption………………………...101
Decanting in net income/HEMS trusts without absolute discretion………….….102
Ongoing Income & Surtax Planning for Irrevocable Non-Grantor Trust………104
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
IX.
SLATs or other trusts with OBIT clauses and potential reversions………………92
Adapting ILITs……………………………………………………………………..…..94
Application of OBIT Techniques to Existing Irrevocable Trusts……………...…95
a.
b.
c.
d.
e.
f.
g.
VIII.
Transmutation agreements and community property agreements…………...….62
Alaska/Tennessee community property trusts…………………………………..…62
Joint GPOA or Joint Exemption Step up Trusts (“JESTs”)……………..……...…64
Marital Deduction under §2523 for Gifts to Spouse Complete at Death…….…..65
Into the Wind of §1014(e) – Tacking to Increase Basis Despite 1 yr rule….…....67
The “Estate Trust” as alternative …………………………………………………74
“Naked” GPOAs, Crummey OBITs and Upstream basis planning………….…....78
The Upstream Crummey Optimal Basis Increase Trust………………………...…79
Building on the JEST concept by adapting irrevocable spousal OBITs…….…...88
Using irrevocable OBITs to protect the basis of “loss” assets……………….…...90
Comparison Charts…………………………………………………………………..145
Appendix……………………………………………………………………………..A-1
Frequently cited statutes, glossary of acronyms, author bio, various sample clauses
and agreements, proposed statutory amendment to state rule against perpetuities law
1
PartI–NewProblemswithTraditionalABTrustDesignandAdaptingtoPortability
“Itisnotthestrongestofthespeciesthatsurvives,northemostintelligentthatsurvives.Itis
theonethatisthemostadaptabletochange.”–CharlesDarwin
Formanytaxpayers,thetraditionaltrustdesignformarriedcouplesisnowobsolete.
Thisarticlewillexplorebetterplanningmethodstomaximizebasisincreaseformarried
couples(and,forfuturegenerations),exploitthenewlypermanent“portability”provisions,
maximizeadaptabilitytofuturetaxlaw,enablebetterlongͲtermincometaxsavingsand
improveassetprotectionoverstandard“IloveyouWills”andoverstandardABtrust
planning.Primarily,thisarticlefocusesonplanningformarriedcoupleswhoseestatesare
under$10.5million,butmanyoftheconceptsapplytothosewithlargerestatesaswell.
First,we’lldescribethemainincometaxproblemswiththecurrentdesignofmost
trustsinlightofportabilityandthenewtaxenvironment–andproblemswithmoresimplified
“outright”estateplans(sophisticatedpractitionersshouldskipthissection).InPartII,we’ll
describepotentialsolutionstothebasisissue,includingtheuseofvariousmaritaltrusts(and
thekeydifferencesbetweenthem),andwhythesemayalsobeinadequate.InPartIII,we’ll
explorehowgeneralandlimitedpowersofappointmentandtheDelawareTaxTrapcan
achievebettertaxbasisadjustmentsthaneitheroutrightbequestsortypicalmaritalorbypass
trustplanning.IwillrefertoanytrustusingthesetechniquesasanOptimalBasisIncrease
Trust(“OBIT”).InPartIV,wewilldiscusshowthesetechniquesaccommodatedisclaimer
basedplanning(ordisclaimersfromlackofplanning).PartVdivertstodiscussvarious
“doublestepupatfirstdeath”techniques.PartVIpositsnewassetprotectionopportunities.
PartVIIextolsthetremendousvalueofapplyingOBITtechniquestopreͲexistingirrevocable
trusts.Lastly,inPartVIII,we’lldiscussvariousmethodstoensurebetterongoingincometax
treatmentofirrevocabletrusts–notjustneutralizingthenegativesoftrustincometaxation,
butexploitingloopholesandefficienciesunavailabletoindividuals.Iwillrefertothesetwo
groupsoftechniquestakentogetherasanOptimalBasisIncreaseandIncomeTaxEfficiency
Trust,featuresofwhicharesummarizedintheattachedchartintheappendix.2
2
No trademark claimed, “Super-Duper Charged Credit Shelter Trust” was apparently unavailable. Attorneys have
adopted many names for basis optimizing: “basis harvesting trust”, “basis protection trust”, optimal benefit trust”
1
a.
RespondingtothePortabilityThreatͲͲandOpportunity
TheTaxRelief,UnemploymentInsuranceReauthorization,andJobCreationActof
2010(“2010TaxAct”)introducedaprofoundchangetoestateplanningthatwasrecently
confirmedbytheAmericanTaxpayerReliefActof2012(“ATRA”).Section303ofthe2010Tax
Act,entitled“ApplicableExclusionAmountIncreasedbyUnusedExclusionAmountof
DeceasedSpouse”,iscommonlyknownas“portability”.3ATRArecentlymadethisprovision
permanent,alongwitha$5,000,000exemptionforestate,giftandgenerationskipping
transfertax,adjustedforinflation(evenwithlowinflation,ithasalreadyincreasedto
$5,250,000).4
Theconceptofportabilityissimple:thesurvivingspousegetsanyunusedestatetax
exclusionofthedeceasedspouseprovidedtheForm706isproperlyfiled.Whileitdoeshave
variousflawsandquirks,portabilitygoesquitefartocorrectabasicinjusticethatwould
otherwiseoccurwhenthebeneficiariesofacouplewithnobypasstrustplanningpay
hundredsofthousands(ifnotmillions)moreinestatetaxthanthebeneficiariesofacouple
withthesameassetswhodiewithoutanytrustplanning.
Portabilityhasbeendescribedasboththe“deathknell”oftheABTrust5aswellasa
“frauduponthepublic”.6Ubiquitouspopularfinancialpressarticlesnowrefertothe
“dangers”oftraditionalABtrustplanningorthe“deathofthebypasstrust”.Whilethese
chargeshavesomesurfacejustification,theyallfailtoseethetremendousincometaxand
assetprotectionopportunitiesopeneduptosuchtrustsbythenewlaw–iftrustsareproperly
adapted.
Thelureofportabilityandalargeexemptionisindeedasirensongforsomemarried
taxpayerstoavoidtrusts.LikeOdysseus,weshouldlistentoitdespiteofourmisgivings.The
newexemptionlevel,coupledwiththeadvantagesofportability,eliminateswhatwas
3
Section 303 of Public Law 111-312, known as the Tax Relief, Unemployment Insurance Reauthorization, and
Job Creation Act of 2010
4
Rev. Proc. 2013-15 – it will increase to $5.34 million in 2014
5
E.g. “AB Trust can be hazardous to your health”, “Serious tax consequences to AB Trust owners” “Portability
Threatens Estate Planning Bar”, “Is it time to bypass the bypass trust for good?”, and dozens more
6
Frequent Trusts and Estates author Clary Redd at May 2011 Advanced Trust Planning CLE, Dayton, Ohio - to be
fair, he made this comment before the provision was made permanent.
2
previouslythemosteasilyquantifiablereasonstodotrustplanning–savingestatetaxͲfor
thevastmajorityoftaxpayers.Morethanthat,however,thenewtaxenvironmentseemingly
deterstaxpayersfromusingtruststhroughsignificantincometaxdisparities,despitethemany
nonͲtaxreasonsforusingthem.
b.
What’s“wrong”withthetraditionalABtrustpostͲATRA?
1) No Second “Step Up” in Basis for the Bypass Trust Assets for the Next Generation.
Imagine John leaves his wife Jane $3 million in a bypass trust and Jane outlives him 10
years. Over that time the income is spent but the fair market value has doubled to $6
million.Janehasherown$3millioninassets.AtJane’sdeath,theirchildreninheritassets
inthebypasstrustwithonly$3.5millioninbasis.HadJohnlefthisassetstoheroutright
or to a differently designed trust and Jane elected to use her Deceased Spousal Unused
Exclusion Amount (DSUEA), heirs would receive a new step up in basis to $6 million,
potentiallysavingthem$750,000ormore!7
2)HigherOngoingIncomeTax.Anyincometrappedinatypicalbypassormaritaltrust
over $11,950 is probably taxed at rates higher than the beneficiary’s, unless the
beneficiary makes over $400,000 ($450,000 married filing jointly) taxable income.
IncludingthenewMedicaresurtax,thismightbe43.4%forshortͲtermcapitalgainsand
ordinaryincomeand23.8%forlongͲtermcapitalgainsandqualifieddividends.Thisisa
staggeringdifferentialforevenanupperͲmiddleclassbeneficiarywhomightbesubjectto
only28%and15%ratesrespectively.
7
Of the $3 million original basis, this assumes $500,000 is added due to income or gain realized over time
(increasing basis), over the loss in basis due to depreciation or realized losses (which decrease basis), creating $2.5
million unrealized gain times a hypothetical 30% combined federal (23.8%) and state (net 6.2%) long term capital
gains tax – this may be higher if you consider 28% rate for collectibles, or if the assets were depreciable property,
one might look at the depreciation lost and the ordinary income that could have been offset by the extra basis,
which might drive this estimated loss to beneficiaries even higher (though you would have to back out for present
value). Of course, if heirs never sell the property (and depreciation does not apply) and hold until death, losses
resulting from decreased basis would be non-existent. In short, it’s a rough “guesstimate”. As discussed later
herein, some assets do not receive a new basis even if in the decedent’s estate, some assets receive a basis not
based on the fair market value at date of death or under an alternate valuation date. IRC §§691(c), 1014, 2032,
2032A, and some receive de facto step up (Roth IRA, life insurance)
3
3) Special assets can cause greater tax burden in trust. Assets such as IRAs, qualified
plans, deferred compensation, annuities, principal residences, depreciable business
property, qualifying small business stock and S corporations are more problematic and
maygetbetterincometaxtreatmentleftoutrighttoasurvivingspouseortoaspecially
designed trust. Retirement plan assets left outright to a spouse are eligible for longer
income taxdeferral than assets left in a bypass trust, even if trust makes it through the
gauntletof“seeͲthroughtrust”rulesandtheminefieldofplanningandfundingtrustswith
“IRD” (income in respect of a decedent) assets.8 Other assets, such as a personal
residence,havespecialcapitalgainstaxexclusionsorlossprovisionsifownedoutrightor
inagrantortrust.9Ownershipofcertainbusinessesrequiresspecialprovisionsinthetrust
that are sometimes overlooked in the drafting, postͲmortem administration and/or
electionstages.10
Yetoutrightbequestsarenotnearlyasadvantageousasusingatrust,andthereare
varioustechniquesdiscussedhereintoavoidthesethreenegatives.Thebestplanningshould
probablyutilizeanongoingtrustaswellasexploitportability,whichwillbediscussedinthe
nextsection.
c. Whynotjustskiptheburdensofanongoingtrust?11Here’saquickbaker’sdozen:
1) Atrustallowsthegrantortomakecertainthattheassetsaremanagedanddistributed
accordingtohis/herwishes,keepingfunds“inthefamilybloodline”.Sure,spousescan
agree not to disinherit the first decedent’s family, but it happens all the time – people
8
For a checklist of reasons why to use a trust and drafting and administration issues to consider if you do name a
trust as beneficiary, email the author for separate CLE outline, comprehensive checklist and related articles. Also,
see Sal LaMendola’s excellent comparison of IRA/trust options for second marriage situations in Estate Planning
for Retirement Plan Owners in Second (or Later) Marriages - http://www.michbar.org/probate/pdfs/summer13.pdf
9
IRC §121, discussed further in Part VIII of this outline, page 95
10
For S Corp qualification, including QSST and ESBT, see IRC §1361 et seq., for small business stock exclusion
and rollovers, see IRC §1202 and §1045, for losses on qualifying small business stock, see IRC §1244
11
I will avoid the probate/non-probate revocable trust v. will debate, since probate costs and fees will vary from
state to state. A bypass or marital trust might be a testamentary trust under a will.
4
moveaway,getsickandgetremarried–themoretimepasses,themorethelikelihoodof
asurvivingspouseremarryingorchanginghisorhertestamentarydisposition.12
2) Unlike a trust, assets distributed outright have no asset protection from outside
creditors(unless,likeanIRAorqualifiedplan,theassetisprotectedinthehandsofthe
newowner)ͲwhereasabypasstrustisordinarilywellͲprotectedfromcreditors;
3) Unlikeatrust,assetsdistributedoutrighthavenoassetprotectionfromsubsequent
spouses when the surviving spouse remarries. Property might be transmuted or
commingledtobecomemarital/communitypropertywithnewspouse.Ifitisa401(k)or
other ERISA plan, it might be subject to spousal protections for the new spouse (which
cannot be cured via prenup, and become mandatory after a year of marriage).13 Most
states also have spousal support statutes which require a spouse to support the other Ͳ
andthereisnodistinctionifitisasecond,thirdorlatermarriage.Also,moststateshave
someformofspousalelectivesharestatutesthatcouldpreventasurvivingspousefrom
leavingassetstochildrentothecompleteexclusionofanewspouse;14
4) Unlike a trust, assets left outright save no STATE estate or inheritance tax unless a
state amends its estate tax system to allow similar DSUEA elections (don’t hold your
breath–nonehaveyet).Thissavingswouldbegreaterinstateswithhigherexemptions
andhigherratesoftax,suchasWashingtonState(20%toprate)orVermont(16%toptax
rate),bothwith$2millionexemptions. Assuming growth from $2 million to $3 million
anda16%stateestatetaxrate,thatsavingswouldbenearly$500,000!
12
A contract to make a will may offer a tempting solution, but there are significant problems with those that
exceed the scope of this paper, such as triggering a prohibited transaction or violating the exclusive benefits rule as
to retirement plan assets or disqualifying assets from marital deduction, not to mention significant practical
enforcement complexities
13
See the Retirement Equity Act of 1984, IRC §401(a)(11), IRC §417(d)(1), Treas. Reg. §1.401(a)-20, Q&A 28 –
but beware - many retirement plan documents vest the spouse before the one year required by statute. This can be
waived after marriage, but most courts follow Treas. Reg. §1.401(a)-20, holding a waiver in a prenup to be invalid
14
See, e.g., Uniform Probate Code §2-201 et seq.
5
5) Unlike a bypass trust, income from assets left outright cannot be “sprayed” to
beneficiaries in lower tax brackets, which gets around gift tax but more importantly for
most families can lower overall family income tax – remember, the 0% tax rate on
qualifieddividendsandlongͲtermcapitalgainsisstillaroundforlowerincometaxpayers!
6) TheDeceasedSpousalUnusedExclusionAmount(DSUEA),onceset,isnotindexedfor
inflation, whereas the Basic Exclusion Amount (the $5 million) is so adjusted after 2011
($5.25 million in 2013). The growth in a bypass trust remains outside the surviving
spouse's estate. This difference can matter tremendously where the combined assets
approximate$10.5millionandthesurvivingspouseoutlivesthedecedentbymanyyears,
especiallyifinflationincreasesand/ortheportfolioachievesgoodinvestmentreturns;
7) The DSUEA from the first deceased spouse is lost if the surviving spouse remarries
and survives his/her next spouse’s death (even if last deceased spouse’s estate had no
unused amount and/or made no election). This result, conceivably costing heirs $2.1
million or more in tax, restrains remarriage and there is no practical way to use a
prenuptial(orpostnuptial)agreementtogetaroundit;15
8) ThereisnoDSUEAor“portability”oftheGSTexemption.Acoupleusingabypass
trust can exempt $10.5 million or more from estate/GST forever, a couple relying on
portabilityalonecanonlyexploitthesurvivingspouse’s$5.25millionGSTexclusion.This
is more important when there are fewer children, and especially when these fewer
childrenare successful(or marry successfully) in their own right. Forexample, acouple
has a $10.5 million estate and leaves everything outright to each other (using DSUEA),
then to a trust for an only child. Half will go to a GST nonͲexempt trust (usually with a
general power of appointment), which can lead to an additional $5.25 million added to
15
This is not to say that prenuptial agreements should not address DSUE and portability – they should. See
Karibjanian and Law, Portability and Prenuptials: A Plethora of Preventative, Progressive and Precautionary
Provisions, 53 Tax Management Memorandum 443 (12/3/12)
6
thatchild’sestate–perhapsneedlesslyincurringmorethan$2millioninadditionalestate
tax.
9) Unlikeabypasstrust,portabilityrequirestheexecutortotimelyandproperlyfilean
estate tax return to exploit the exclusion, and is irrevocable once elected.16 This may
require opening a probate simply to appoint an executor.17 This is easy for nonͲ
professionalexecutor/trusteestooverlook.TheIRSisnotauthorizedtograntexceptions
or extensions for reasonable cause, though it is still open whether 9100 relief might be
availableiftheestatevaluewasunderthethresholdfilingrequirement(e.g.grossestate
under$5.25million);
10) Unlikeabypasstrust,outrightbequestscannotbestructuredtobetteraccommodate
incapacityorgovernmentbenefits(e.g.Medicaid)eligibilityplanning;18
11) A bypass trust can exploit the serial marriage loophole. Example: John Doe dies
leavinghiswifeJane$5.25millioninabypasstrust.SheremarriesandwithgiftͲsplitting
cannowgift$10.5milliontaxͲfree.Ifhusband#2diesusingnoexclusion–Janecanmake
theDSUEAelectionandhaveupto$10.5millionApplicableExclusionAmount(AEA),even
with the $5.25 million in the bypass trust John left her, sheltering over $15.75 million
(threeexclusionamounts,notadjustingforinflationincreases)fortheirchildrenwithout
any complex planning, not even counting growth/inflation. Had John left his estate to
Janeoutrightorinmaritaltrust,evenw/DSUEA,theircombinedAEAwouldbecappedat
two exclusion amounts ($10.5 million, not adjusting for inflation increases) – a potential
lossofover$2millioninestatetax.19
16
IRC §2010(c)(5); Treas. Temp. Reg. §20.2010-2T(a)
If there is no executor, those in possession may file, but that may be a mess for many reasons. IRC §2203. Coexecutors must ALL sign the return and agree to election or it is not valid. Treas. Reg. §20.6018-2
18
Strangely enough, there may be a difference here between a testamentary and living trust. See 42 U.S.C. §
1396p(d)(6); HCFA Transmittal 64 § 3259.1(A)(1)
19
It appears from new regulations that DSEU has its own serial marriage loophole, though. If John left assets
outright to Jane and she then gifts $5.25 million after John dies, she retains her own $5.25 exclusion, and when
Husband #2 dies, she can gift another $5.25 million while retaining her own exclusion, ad infinitum.
17
7
12) Portability only helps when there is a surviving spouse. It may not work in a
simultaneous death situation, whereas a bypass trust with proper funding or a
simultaneousdeathclauseimputingJohnasthefirsttodieandJaneassurvivorwould.20
Example: John has $8 million in assets, Jane $2.5 million. There is no community
property.Johnbelievesthepopularpressandthinkshecanrelyonportabilityandthe
DSUEA to kick in and shelter their $10.5 million. But, John and Jane are in a tragic
accidenttogether.NeitherJohnnorJanehasasurvivingspouse.John’sestatecannot
elect to use $2.75 million of Jane’s wasted Basic Exclusion Amount and now their
familyneedlesslypaysataxonJohn’sestateof$1,100,000($2.75millionexcesstimes
40%).
13)
Tax Apportionment under §2207A and state law shafts the first to die’s children
whenrelyingonportability.
Example:Johnhas$10.25million,Janehas$10.25million.Johndies,leavingassetsin
a QTIP for Jane to “get a second step up”, believing his kids are assured equal
treatmentandprotectionviaQTIP,thus$5.25millionDSUEisported.Janedieswith
$10.5 million applicable exclusion amount (AEA), but a $20.5 million estate. This
causes approximately $4 million estate tax due (or much more, depending on the
state). Guess whose kids pay all the tax? That’s right – John, the first to die’s, kids
(through John’s QTIP) pay ALL of the federalestate tax(and probably much moreof
anystateestatetax,dependingonthestate),nothalforproͲrataassomemayexpect.
Jane’s kids, through her estate, pay none, unless she specifically overrides the state
andfederalapportionmentstatutesinherWill/trust.
14)
Bonus–Thesurvivingspouse’snewspousecanutilizealltheDSUEifthesurviving
spouse agrees to gift split. Example: John leaves $5.25 million to QTIP for wife
Mary,whoremarriesandhernewwealthyhusbandconvinceshertosplithisgift.
20
See Treas. Reg. §20.2056(c)-2(e) – had John’s will/trust had an A/B split or QTIPable trust with a simultaneous
death clause stating that Jane is deemed to have survived him that would have overridden the Uniform
Simultaneous Death Act and the IRS would respect the marital trust and hence add enough assets to Jane’s estate
to use both exemptions. When the order of death can be determined, you cannot simply change the order in the
Will/Trust for “surviving spouse” purposes. See Estate of Lee v. Commissioner, T.C. Memo 2007-371. If we
include a presumption that Jane dies first, will the IRS respect John as a “surviving spouse” for purposes of
DSUEA? Probably, but we have no guidance yet – temporary regs do not mention this issue. Note – I have not
verified whether this issue is addressed in final regulations issued in 2013 after this was written.
8
PartIIͲUsingMaritalDeductionTrustsandOtherOptionstoAvoidBasisStagnation
“Primum,nonnocere.”First,donoharm.–dictatefromphysician’sHippocraticOath
Thereareotheralternativesthatgetusclosertopreservingthebestbasisincreaseand
income tax result for the family. First, let’s consider variations to enable/disable or limit
funding of marital trusts to maximize postͲmortem flexibility, then explore the variations of
maritaldeductiontrusts.Rememberthatamaritaldeductiontrust,evenwhenitwouldnot
beneededtoreduceestatetax,doeshavetheadvantageofasecondstepupinbasisatthe
survivingspouse’sdeath.
a.
ThinkingOutsidethe“Outrightv.BypassTrust”Box:ClaytonQTIPv.Disclaimer
Ofcourse,simpleoutrightgiftsandtraditionalbypasstrustplanningarenottheonly
twooptions–andtheyneednotbe“allornothing”.Disclaimerfundedbypasstrustsallow
thesurvivingspousetochoosehowmuchisallocatedbetweenthosetwo(ormore)options.
Thechiefdisadvantageofdisclaimerplanningisthatitusuallyprohibitsthesurvivingspouse
fromusingpowersofappointmentforgreaterflexibility(seePartIV)andrequirestimelyand
proactiveanalysisandaction(and,justasimportantly,restraint)immediatelyafterthedeath
ofalovedone.Asdiscussedfurtherherein,thislossinflexibilitymaycostthefamilydearly.
Attorneysmaywishtoconsiderasavingsclause/fundingvariantsimilartotheClayton
QTIP21tosavetheuseoftheexclusionviabypasstrusteveniftheForm706filingtoclaim
portabilityisbotched.22TheClaytonQTIP/bypasstrustcombinationmayalsosaveadditional
basisifthesurvivingspousedieswithin15months.23
21
Clayton v. Commissioner, 976 F.2d 1486 (5th Cir 1992) – decedent’s Will directed that if a QTIP election was
not made for a trust that the assets moved to bypass trust with different dispositive provisions. See also Treas.
Reg. §20.2056(b)-7(d)(3) “a qualifying income interest for life that is contingent upon the executor’s election
under Section 2056(b)(7)(B)(v) [QTIP] will not fail to be a qualifying income interest for life because of such
contingency or because the portion of the property for which the election is not made passes to or for the benefit of
persons other than the surviving spouse.”
22
Example: John wishes to leave his $5 million estate to his longtime wife Jane outright (ignoring all the reasons
herein for ongoing trusts), but he certainly does not want to lose his exclusion amount, because his wife Jane also
has a $5 million estate. His attorney therefore drafts a savings clause in his Will (or revocable trust) that leaves his
available exclusion amount to a bypass trust, but if a proper estate tax return is timely filed to exploit the DSUEA
(and the will/trust provisions may even require this, though this might give up some post-mortem flexibility), the
assets instead go outright to his wife to the extent of the election. Thus, if the executor files the Form 706 timely
and successfully “ports” $5 million DSUE, then $5 million goes outright. If the executor fails to timely file the
Form 706 (or opts out), then $5 million goes into a liberal bypass trust for Jane. Either way, the exclusion is
9
Example:Johndiesleaving$1.25millionIRAoutrightand$4millioninnonͲIRAassets
tohiswifeJaneintrust.TotheextentaQTIPelectionisnotmade,the$4millionwill
gointoaflexiblebypasstrust.IftheQTIPelectionismade,the$4millionwillgointoa
QTIPtrustforJane.Janediesayearlaterwith$5millionofherownassets(including
the rollover IRA), and John’s trust has since appreciated to $5 million. John’s estate
makes the QTIP election and elects to port all $5.25 million DSEU, Jane’s estate
includesher$5million,plusthe$5millionQTIP,andtheentireestatereceivesanew
basis (absent IRD/IRA assets etc). Conversely, John’s executor would not make the
QTIPelectionhadthemarketdippedandJohn’strustdepreciatedto$3million,tosave
theestatefroma“stepdown”inbasis.
Clayton QTIP arrangements have the added benefit over disclaimer funded trusts of
permittinglimitedpowersofappointment,aswellasthesixmonthsofadditionalwindowof
opportunity. Moreover, they do not have dicey acceptance and control issues as with
qualifieddisclaimerrules,northepotentialforfraudulenttransfer,Medicaidortaxlienissues
affecting disclaimants.24 Parties often assume joint brokerage accounts, for instance, can
easilybedisclaimedbuttracingwhocontributedthefundsmaybecrucialtodisclaimingsuch
accounts.25 However, Clayton QTIP arrangements are best made with an independent
executor,whereastheidentityoftheexecutorwithdisclaimersiscompletelyirrelevant.
Extreme,butnotuncommon,scenariossuchasthiscouldsavehundredsofthousands
of dollars in basis by building flexibility into the plan. Even a heavy bond portfolio
(approximately10yrduration)couldeasilydecreaseinvalue25%ifinterestrateswentupa
saved. An independent executor/trustee may be desired here. A surviving spouse would have obvious conflicts
with his or her fiduciary duties to other beneficiaries by filing such an election and potentially gift tax issues as
well, unless the filing were mandated in the document (in this example that would be the best route). Even if an
independent party is named, it may be best to outline parameters or indemnify the executor from diverse ranges of
elections selected. See appendix for a drafting example. This technique would be difficult to use for non-probate,
non-trust assets such as qualified plans, IRAs etc., so it’s hardly a universal planning option.
23
As discussed in the next Part II, page 15, QTIPs elections can be made on a late return, but since DSUEA
requires a timely filed Form 706, it is recommended that timely Forms 706 be filed for any substantial estates.
24
Despite the general common law rule espoused by the Uniform Disclaimer of Property Interest Act (see § 6 and
§ 13 and commentary), some states do not buy into the “relation back” myth that a disclaimer is not a transfer of a
property interest subject to fraudulent transfer laws (Ala Code § 43-8-295; Fla. Stat. Ann. § 732.801(6);
§739.402(d); Mass. Gen. Laws Ann. 191A § 8; Minn. Stat. Ann. § 525.532(6); N.J. Rev. Stat. Ann. § 3B:9-9; and
Wash. Rev. Code Ann. § 11.86.051, In re Kloubec 247 BR 246, (2000, Bk. ND Iowa), Lowe v Brajkovic (1993, Bk
WD Tex) 151 BR 402 (list not shepardized for current status). Ohio recently legislatively overruled an adverse
state Supreme Court decision (Stein v Brown), with Ohio R.C. §5815.36(N), effective March 2013, to protect
debtor/disclaimants. Disclaimers cannot avoid tax liens. Drye v. United States, 528 U.S. 28 (1999)
25
Treas. Reg. §25.2518-2(c)(4)(iii), even though IRC §2040(b) would deem 50% to be in each spouse’s estate
10
couple percentage points.26 Practitionersshouldfile for a six month extensionon Form 706
evenifnoestatetaxwouldbeduetobuyadditionaltimeforbasisadjustment,evenifoneof
thepreferredOptimalBasisIncreaseTrustdesignoptions,discussedinPartIII,isutilized.
b.
VariationsinMaritalTrusts–DifferencesbetweenGPOA,EstateandQTIPTrusts Aside from the potential state estate tax deferral/savings, marital trusts receive a
second step up in basis without sacrificing most of the protection and control of a trust.
Succeedingtrusts/beneficiariesgenerallyreceiveanewbasiswhenassetsareinthesurviving
spouse’sestate,whichmaritaltrustsare.27Varietiesincludetheestatetrust,generalpower
ofappointmentmaritaltrustandqualifiedterminalinterestproperty(QTIP)maritaltrust.
Anestatetrustisveryrarelyused–itrequiresthetrustpaytothesurvivingspouse’s
estate.AGPOAmaritalisnotmuchmoreprotectiveofasettlor’sintentattheseconddeath–
itmustgrantthespousethepowertoappointtohis/herestatewithoutanyotherconsenting
party.28TheQTIPmaritaltrustcanbemuchmorerestrictiveatseconddeaththananestate
or GPOA marital trust, by restricting or even omitting the surviving spouse’s power to
appoint.29 Because of this and other advantages, QTIPs are by far the most preferred.30
However, especially in smaller estates of older couples with children of the same marriage,
andinstateswithnostateestatetax,theestateandGPOAmaritaltrustsmayseearisein
popularitybecausecoupleswithsmallerestatesdon’tneedtofileaForm706togetasecond
stepupinbasisandwon’tgethitwithadditionalvaluationdiscountshamperingbasisincrease
(discussedinnextsection).
Example: John and Jane, married, in their midͲ70s, have less than $1 million each.
TheywishtoleaveassetsintrusttoeachotherforallthevariousnonͲtaxreasonsherein,but
want to preserve the second step up in basis at the second death. Using a QTIP design
requires the first decedent’s executor to file a costly Form 706 with the appropriate QTIP
electionͲotherwise,it’snodifferentthanabypasstrust,andwon’tgetastepupinbasisat
26
http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/Bonds/P204318 - 2% or more jumps happened
several times within rather short time frames in the late 70s, early 80s.
27
IRC §1014(b)(6),(9), (10).
28
IRC §2056(b)(5), Treas. Reg. §20.2056(b)(5)(g)
29
At IRC §2056(b)(7) and IRC §2056(b)(5) respectively
30
If the GPOA does not bother a client for non-tax reasons, most of the other advantages, like reverse QTIP and
optimizing GST, flexible use of previously taxed property credit if deaths are close together in time or valuation
discounts, really only apply to larger taxable estates – irrelevant to more than 99% of the population now.
11
the second spouse’s death. However, using a GPOA marital trust does not require such a
filing. Even if no Form 706 is filed at the first death, assets in the GPOA marital get a new
adjustedbasisattheseconddeath.31
GPOAtrustsmayalsobepreferredfortaxpayersinstatessuchasNewYorkandNew
JerseythatdonotpermitaseparatestateQTIPelection.32
c.
Theweakthreat(andniftyloopholes)ofRev.Proc.2001Ͳ38forQTIPs
Another reason marital GPOA trusts might be preferred for taxpayers with estates
undertheapplicableexclusionamountisthepotentialthreatposedbyIRSRev.Proc.2001Ͳ38.
Rev.Proc.2001Ͳ38outlinesaproceduretopermittaxpayersandtheIRStodisregardaQTIP
election,eventhoughtheelectionisirrevocable,undercertaincircumstances.Itwasclearly
designed to help taxpayers who unnecessarily overͲqtipped what should have remained a
bypasstrust.ThereisnoindicationyetthattheIRSwilluseitasaweaponofattack,againsta
taxpayer’sinterests,yetitdoespurportedlyallowthemto“disregardthe[QTIP]electionand
treat it as null and void for purposes of sections 2044(a), 2056(b)(7), 2519(a) and 2652.”33
SincethebasisrulesunderIRC§1014(b)(10)referenceinclusionviaIRC§2044,thiswouldbea
probleminpreservingasecondbasisincrease,becausedenyingtheQTIPelectionwoulddeny
inclusionunderIRC§2044,andhencedenythenewbasis.Thisunilateralrevenueprocedure
should not entitle the IRS to retroactively disregard a validly made statutorily granted QTIP
electionontheirownaccord.Rev.Procscannotoverrulestatuteandtreasuryregulation!
However,untiltheIRSissuesfurtherguidance,somepractitionersmayprefertoavoid
theissuealtogetheranduseamaritalGPOA(oruseintervivosQTIPs,towhichtheRev.Proc.
doesnotapplyifyourstatehasfixedotherintervivosQTIPproblems).34Thiswilldependon
31
Under IRC § §1014(b)(9), not IRC §1014(b)(10)
See, The General Power of Appointment Trust is Back, Bruce Steiner, LISI Estate Planning Newsletter #2060
(February 6, 2013).
33
IRS Rev. Proc. 2001-38, see also PLRs 2009-18014, 2007-29028, 2010-36013, voiding valid QTIP elections
34
The problem with inter-vivos QTIPs is that, after the death of the donee spouse, if assets come back to the donor
spouse in trust, even though IRC §2044(c), Treas. Reg. §25.2523(f)-1(f), Example 11 would deem the donee
spouse the grantor/transferor for 2036/2038 purposes, under most state laws, the donor spouse is still the settlor,
making the trust self-settled and therefore subject to the donor’s creditors despite any discretionary standard or
spendthrift provision, and therefore in the donor spouse’s estate indirectly under IRC §2041. See also Rev. Rul.
76-103. States that have recently fixed this issue are Arizona (Ariz. Rev. Stat. 14-10505(E)), Michigan (MCL
§700.7506(4)), Virginia (Va.Code 55-545.05(B)), Ohio (Ohio R.C. §5805.06(B)(3)(b)), Delaware (12 Del Code
3536(c)(2), Florida (Fla Stat. 736.0505(3)) , Texas (Code §112.035(g)), South Carolina
32
12
whetheraGST/reverseQTIPelectionwouldbeused,thecompatibilityoftheestateplanwith
powers of appointment and other factors. QTIPs will probably remain the preferred vehicle
forpotentiallyestatetaxableestates.Ultimately,theIRSwillprobablymodifytheRev.Proc.
notonlytoclarifythispoint,buttopreventotherobviousabusesoftheprocedure.35
Aside from potentially using the Rev. Proc. to defer/avoid state estate tax, the Rev.
Proc.alsoopensupanincometax/basisplayprobablynotintendedbytheIRSifthesurviving
spouse dies after a “market correction”, be it the bond market, stock market, real estate
market,etc.Wehaven’thadabadoneinthelastfiveyears,butitwillcomeagaineventually.
SaywhenthesurvivingspousediestheQTIPhasassetsworth$3million,withbasis$4million.
TheQTIPelectionwasn’tneeded,isn’tdesiredwith20/20hindsightͲitwasmadepurelyon
assumption that basis would increase by the second death. Can the surviving spouse’s
executorsimply“undo”theQTIPelectionmadeinthefirstspouse’sestatepursuanttoRev.
Proc. 2001Ͳ38, restoring $1 million basis? Why not? This assumes this Rev. Proc. is not
amended,asitprobablyshouldbe.
d.
TheEstate/Basis/ValuationAdvantage(for<1%),andPitfall(for>99%)ofQTIPs
GPOAtrustsmayalsobepreferredfortaxpayersinthe99%whowouldfundaportion
ofrealestateorfractionalinterestsinLLCs/LP/SCorps,e.g.,intotrust.
Example:JohnandJane,intheexampleabove,plantofundtheirtrustwiththeir50%
interest in a home, total value $600,000 and 50% of rental property LLC, underlying
assetvalue$500,000.IfaQTIPisused,thesurvivingspouse’sestatemustvaluethe½
in the QTIP and the ½ in the surviving spouse’s estate separately, generating a
fractional interest, and/or marketability, nonͲcontrolling interest “discount”. At
second death, these “fair market values” might total $500,000 and $300,000
respectively, rather than $600,000 and $500,000 (an LLC would probably have a
greaterdiscountthana50%tenancyincommoninterest).
This reduction in valuation would be optimal planning if Jane had a taxable estate, but for
mostpeople,“discounting”willsavenoestatetaxandcosttheheirssignificantbasisincrease
35
The Treasury-IRS Priority Guidance Plan for the 12-month period beginning July 1, 2013, included a new
guidance project described as “Revenue Procedure under §2010(c) regarding the validity of a QTIP election on an
estate tax return filed only to elect portability.” As of August 2014, however, there is no such guidance issued.
13
– for Jane and John’s family, $300,000. Had the 50% interest in the home and 50% LLC
interest gone to a GPOA marital trust for the survivor, or through any other trust with a
testamentarygeneralpower,asdiscussedinPartIII,thetwohalveswouldbevaluedtogether
forestatetaxattheseconddeath,andthereforeretainfull“undiscounted”basis.36
e.
HowtoAdaptQTIPsforBetter“StepUp”
There may be a solution for the fractional interest discount issue, although many
practitioners will find it odd and counterintuitive – use a formula general power of
appointment (discussed in Part III) designed to pull such assets into the estate under IRC §
2041ratherthanIRC§2044toaccomplishconsolidationforvaluationpurposes.Suchapower
would be designed to not qualify the trust under IRC §2056(b)(5), yet be permitted to be
retained under IRC §2056(b)(7). The public policy behind the consolidation for valuation
purposes is that the surviving spouse, via GPOA, effectively controls 100% of the combined
assets.Thereisnothingin§2056(b)(7)thatprecludesaddingthisfeature,andsincetheassets
areincludedintheestateanyway,thereislittletobelostevenunderaworstcasescenario.
Thedifficultywouldlieincraftingthepowertobecappedornegatedintheunlikelyscenario
that the increase in valuation due to aggregation would cause a federal or state estate tax.
Forexample:Janehas$2millionestate,$3millioninQTIP,partofwhichiscomprisedof$2
million property, in LLC owned by her and QTIP as 50/50%, valued at $700,000 for each
interest. A GPOA would aggregate the valuation so to increase the gross estate to $5.6
million,causinganestatetax(ignoringdeductions,assumingnoDSUE,$5.34millionAEA),but
if the estate were a bit smaller or the AEA larger, such a provision could add $600,000 of
basis.SeevariousexamplesinappendixanddiscussionofcappingGPOAsinPartIII.
Query whether inclusion via IRC §2041(a)(3) (using a limited testamentary power of
appointmentandtriggeringtheDelawaretaxtrap)willleadtothesameaggregation?Whileit
is triggering the same statute causing estate inclusion (§2041), the same public policy
36
Compare, e.g., IRS Field Service Advice Memo 2001-19013, Estate of Aldo H. Fontana v. Comm., 118 T.C. 318
(2002)(stock shares in trust with decedent holding testamentary general power of appointment combined with
shares held by decedent outright at death for valuation purposes) with Estate of Ethel S. Nowell v. Comm., T.C.M.
1999-15 (1999), Estate of Ambrosina Blanche Lopes v. Comm., 78 T.C.M. 46 (1999) (non-aggregation for
valuation at death, valued separately).
14
argument discussed in the cases and IRS memos justifying the valuation aggregation for
GPOAsisnotquitethere.Inshort,it’satenableargumentbuttoouncertaintocounton.
f.
SummarizingBenefitsandDrawbacksEndemictoallMaritalTrusts
Thus, marital trust planning can combine the income tax basis benefit of the
outright/portability option with the estate preservation and the asset protection planning
advantages of a bypass trust. Marital trusts can at least partially solve the first major
drawbackofthebypasstrustdiscussedabove–basisattheseconddeath,andcansolvemost
ofthetwelvedrawbacksofoutrightplanningdiscussedinPartIabove.
Butwemightdoevenbetter.Afterall,maritaltruststypicallydon’tsolvethehigher
ongoingincometaxissue,andareproblematicinthattheyalsoreceiveasecondstepdown
inbasis.Moreover,theycannotsprayincomeasabypasstrustcouldandtheyareleakyfor
bothassetprotectionandtaxreasons,becauseofthemandatoryincomerequirement.They
cannothaveprotectiveforfeitureprovisionslikeabypasstrustmight.Theyprovidegreater
complications for seeͲthrough trust status (aka “stretch IRAs”), especially for GPOA marital
trusts. They cannot use broad lifetime limited powers of appointment – which can be
importantforgiftingandincometaxplanningtechniquesdiscussedinPartVIII.37Theycannot
be used by nonͲtraditional couples who are not officially recognized as “married.”38 QTIPs
havemoreoneroustaxapportionment.39DSUEgainedthroughoveruseofmaritaltrustscan
belost.Furthermore,theysimplywon’tbeasefficientinsavingstateestatetaxesorfederal
estate taxes for estates close to the applicable exclusion amount, especially if the surviving
spouse does live long and assets appreciate significantly, since the DSUEA amount is not
indexedforinflation.
g.
Whatwaysotherthanusingmaritaldeductiontrustscouldweachieveasecondstep
upinbasisatthesurvivingspouse’sdeathonassetsinabypasstrust?
Wecouldbuildgreaterflexibilitytoaccomplishthesamegoalsbyeither:
37
IRC §2056(b)(7)(B)(ii)
After the Supreme Court struck down Section 3 of the Defense of Marriage Act (DOMA) recently in Windsor
and the IRS issued Rev. Rul. 2013-17, same sex couples in a legally recognized marriage will now get the marital
deduction. However, this does not include registered domestic partners or similar statuses.
39
IRC §2207A
38
15
1)givinganindependenttrustee(orcoͲtrustee,or“distributiontrustee”)discretionto
distributeuptotheentireamountinthebypasstrusttothesurvivingspouse;
2)givinganindependenttrusteeortrustprotectorthepowertoaddgeneral
testamentarypowersofappointment,oreffectingthesameviadecantingorother
reformationunderstatelawifenoughtrusteediscretionisgranted;
3)givinganotherparty(typicallyachild,butitcouldbeafriendofspouseornonͲ
beneficiary),anonͲfiduciarylimitedlifetimepowertoappointtothesurvivingspouse;40
4)ifthetrustotherwisequalifies,andnoreturnwaseverfiledtonotmakeaQTIP
election,trytofilealateForm706andmakealateQTIPelection.
5)givingthesurvivingspousealimitedpowertoappoint,butenablingthe
appointmenttotriggertheDelawareTaxTrapovertheappointedassets;41
6)givingthesurvivingspousealimitedpowertoappointthatalternativelycascadesto
ageneralpowertotheextentnotexercised.42
7)givingthesurvivingspouseageneralpowertoappointappreciatednonͲIRDassets
uptothesurvivingspouse’sremainingapplicableexclusionamount.
Thisarticlewillfocusontheadvantagesofthelastthreeofthese,referredtoasan
OptimalBasisIncreaseTrust.Theproblemwiththefirsttwoabovetechniques,whichinvolve
placingtheburdenonthetrusteeortrustprotector,isthattheyareoftenimpracticaland
requireanextraordinaryamountofproactivityandomniscience,nottomentionpotential
liabilityforthetrustee/trustprotector.Gallingly,clientsdon’ttelluswhentheyaregoingto
die,handusaccuratecostbasisandvaluationstatements,marshalbeneficiaryagreementand
giveusenoughtimetoamend,decantorgotocourttochangetheestateplantomaximize
taxsavings.Furthermore,fiduciariestakingsuchdrasticstepsarelikelytowishtohire
40
This is known as a collateral power, See Restatement Property, Third, Donative Transfers, §17.3, comment f
IRC §2041(a)(3), IRC §2514(d). While it’s very simple to add a LPOA that would in theory permit this,
understanding the DTT involves considerable complexity. Michigan and Ohio have recently amended their Rule
Against Perpetuities to specifically prevent most unintentional triggerings of the “trap”, but clearly permit
intentional triggerings by appointing to a trust that has a presently exercisable general power of appointment and
therefore triggering IRC §2041(a)(3). See Ohio R.C. §2131.09, and a comprehensive article on the subject from
Attorney James Spica regarding Michigan’s RAP at http://www.michbar.org/probate/pdfs/Summer08.pdf
42
A rather clever variation that the IRS fought, lost and finally acquiesced to in Chisholm v. Commissioner, 26
T.C. 253 (1956), but beware Restatement of Property, Second, Donative Transfers §13.1(c), which would deem
any LPOA to be a GPOA if the gift in default of exercise were to pass to the powerholder’s estate.
41
16
counsel,getsignedwaivers,orconsultadistributioncommittee–timeforwhichmaybe
scarceinasituationwherethesurvivingspouseishospitalizedorterminallyill.
Distributingassetsoutrighttothesurvivingspouse,evenifclearlyundertheauthority
ofthetrustee,protectorordoneeofapowerofappointment,riskslosingtheassetprotection
forthefamilyandrisksadisinheritanceorremovaloutsideinthefamilybloodline.Ifthe
distributionisarguablybeyondthetrustee’sauthority(e.g.,thedistributionstandardsare
onlyfor“health,educationandsupport”),evenwithchildren’sconsent,theIRSmayseeitas
collusiontoavoidtax,thatfundswereheldinconstructivetrustbythedecedent,therefore
mustbedeniedinclusion/stepup.43Plus,we’veallheardcasesofsomeoneondeath’sdoor
thatmiraculouslymakesafullrecoveryandlivesanotherdecadeormore.Oncetheassets
areoutoftrust,youcan’tsimplyputthembackinandbeassuredthesametaxresults.
Addingageneraltestamentarypowerofappointmentdoesnothavethesamelevelof
risk,northesamedestructionofassetprotectionfromoutsidecreditors,asanoutright
distribution.44Sometrustswillhaveatrustprotectorprovisionthatallowsthis,andseveral
stateshaveadecantingstatutethatallowsGPOAstobeaddedifthereisenoughdiscretion
grantedthetrustee.45However,itmerelybegsthequestion–ifit’sworthdoinglater,why
isn’titworthdoingnowbeforeit’stoolate?
LeavingtheabilityforatrustprotectortoaddGPOAbasissavingsclauseslaterislike
GMorToyotadecidingtoleaveaspaceforairbagsandseatbeltsandtellingpeopletheycan
alwaysgobacktoamechanictoaddthemlater.Whynotaddthesafetynetnowandallowit
tobeamended?
h.
AreTrustProtectorPowerstoAddGeneralPowersofAppointmentDangerous?
43
E.g. in McCombs v. United States, 248 F. Supp. 568 (W.D. Ky 1965), widow/children tried to argue that widow
had a GPOA to qualify for marital estate tax deduction, and even went to state court and distributed the entire trust
to the widow outright. Despite the state court decree, the fed court denied the marital deduction, because the trust
did not authorize her to receive outright or GPOA equivalent rights – could the IRS use a similar argument re
income tax? I think so, unless state law to terminate the trust is closely followed. See also Stansbury v. U.S., 543
F. Supp. 154 (N.D. Ill. 1982) – funds held in constructive trust for another held not to be in a decedent’s estate.
44
See Restatement of Property, Second, Donative Transfers, §13.2 Creditors of the Donee - Unexercised General
Power Not Created by Donee. If creditor protection is a potential threat, and state law is unfavorable, consider the
LPOA/DTT variant (assuming of course, state law easily allows triggering the trap).
45
E.g. Ohio, http://www.actec.org/public/Documents/Studies/Bart_State_Decanting_Statutes_11_18_13.pdf
17
DistinguishedattorneyshavecautionedagainstgivingnonͲadversepartiessuchas
trustprotectors,trusteesortrustadvisorstheabilitytoaddGPOAs(beyondwhatstatelaw
alreadygrantsinthetrustcode,decantingstatute,etc).46Thereasonisthatthismaybe
deemedtobeageneralpowerofappointmentovertheentiretrustinitself.Considerthis:if
spousehasaGPOAonlyexercisablewithconsentofatrustprotector(assumetheTPisnota
childorremainderman,whichishighlylikely),weknowthisisstillataxableGPOAbecause
theconsentingpartyisnonͲadverse.47IsthissodifferentfromanonͲadverseparty(trust
protector)beingabletograntaspouseaGPOA?BothvariationsallowaGPOAtobeexercised
onlywiththeconsentofthespouseandtrustprotectorwhoisnonͲadverse.Couldthisbe
merelyasemanticdifferenceassomewarn?
Iwouldarguethisisnotsubstantiallydifferentfromanindependent,nonͲadverse
trusteewiththesolediscretiontopaytheentireamountofatrusttoaspouseorother
beneficiary,oranonͲbeneficiaryholdingalifetimelimitedpowerofappointmentenablingthe
same.SincethetrusteeorpowerholderinthesescenariosisnonͲadverse,aren’tthese
situationssimilartothespouseandnonͲadversetrustprotectorifconsideredtogetherhaving
aGPOAassomewouldargue?Whenwelookatitthisway,weprobablyseesomeabsurdity
andconcludesuchtrustprotectorpowerscannotcreateaGPOAinpeoplebythemerepower
toaddaGPOAlater–elsetheIRSwouldhavelongsincehammeredthousandsoftrustswith
estateinclusion.Woulditmatterifthetrustprotectororotheradvisorisconsidereda
fiduciaryandheldtofiduciarydutiesinhisorherabilitytoaddaGPOA?Someattorneysand
statelawallowtrustprotectors/advisorstobeconsiderednonͲfiduciaries.Thosemaybe
riskier.
Tosummarize,whileitisnotastrongargument,whytemptit?Ifyouallowatrust
protectororotherpartytograntoramendabeneficiary’sGPOA,especiallyifthepartyisnot
consideredafiduciary,considerlimitingthepotentialcategoryandamountofappointive
assetsinthesamemannerasdiscussedinthefollowingPartIII.
46
Identifying and Respecting the Core Elements of a Modern Trust, comments by Ronald Aucutt, 48th Annual
Heckerling Institute on Estate Planning ¶1305.1[B]
47
IRC §2041(b)(1)(C)(ii)
18
Thethirdtechnique,usingalimitedlifetimepowerofappointment(akacollateral
power),simplymovestheburdentosomeoneotherthanthetrustee,andmayleadtomany
difficultissuesevenintraditionalfamilies.Alifetimelimitedpowertoappointcouldbemade
conditionaluponunanimousconsentofthechildren,butthisofcoursebringsupthe
possibilityofonechild’sobstinanceholdingbackthefamily’staxplanning.
The4thtechniqueabove,makingalateQTIPelection,maysurprisepeople.Some
bypasstrustsmightqualifyasaQTIPwiththeproperelection(e.g.ifspouseissolebeneficiary
duringhisorherlifetimeandentitledtodemand/receiveallnetincome).AQTIPelectioncan
bemadeonthelasttimelyfiledestatetaxreturn,or,ifnotimelyreturnisfiled,onthefirst
latereturn.48Thismightbeafullor,perhapsbetterforRev.Proc.2001Ͳ38reasons,partial
election.Youneednotreopenaprobateestatetoappointanexecutor,thetrusteemayfile.49
Ifestateadministrationisfinished,itmaybetoolatetodivideatrustsubjecttopartial
electionintotwoseparatetrustsforoptimalefficiency.50Conceivably,thetrusteecouldeven
waituntilafterthedeathofthesurvivingspousesothattheQTIPelection“relatesback”to
causeinclusioninthesurvivingspouse’sestatetoseizetheadditionalstepupinbasis.This
couldcauseseriousheadacheswithaClaytonQTIParrangement.Moreimportantly,
however,planningforalateQTIPelectionissimplynotaviableproactiveplanningtechnique
becausefailingtotimelyfileaForm706eliminates,oratbestjeopardizes,portability.
So,howdowebetterensurethatassetsgetthemaximumstepuppossible,notastep
down,don’tcauseextrastateestatetax(orfederal),andachievebetterongoingincometax
treatmentandassetprotectionthanatypicalbypassormaritaltrust,withouttheabove
drawbacks?
Let’sturntothefinalthreemethodsabove,whichuseformulapowersofappointment
toallowforfirmerandmoreprecisetaxplanning.Iwillrefertoallofthesevariantstogether
asanOptimalBasisIncreaseTrust(OBIT).
48
Treas. Reg. §20.2056(b)-7(b)(4)(i). Be careful using this for state estate tax planning, some states (formerly,
this was the case in Ohio) may not follow federal law to allow a late filing for a state-equivalent QTIP.
49
Treas. Reg. §20.2056(b)-7(b)(3)
50
Treas. Reg. §20.2056(b)-7(b)(2)
19
PartIIIͲTheOptimalBasisIncreaseTrust(OBIT)
"Anyonemayarrangehisaffairssothathistaxesshallbeaslowaspossible;heisnot
boundtochoosethatpatternwhichbestpaysthetreasury.Thereisnotevenapatrioticduty
toincreaseone'staxes.OverandoveragaintheCourtshavesaidthatthereisnothingsinister
insoarrangingaffairsastokeeptaxesaslowaspossible.Everyonedoesit,richandpooralike
andalldoright,fornobodyowesanypublicdutytopaymorethanthelawdemands."
ͲJudgeLearnedHand,Gregory v. Helvering, 69 F.2d 809 (2d Cir. 1934), aff'd, 293 U.S. 465 (1935)
a.
IntroducingtheTargetedFormulaGPOAConcept
Using testamentary general and limited powers of appointment more creatively can
assure that assets in the trust receive a step up in basis, but not a step down in basis, and
thesepowerscanbedynamicallydefinedorinvokedsoastonotcauseadditionalestatetax.
Example:JohnDoediesin2013with$2MillioninassetsleftintrustforhiswifeJane.
ShefilesaForm706and“ports”$3.25millionDSUE.We’llassumethatmostofthisgainhas
beenrealized,thoughwithmoretaxefficientorbuy/holdstrategy,realizationwouldbemuch
less.After8years,whenshedies,thesetrustassetshavegrownto$4million,asfollows:
TraditionaldeductibleIRA51 basis$0,
FMV $700,000
Total“IRD”Property basis$0
FMV$700,000
AppleStock(theiPhone9flopped), basis$500,000,FMV$200,000
CondoinFlorida(hurricanedepressesvalue),
basis$1,000,000,FMV$600,000
LTBondportfolio(inflationdepressedvalue)
basis$400,000FMV$300,000
Variousstocksthathavedecreasedinvalue
basis$150,000,FMV$100,000
Total“loss”property basis$2,050,000,FMV$1,200,000
RentalRealEstate52 basis$200,000,FMV$600,000
51
In many cases, I would not recommend that an IRA be used to fund a bypass trust, since a spousal rollover has
better income tax treatment, but it may be preferable when needed to soak up state estate tax exemption, or for
various non-tax reasons. This is mostly included to show the lack of effect on basis on IRD at death. If an
accumulation trust (as opposed to conduit trust) design is used, consider a separate or standalone trust so that no
broad power to appoint can be construed to apply to the retirement benefits. Blanket savings clauses may not save
the stretch, especially since most POAs by default can include non-qualifying trusts as appointees. See
Restatement of Property, Third, Donative Transfers §19.14, other IRA CLE and checklist materials developed by
author and ¶6.3.09, Life and Death Planning for Retirement Benefits, 6th Edition, by Natalie Choate.
52
If real estate is held in an LLC/LP or other entity taxed as a partnership, the underlying assets do not
automatically get a date of death basis even if the LLC/LP is in the decedent’s estate, but the partnership may
make an election under IRC §754 to step up inside basis. Treas. Reg. §1.754-1. Advisors to the 99% should
consider REDUCING discounts to FLPs/LLCs by amending operating agreements (adding put/termination rights,
etc), despite articles stating essentially “you can just reduce the discount you take”, which is absolute nonsense.
20
Variousstocksthathaveincreasedinvalue basis$400,000,FMV$900,000
STBondPortfolio,Moneymarket,Cash
basis$400,000,FMV$400,000
Gold basis$100,000FMV$200,000
Total“gain”property basis$1,100,000,FMV$2,100,000
TotalatJane’sdeath basis$3,150,000FMV$4,000,000
HadJohnusedanoutrightbequest,oramaritaltrust,alloftheassetsabove(except
the IRA) would get a new cost basis – including the loss properties.53 Had John used an
ordinary bypass trust, none of the assets above would get a new cost basis, including $1
millionofunrealizedgains(seechartbelow)!
Instead, John’s Optimal Basis Increase Trust (OBIT) grants Jane a limited power of
appointment(ornopoweratall)overallIRDassetsandassetswithabasishigherthanthe
fairmarketvalueatthetimeofherdeath(totalassets$1.9million).ItgrantsJaneageneral
powerofappointment(“GPOA”)overanyassetsthathaveafairmarketvaluegreaterthantax
basis (total assets $2.1 million). As discussed below, this may also be accomplished with a
limitedpowerofappointment(“LPOA”)thattriggerstheDelawareTaxTrap.
JohnDoeTrust
TraditionalABTrust
JohnDoeTrust
FboSpouse(&poss.
children)
<$5.25mm(orbasicexcl)
JohnDoeTrust
FbospouseonlyQTIP,
>$5.25mm(orbasicexcl)
Trustforchildren
Trustforchildren
Nochangeinbasis
Allnewbasis
53
Potentially, the QTIP may be worse than an outright marital transfer if there is no estate tax, since you may have
discounting if, for instance, a QTIP owns half the home and the surviving spouse owns half – this would result in
less basis for remaindermen than if the surviving spouse had owned the whole.
21
JohnDoeTrust
OptimalBasis
IncreaseTrust
JohnDoeOBIT
JohnDoeMaritalTrust
FboSpouse(&children?)
Fbospouseonly,
<$5.25mm(orbasic
exclusionamount)
>$5.25mm(orbasic
exclusionamount)
Trustforchild(ren)
Trustforchildren
Stepupinbasisforassets
w/basis<FMV
Nochangeinbasis(IRD,
assetsw/
(uptospouse’sAEA)
Basis=>FMV)
Trustforchildren
Allnewbasis
(includingstepdown)
Stepupcausedbyformula
GPOAorLPOAand§2041(a)(3)
b.
ComparingtheEffectofOBITv.QTIPv.Bypass
NewBasisatSurvivingSpouse’sDeathifusing:OrdinaryBypass QTIP/outrightOBIT
TraditionaldeductibleIRA
$0
AppleStock(theiPhone9flopped), $500,000
$0
$200,000
$0
$500,000
CondoinFlorida(hurricanedepressesvalue),
$1,000,000 $600,000
$1,000,000
LTBondportfolio(inflationdepressedvalue)
$400,000
$300,000
$400,000
Variousstocksthathavedecreasedinvalue
$150,000
$100,000
$150,000
RentalRealEstate
$200,000
$600,000
$600,000
Variousstocksthathaveincreasedinvalue $400,000
$900,000
$900,000
STBondPortfolio,Moneymarket
$400,000
$400,000
$400,000
Gold $100,000
$200,000
$200,000
TotalBasisforBeneficiariesatJane’sdeath
$3,150,000 $3,300,000
$4,150,000
22
Result:JohnandJaneDoe’sbeneficiariesgetastepuponthetrustassets,but,more
uniquely,donotgeta“stepdown”inbasisforanylossproperty(inourexample,newbasisis
$4,150,000versus$3,150,000hadastandardbypasstrustbeenusedandonly$3,300,000of
basis had a marital trust been used. That’s a lot of savings. The beneficiaries (through a
continuingtrustoroutright)getacarryoverbasisoveranyassetsreceivedvialimitedpower
ofappointment(orreceivedbydefaultifsuchassetswerenotsubjecttoageneralpowerof
appointment at death). This allows them to use the higher basis for depreciable assets to
offsetincome,orsellassetstotakethecapitallosstooffsetothercapitalgainsplus$3,000/yr
againstordinaryincome,orholdforfuturetaxͲfreeappreciationuptobasis.
Think people won’t die with unrealized capital losses? It happens all the time. Ask
anyone who handled an estate in 2008Ͳ2009. It is a dangerous misnomer to call the basis
adjustmentatdeatha“stepup”withoutrealizingit’sequallya“stepdown”whenassetsdon’t
appreciate as we had wished them to, yet we are all guilty of this pollyannaish shorthand.
Increasingtrustcapitalgainstaxrates,discussedinmoredetailinPartIIandVIII,maycause
moretaxsensitivity,meaningmoreuseofindividuallymanagedbondsandequitiesoratleast
lowͲturnover funds or ETFs in order to decrease turnover and gains realization, which may
meanevenmoreunrealizedgainsinfutureirrevocabletrusts.
Whyhaven’tpeopledonethisbefore?Besidesthefrustratinginstabilityofthetransfer
taxregimeandthesmallerexemptionspriortoEGTRRA,therearetwomainreasons:ifnot
properly curtailed with careful drafting, it could increase estate tax exposure and decrease
testamentary control by the first spouse to die. Solutions for these two issues will be
discussed below. Regarding the first reason, we need to wake up and smell the new
paradigm. What percentage of the population cares about the estate tax now, even with
someassetsincludedinbothestates?
Let’srevisitourexampleabove.Let’ssayJanehas$3millionofherownassets.Her
DSUEfromherlatehusbandJohn was$3.25 million(frozen,notadjustedforinflation),and
her own basic exclusion amount is $6.25 million ($5.25 million plus 8 years of estimated
inflation adjustments adding $1 million more). Even if she had missed the Form
23
706/portability filing, adding $2.1 million to her estate doesn’t even come close to her $9.5
millionapplicableexclusionamount.ButwhatifJanewinsthelotteryandhas$9millionin
her estate without John’s trust? Could this type of trust provision cause $640,000 of
additionalestatetax($9millionplus$2.1million,minus$9.5millionAEA,times40%rate)?
c.
CappingtheGPOAtoAvoidStateand/orFederalEstateTax
Fortunately, John’s Optimal Basis Increase Trust includes a formula. The GPOA is only
applicable to those assets to the extent it does not cause increased federal estate tax (and
takesintoaccountstateestatetax,discussedfurtherbelow).Powersofappointmentcanbe
limitedinscopeastoeitherappointeesorassets.ManyexistingtrustsalreadyhaveGPOAs
overonlyaportionofthetrust(typically,theGSTnonͲexemptshare).Thereisnoreasonone
cannot grant a general power of appointment over less than 100% of trust assets, or by
formula.54AllofourtraditionalplanninghasA/B/C,GSTformulasthattheIRShasblessedand
thisshouldbenodifferent.55Youcanselectassetsspecificallysubjecttothepower(e.g.an
assetthatyouknowthenextgenerationwillsell),orcarveoutassetsnotsubjecttothepower
(e.g.anassetthatyouknowthenextgenerationwillnotsell).
Furthermore,theappointmentcouldbeapplicabletotheassetswiththegreatest
embeddedgaintosatisfythisamount.Thedraftingdifficultyisnotsomuchincappingthe
GPOAbutincreatingtheoptimalorderingformulaandadjustingforstateestatetaxes.
d.
DeterminingtheAppointiveAssetsWhentheGPOAisCapped
54
Treas Reg. §20.2041-1(b)(3) states that “(3) Powers over a portion of property. If a power of appointment exists
as to part of an entire group of assets or only over a limited interest in property, section 2041 applies only to such
part or interest.” There are probably dozens of cases and rulings about limiting powers and funding trusts with
“caps” - a few in the formula GPOA context are PLR 2001-23045, 2000-101021, 2002-10051, 2004-03094, 200604028 (discussed in Part V), PLRs 9110054 and 9527024 (discussed extensively later in this Part).
55
Formulas tied to tax exemption have always been used for AB/GST funding, and formula gifts designed for
specific tax results have had recent success in the Wandry, Petter and Christiansen line of cases, but there are good
examples even in Treasury guidance. See Treas. Reg. §25.2518-3(d), Example (20) in the area of qualified
disclaimers: “A bequeathed his residuary estate to B. B disclaims a fractional share of the residuary estate. Any
disclaimed property will pass to A's surviving spouse, W. The numerator of the fraction disclaimed is the
smallest amount which will allow A's estate to pass free of Federal estate tax and the denominator is the
value of the residuary estate. B's disclaimer is a qualified disclaimer.” An OBIT formula is the same concept
applied to powers of appointment. See other formulas blessed in Rev. Rul. 64-19 (A/B trusts), Treas. Reg.
§26.2632-1(b)(4), (b)(2)(11) and (d)(1) (GST formula allocation); Treas. Reg. § 1.644-2(a)(1)(iii); Rev. Rul. 72395, 1972-2 C.B. 340; Treas. Reg. § 20.2055-2(e)(2)(vi)(a)(split interest charitable trusts); Treas. Reg. § 25.27023(b)(1)(ii)(B)(Formula transfers to a GRAT), and other PLRs discussed herein
24
Let’stakethenonstateͲtaxedsituationfirst.Inourlotteryscenarioabove,Jane’s
estatehasonly$500,000ofapplicableexclusiontospare,buttheappreciated“stepupable”
assetsoftheOBITtotal$2.1million.Whichassetsshouldbesteppedupfirst?
Assetsthatmayincurhighertaxrates,suchascollectibles(artwork,antiques,orgold,
intheexampleabove)wouldbenaturalcandidatesforpreference.Ontheoppositeendof
thespectrum,otherassetsmighthavelowertaxratesorexclusions,suchasqualifyingsmall
businessstockoraresidencethatabeneficiarymightmoveinto,butthosewouldbe
relativelyraresituations.Mostfamilieswouldpreferthebasisgotodepreciablerental
property,whichcanoffsetcurrentincome,beforeallocatingtostocks,bonds,rawland,family
vacationhome,etc.Therefore,ultimatelyaweightingmaybeoptimal,orevenaformula
basedontaximpact,butatthemostbasiclevelpractitionerswouldwanttheGPOAtoapply
tothemostappreciatedassetsfirst.
Someofthisanalysiswillsoundsimilartothosewhohandledestatesofthosewho
diedin2010whenthepricetopayfornoestatetaxwasalimitedstepupinbasis.Whilethe
conceptsoundssimilar,inpractice,itisquitedifferent.In2010theexecutorcouldchoose
assetstoapplyasetquantityofbasisto,pursuanttospecificstatute.56Ideally,wewouldlike
togiveJane’sexecutororthetrusteethepowertochoosetheassetstocomprisethe
$500,000ofappointedassets–inbothdraftingandinpracticethatisdeceptivelysimple.
However,thisisquitedifferentfrom2010carryover/stepuplaw,anddifferentfrom“pick
andchoose”formulafunding.
Ifthepowerofappointmentisdeemedtoapplytoapecuniaryamount(here,
$500,000),ratherthanafractionalformula(500,000/2,100,000),itmayhaveundesired
incometaxconsequencesuponfunding.57
56
IRC §1022
See IRS Chief Counsel Memorandum (CCM) 200644020 regarding IRD assets. Also see Treas. Reg. §1.10144(a)(3): “Thus, for example, if the trustee of a trust created by will transfers to a beneficiary, in satisfaction of a
specific bequest of $10,000, securities which had a fair market value of $9,000 on the date of the decedent's death
(the applicable valuation date) and $10,000 on the date of the transfer, the trust realizes a taxable gain of $1,000
and the basis of the securities in the hands of the beneficiary would be $10,000. As a further example, if the
executor of an estate transfers to a trust property worth $200,000, which had a fair market value of $175,000 on
the date of the decedent's death (the applicable valuation date), in satisfaction of the decedent's bequest in trust for
the benefit of his wife of cash or securities to be selected by the executor in an amount sufficient to utilize the
marital deduction to the maximum extent authorized by law (after taking into consideration any other property
qualifying for the marital deduction), capital gain in the amount of $25,000 would be realized by the estate and the
57
25
Thus,weshouldavoidsimplepowersofappointmentover,forexample,“the
maximumamountofassetsthatwouldnotcausemyspouse’sestatetoincurstateorfederal
estateorgenerationskippingtransfertax”–eventhoughthismaynotbeaprobleminmany
cases,andusuallyfarsuperiortodoingnothing.
IfJane’stestamentarypowerpotentiallyextendstoalloftheapplicableproperty
equally($2.1million),onlylimitedto$500,000,allpropertysubjecttothatprovisionshould
getafractionaladjustmenttobasisaccordingly–nodifferentthanifachilddiesatage36and
hadapowertowithdraw1/3ofcorpusatage35anddidnottakeit–allassetswouldgeta
1/3basisadjustment.58Aprorataadjustmentwouldleadtowastedbasis,sincea$1,000,000
assetwith$1gainwouldsoakupthesameapplicableexclusionamountasa$1,000,000asset
with$900,000gain.Thiswouldbebetterthannoextrabasisatall,butnotasoptimalasthe
trusteelimitingthepowerholder’sgeneralpower,or,moreconservatively,establishingan
orderingruletodetermineexactlywhichpropertythepowerpertainsto.
TrusteeChoicev.OrderingRule
The trustee might be given a fiduciary limited power of appointment to choose the
appointiveassetssubjecttothebeneficiary’stestamentaryGPOA.Blackletterlawdefinesa
power of appointment as “a power that enables the donee of the power to designate
recipientsofbeneficialownershipinterestsinorpowersofappointmentovertheappointive
property.”59Arguably,atrusteewithsuchapowerwouldbethedoneeofafiduciarylimited
basis of the property in the hands of the trustees would be $200,000. If, on the other hand, the decedent bequeathed
a fraction of his residuary estate to a trust for the benefit of his wife, which fraction will not change regardless of
any fluctuations in value of property in the decedent's estate after his death, no gain or loss would be realized by
the estate upon transfer of property to the trust, and the basis of the property in the hands of the trustee would be
its fair market value on the date of the decedent's death or on the alternate valuation date.” and Treas. Reg.
1.661(a)-2(f): “(f) Gain or loss is realized by the trust or estate (or the other beneficiaries) by reason of a
distribution of property in kind if the distribution is in satisfaction of a right to receive a distribution of a specific
dollar amount, of specific property other than that distributed, or of income as defined under section 643(b) and
the applicable regulations, if income is required to be distributed currently. In addition, gain or loss is realized if
the trustee or executor makes the election to recognize gain or loss under section 643(e). This paragraph applies
for taxable years of trusts and estates ending after January 2, 2004.” Presumably the result here would not be too
harsh, since assets would get a step up in basis at death and hence less gain, but executing the appointment transfer
may take place months after death, by which time assets might have appreciated significantly. Best to avoid the
issue and have it apply to specific assets based on date of death or AVD value.
58
If the power to withdraw 1/3 had lapsed, 5% might be “lapse protected”, causing slightly less to be in the
beneficiary’s estate (and thus less basis adjustment).
59
Restatement, Third, Property, Wills and Other Donative Transfers §17.1
26
powerofappointmenttodesignaterecipientsofpowersofappointmentovertheappointive
property.60
While this is fundamentally different in some ways from AB funding formulas that
involve trustee choice, the IRS may try to apply a “fairly representative” requirement
anyway.61Moreover,becausethepowerdoesnotapplytospecificassetsatdeath,itmaybe
seen as a fulfillment of a pecuniary amount, rather than a power over specific assets, with
attendantpostͲmortemgaintriggeringissuesdiscussedabove.Arguablythepowerholder’s
GENERALpower,oncecurtailedbythetrustee’sfiduciarylimitedpower,isonlyoverspecific
assetschosenbythetrustee.ButIwouldnotcountonanIRSagentunderstandingthis.
Moreover,whatifthebeneficiarydoesnotexercisetheGPOA?Thiswouldbequite
common.WouldtheIRStrytoignorethetrustee’schoiceasmootexceptforthetaxeffect
andattempttodisregardit,sincethetrustee’s“choice”hasnoeffectonwheretheassetsgo
or how they are administered?62 It’s not a strong argument. All in all, it is probably more
conservativeandsimplerinconcepttosimplymakecleartheGPOAneverappliestotheless
appreciatedassets,andisneversubjecttoanytrustee’sdiscretionarychoice.
So,inourexample,thetrustprovidesthattheGPOAappliestothemostappreciated
assetfirst,cascadingtoeachnextindividualassetuntil$500,000intotalpropertyisreached.
In our case, the real estate has the greatest appreciation (assuming there is not a more
appreciatedstockin“variousstocks”category),thustheGPOAwouldapplyto5/6interest(be
it%astenantincommon,ormorelikely,%LLCmembershipinterest).Thus,thebasiswould
be increased to FMV on the date of Jane’s death as to 5/6 of the property (5/6 times
$600,000, or $500,000) and the remaining 1/6 would retain its carry over basis (1/6 of
$200,000, or $33,333).63 This means a basis increase from $200,000 to $533,333. This
60
See comment g in Restatement, Third, Property, Wills and Other Donative Transfers §17.1
Rev. Proc. 64-19, which has to do with post-mortem gains/losses when distributing in kind based on DOD value
62
Perhaps a solution to this aspect would be to have a different takers in default provision for assets subject to a
GPOA lapse than for assets subject to an LPOA lapse, making the trustee’s choice have real effect on property
rights. An example would be to instruct the trustee of the subtrusts to exhaust funds funded via GPOA lapse first,
similar to traditional clauses in bypass/QTIP and GST exempt/non-exempt bifurcated trusts that encourage
spending from non-exempt/QTIP assets prior to GST exempt.
63
The example did not specify whether the property TIC or LLC shares in trust was 100% or a mere fractional
share. I assume here that taking 5/6 of the property is valued at 5/6 of the whole, which might be the case if the
trust owned e.g. 40%. If the trust owned 100% or 51% of the LLC, it may apply to a greater number of
shares/membership interests.
61
27
methodcouldeasilymakeforaratherextensivespreadsheetwhendealingwithdozensifnot
hundredsofindividualstockpositions,butit’slessburdensomethanwhat2010executorshad
todealwithforcarryoverbasis,andisnotmuchofanissuewithmodernspreadsheets.
Inourorderingexample,theGPOAcouldneverapplytothelessͲappreciatedassets,
andhencetheIRSwouldhavenostatutorybasistoincludetheminJane’sestate(oraccord
them an adjusted basis). It applies to specific property, not a dollar amount or a fraction
(thoughitcouldapplytosay,34of100shares,etc).Ifthemostappreciatedpropertyisfamily
business stock, that’s what it applies to, and there is no discretion in the trustee or the
powerholdertochangetheappointiveassetssubjecttotheGPOA.Whilethisgivesupsome
flexibilityoverthetrusteepowernotedabove,itisprobablythemoreconservativeroute.
IncomeTaxCertaintybyForcingaForm706FilingforthePowerHolder’sEstate
SomearguethataformulaGPOA,iftheappointiveassetsarelargeenoughtotriggera
cap,triggersaForm706filingandadditionalestateexpense.Thisistrue,becauseevenwitha
zeroͲtaxformula,thegrossestatebeforewillalwaysbelargerthanapplicableexclusion.The
requirement to file an estate tax return is based on the gross estate, not the net.64 This is
actuallyasignificantbenefit.Thereasonisthat,whenaForm706isrequiredtobefiled,the
IRSislockedintothebasisofhardtovalueassetsforsubsequentincometaxpurposes:65
(a) Fair market value. For purposes of this section and § 1.1014Ͳ1, the value of
property as of the date of the decedent's death as appraised for the purpose of the
Federalestatetaxorthealternatevalueasappraisedforsuchpurpose,whicheveris
applicable, shall be deemed to be its fair market value. If no estate tax return is
required to be filed under section 6018 (or under section 821 or 864 of the Internal
Revenue Code of 1939), the value of the property appraised as of the date of the
decedent's death for the purpose of State inheritance or transmission taxes shall be
deemedtobeitsfairmarketvalueandnoalternatevaluationdateshallbeapplicable.
Thishelpstoensurecertaintyforlaterdepreciationandcapitalgainscalculations,not
onlyfortheappointedassets,butthepowerholder’sotherestateaswell.
e.
IssuesiftheSpouseisSoleTrusteeorInvestmentAdvisor
If the spouse is the sole trustee or sole investment advisor under direction or
delegation, could his or her indirect power to manipulate gains and losses on investments,
64
65
IRC §6018(a)
Treas. Reg. § 1.1014-3
28
andthereforebasis,somehowdeemsuchpowerstobegeneraloveralltheassetsuptothe
remaining applicable exclusion amount? This would be quite a stretch, since the Uniform
Prudent Investor Act and other common law fiduciary duties preclude any selfͲdealing or
avoidanceofdiversificationunlessthedocumentwaivesthem.66Thereisalongstandingduty
ofimpartialityimposedontrustees.67Thankfully,thereisaregulationtoprotectfromthis:
“The mere power of management, investment, custody of assets, or the power to
allocatereceiptsanddisbursementsasbetweenincomeandprincipal,exercisableina
fiduciary capacity, whereby the holder has no power to enlarge or shift any of the
beneficial interests therein except as an incidental consequence of the discharge of
suchfiduciarydutiesisnotapowerofappointment.”68
Still, this may simply be one more reason for a conservative practitioner to use an
independenttrustee,coͲtrusteeand/orinvestmenttrustee.Thereareimportantsidebenefits
tothis–betterassetprotectionwhenacurrentbeneficiaryisnotsoletrustee,protectingthe
surviving spouse from breach of fiduciary duty charges from remaindermen for bad
investmentdecisions,orprotectingthefamilyfromsuchmismanagementinthefirstplace.69
If such a design is still undesirable, consider granting the spouse a limited
testamentarypowerofappointmenteligibletotriggertheDelawareTaxTrap,whichcouldbe
overallassetsequally.Anystructuringtoexploitastepuporavoidastepdownwouldbe
done through the spouse’s own Will or Trust exercising the nonͲfiduciary LPOA over only
specificassets,ratherthanthroughthetrustdocumentorvagariesofinvestmentreturn,and
therefore immune to any such argument. However, the regulation cited above probably
providesamplecoverforsurvivingspousesassoletrustees.Thereareothervariousreasons
thatLPOAsandtheDelawareTaxTrapshouldbeconsidereddiscussedlaterinthisarticle.
66
See, Gifts by Fiduciaries by Tax Options and Elections, November/December 2004 issue Probate and Property,
by Jonathan Blattmachr, Stephanie Heilborn and Mitchell Gans, for a good discussion of gift tax effects of
interested fiduciary decisions regarding Clayton QTIPs, investment choices, alternate valuation date, choice of
where to deduct expenses and other dilemmas, concluding that independent fiduciaries are generally safer, but that
investment choices by a beneficiary/trustee should not lead to GPOA inclusion.
67
Restatement, 3d, Trusts, §79(2), §183, Uniform Trust Code §803, Bogert’s Trusts and Trustees, Ch. 26 § 541
68
Treas. Reg. §25.2514-1(b)(1)
69
For a recent case “piercing the trust veil” by creditors where a son inherited funds from his deceased mother in a
spendthrift trust, because he could appoint himself sole trustee, see In re Heifner, 2012 Bankr. LEXIS 3032
(Bankr. N.D. Ohio, 2012), also see separate trust piercing cases in author’s separate asset protection CLE outlines.
As a whole, practitioners are woefully unaware of the different standards bankruptcy courts use for piercing trusts
(or domestic relations courts for counting). For a case of surviving spouse/trustee not only losing the inheritance
through mismanagement, but also losing bypass trust benefits, see Estate of Wendell Hester v. U.S. (4th Cir. 2008).
29
f. VariationstoAccommodateSeparateStateEstateandInheritanceTaxes
Wedonotwantinclusioninthefederalestate,evenifitcausesnoestatetax,toalso
inadvertentlyincreasestateestatetax,unlessthereisagreateroverallincometaxbenefit.70
Considertheextremes:wedonotwanttograntaGPOAoverstockboughtat$95risingto
$100atdateofpowerholder’sdeathtosave$1orsoinpotentialcapitalgainstaxsavingsif
thestateestatetaxincurredonthe$100is$16!Clientsinthosestatesmayhavea$1of$2
millionstateestatetaxexempttrustandupto$3.25or$4.25millionstateͲQTIPedtrust.
Obviouslythelatterisfirstchoicetocullanybasisfrombyinclusioninthebeneficiary’s
estate,sinceitwouldnotcauseanyadditionalstateestatetax.71
Conversely,assetswithalotofgainmaybenefitfromanincreasedespiteanystate
estatetax.WiththeexceptionofWashington,moststatesthathaveestatetaxalsohavea
substantialstateincometax,sothatsavingsshouldbeconsideredaswell.Thegoldinthe
exampleabovemightbesaidtobenefitfrom$40,000orsoofsavingsbyincreasedbasis
($100,000gaintime31.8%federal,8.2%netstateincometax),asopposedtoperhaps
$24,000orsoinstateestatetaxloss($200,000inclusiontimes12%rate).Again,thiscanbe
accomplishedwithaformulatoensurethatincreasestotheestateareonlymadetothe
extentthatthevalueofthestepupexceedsthecostoftheextrastateestatetax.
Practitionersinstateswitha$1millionorlessestatetaxexemptionmayoptfor
simplicityofdrafting/administrationandsimplyforegotheGPOAoveranystateͲestatetax
exempttrustproperty,sincethesavingsmaynotbeasgreat.However,survivingspouses
maychangeresidenceortheapplicablestatetaxregimemaychange(asithasrecentlyin
Ohio,IndianaMinnesotaandotherstates).Somestateshavelargerexemptionsof$2million,
$3.5millionormorethatmakeitmorecompelling.
70
Ohio’s former estate tax, eliminated this year, failed to catch the Delaware Tax Trap (R.C. §5731.11), but most
states piggy back onto the federal estate tax inclusion criteria.
71
While most states with an estate tax use the same criteria as the federal estate tax and Form 706 as their base,
this is necessarily state specific. Pennsylvania’s inheritance tax, for example, does not tax a general power of
appointment (or limited power of appointment triggering the Delaware Tax Trap) as the federal estate tax would.
See http://www.picpa.org/Content/Files/Documents/Resources/Presentations%20and%20Brochures/6545Inheritance%20Tax%20Brochure.pdf. This creates a great loophole for Pennsylvania residents (which should be
discussed with anyone planning to otherwise leave assets directly to a Pennsylvania resident).
30
Practitionersmaywanttomodifytheirformulawithsomethingsimilartosoakup
availablestateestatetaxexclusion,andthenlimitappointiveassetsalsosubjecttostate
estatetax.Forexample,only“collectibleassetswithbasis70%orlowerthanfairmarket
valueatdateofdeath,realestatewithbasis60%orlower,oranyotherassetwithabasis50%
orlower.”Theabovepercentagesareapproximationsandclientsandpractitionersmay
deviatefromtheseconsiderably,buttheconceptistocreatesomegreaterthresholdfor
inclusionifstateestatetaxweretobepaid.Someclientsmayprefertoforegoabasis
increaseatseconddeathaltogetherifa12Ͳ19%stateestateorinheritancetaxwereincurred,
onthetheorythatanycapitalgainstaxcantheoreticallyremainunrealizeduntilthe
beneficiary’sdeathandreceiveanadditionalstepup.Depreciableassetsmaybepreferredas
appointiveassetsduetotheabilityofadditionalbasistodecreasecurrenttaxation.
Practitionersinstateswithanestate/inheritancetaxshouldconsiderwhetherto
modifyanyformulatoaccountforoutofstaterealestateortangiblepersonalproperty.
Somestates’taxregimesexemptsuchassetsfromtaxaltogether,inwhichcaseyouwould
wantanyGPOA(orLPOAappointmenttriggeringtheDTT)toapplytothoseassetsfirst
withoutfearofcausingadditionalstatetransfertax.72
Otherstatesapplyaconvolutedpercentagetotaxoutofstaterealestateandtangible
property(itsmellsunconstitutional,butitwouldprobablybeupheld).Forexample,a
taxpayerhas$3millionestate,$1millionisoutofstaterealestateandthestatehas$2
millionexemption.Ratherthaninterpretingthisasa$2millionnetestateforstatetax
purposes,resultingin$0tax,thismayresultina$3millionestate,tentativetaxof$150,000,
reducedby1/3duetothepercentageofestatethatisoutofstateproperty,or$100,000.
Wouldaclient(orhisbeneficiaries)wanttopayareducedstateestatetaxtogainadditional
basis?Again,itwoulddependonthenatureoftheasset,likelyuseinthehandsofthe
beneficiaryanditsappreciation,butitbecomesaclosercallifstatetaxisreduced.
72
Although the situs state may have its own separate tax, this is unlikely to be an issue because most taxpayers
who have real estate/tangible property out of state over a state’s exemption amount (usually $1, $2 or $3.5
million), will have such assets in an LLC. However, some states such as Maine may attempt to tax that as well.
See description of Pennsylvania tax in footnote above for example of state that does not tax out of state property.
31
g.
CraftingGPOAstoKeepFidelitytotheEstatePlanandPreserveAssetProtection
Thisbringsustothesecondperceiveddrawbackofsuchplanning–thepotential
thwartingofanestateplanbytheinclusionofatestamentarygeneralpowerofappointment.
RememberthattheIRShashistoricallybentoverbackwardstoconstrueaGPOA,becausein
thepastitproducedmorerevenuethanamorerestrictiveinterpretation.73Thankfully,we
haveabroadstatute,regulationsandmanytaxcasesonwhichtorely,aswellasfavorablelaw
intheassetprotectioncontext,sothatGPOAsmayposelittlethreattotheestateplanif
properlyconstructed.
IftheGPOAmaritaldeductionisclaimed,anyGPOAmustincludethespouseor
spouse’sestate,notjustcreditors,andmustbe“exercisablebysuchspousealoneandinall
events”.74However,ifnomaritaldeductionwasclaimed,asweaimtodoinanOptimalBasis
IncreaseTrust,thefollowinglimitationsmaybeincluded:
AGPOAmaylimitthescopeofeligiblebeneficiariessolongascreditorsofthe
powerholderareincluded.Forexample:“Igrantmybeneficiarythetestamentarypowerto
appointtoanyofmydescendants[ortoanytrustprimarilytherefore,whichisusuallyan
optionfortrustsnotdesignedtoqualifyasa“seethroughaccumulationtrust”forretirement
benefits].75Mybeneficiaryalsomayappointtocreditorsofhisorherestate.”76
73
Like horseshoes and hand grenades, you only have to be close. Someone does not have to know the extent of
their power or even if they have one – if you give a mentally incompetent person or a minor a GPOA they don’t
even know or can’t do anything about, it’s still a GPOA for tax purposes. A surprising number of appellate cases
address these issues, all finding GPOAs, even if someone is incompetent and even if a state court appointed
guardian could not exercise the GPOA. Fish v. United States, 432 F.2d. 1278 (9th Cir 1970), Estate of Alperstein
v. Commissioner, 613 F.2d 1213 (2nd Cir 1979), Williams v. United States, 634 F.2d. 894 (5th Cir. 1981), Boeving
v. United States, 650 F.2d. 493 (8th Cir. 1981), Doyle v. United States, 358 F. Supp. 300 (E.D. Pa 1973),
Pennsylvania Bank & Trust Co. v. United States, 451 F. Supp. 1296 (W.D. Pa. 1978), aff’d 597 F.2d 382 (3rd Cir.
1979), Estate of Alperstein v. Commissioner, 71 TC 351 (1978), aff’d 613 F.2d. 1213 (2nd Cir 1979), Estate of
Freeman v. Commissioner, 67 T.C. 202 (1979). See also Rev. Ruls 75-350, 75-351.
74
IRC §2056(b)(5), Treas. Reg. §20.2056(b)(5)(g) – though generally the whole purpose of the OBIT is to avoid
forcing the marital, it’s important to remember. This language is also why you can’t simply let 5% of a GPOA
lapse every year to let the marital trust escape estate tax altogether after 20 years or so.
75
Accumulation trusts should exclude any IRA distributions from being appointed in further trust, since by default
powers of appointment generally permit appointments in further trust, which may jeopardize a “see through” trust.
Restatement, Third, Donative Transfers, ¶19.13 and ¶19.14, Uniform Power of Appointment Act, §305
76
IRC §2041(b)(1) is in the disjunctive “or”. See also Estate of Edelman v. Commissioner, 38 T.C. 972 (1962),
Jenkins v. U.S., 428 F.2d 538, 544 (5th Cir. 1970). As for spouse’s POAs, see also Rev. Rul. 82-156 in accord.
32
Furthermore,apowerisstillaGPOAifitmayonlybeexercisedwiththeconsentofa
nonͲadverseparty.77Whois“adverse”?Generally,itissomeonewithapresentorfuture
chancetoobtainapersonalbenefitfromtheproperty–notallbeneficiarieswouldalwaysbe
adverse.78ThejurisprudenceisstronglyinfavoroffindingpartiestobenonͲadverse.Inone
RevenueRuling,evenachildwhowasacleardefaultremainderbeneficiaryofatrustwasnot
consideredadversetohermother,whohadapowertoappointtoherselfwithpermissionof
herchild.Why?Becausethechildcouldhavebeendivestedviamom’sspecialtestamentary
powerofappointment,makingherinsufficientlyadverse!79
Surprisingly,evenatrusteewithfiduciarydutiestobeneficiarieswhowouldclearlybe
adverseisnotconsideredadverseitself.80Forexample,onemightaddtotheabove:
“However,mybeneficiarymayonlyexercisesaidappointmentwiththeconsentof[nameof
nonͲadverseparty,and/or]mytrustee.”Itisunclearwhetherabeneficiary/trusteewouldbe
adverse–forplanningpurposes,assumeitcouldbeeither.Thereforeifyounameatrustee
asanintendednonͲadverseconsentingparty,thenmakesurethetrusteeisnotabeneficiary,
andperhapsinsertprovisionstoenableappointmentofanonͲadversepartyastrusteeif,for
instance,abeneficiarywerethesuccessortrustee(andadverse)andthebeneficiaryactually
attemptedtoappointtotheircreditors.IfyounameanonͲadverseparty,makesuretoname
alternatesintheeventthefirstisdeceasedorincapacitated.Intheory,onecouldname
multiplenonͲadversepartiesnecessaryforunanimousconsent,butpushingthatenvelopeis
hardlynecessary.
Furthermore,aGPOAis“consideredtoexistonthedateofadecedent'sdeatheven
thoughtheexerciseofthepowerissubjecttotheprecedentgivingofnotice,oreventhough
77
IRC §2041(b)(1)(C)(ii), Treas. Reg. §20.2041-3(c)(2) As for spousal POAs, see also Rev. Rul. 82-156.
Paraphrasing Estate of Towle v. Commissioner, 54 T.C. 368 (1970).To be adverse, the party must have a
“substantial interest in the property subject to the power which is adverse to the exercise of the [GPOA]”. A taker
in default of appointment has an adverse interest. An interest is adverse and is considered substantial if its “value
in relation to the total value of the property that is subject to the power is not insignificant and is valued in
accordance with the actuarial principles of Treas. Reg. §20.2031-7”. Treas. Reg. §20.2041-3(c)(2).
79
Rev. Rul. 79-63 – a dubious ruling in light of Treas. Reg. §20.2041-3(c)(2), but you can rely on it if you keep
your facts close, unlike a PLR.
80
An independent bank co-trustee, for example, is not sufficiently adverse. Estate of Vissering v. Commissioner,
96 T.C. 749 (1971), reversed on other grounds, Estate of Jones v. Commissioner, 56 T.C. 35 (1971), Miller v.
United States, 387 F.2d 866 (1968). Treas. Reg. §20.2041-3(c)(2), Example 3.
However, I prefer naming other non-adverse parties rather than trustees for simplicity in drafting and potentially
asset protection differences (might a rogue court compel trustee acquiescence based on indirect fiduciary duty?)
78
33
theexerciseofthepowertakeseffectonlyontheexpirationofastatedperiodafterits
exercise,whetherornotonorbeforethedecedent'sdeathnoticehasbeengivenorthe
powerhasbeenexercised.”81ThisoffersevenmoreopportunitytomakeGPOAsmore
difficulttoactuallyexercise,yetstillcomewithinthesafeharborofatreasuryregulation.
IfthereisaqualifiedplanorIRApayabletothetrustdesignedtobeaseethrough
trust(specifically,an“accumulation”trust,itwouldnotbenecessaryfora“conduit”trust),
onemightconsiderafurtherrestrictiontopreventdisqualification–“tocreditorswhoare
individualpersonsyoungerthanmybeneficiary”(atechniqueseeminglyblessedbyarecent
PLRthatpermittedsuchacircumscribedGPOAtoretainseethroughtruststatus).82Although
theOBITtechniqueshereintoincreasebasiswouldnotapplytoIRAsorqualifiedplans,83you
mayhaveaGSTnonͲexemptshareoverwhichaGPOAisdesired.Itwouldprobablybe
preferredtouseaconduittrust,butifforsomereasonthatisundesirable,theremaynotbea
lottoloseincircumscribingtheGPOAinthismannerasappliedtosuchatrust.
Generally,IwouldnotattempttolimitaGPOAinthismannerforanynonͲstandalone
IRAaccumulationtrust–requiringappropriatenonͲadverseparties’consentshouldbemore
thanadequatetopreventunwantedexercise.AlthoughIcouldfindnodiscussioninany
restatement,caseorotherwise,areasonableinterpretationmightbethatanattempted
GPOArelyingontheabilitytoappointtocreditorsmustincludecommonlyfoundcreditorsto
avoidbeingillusory.Thatsaid,itmaystillbeprudenttolimitthepowertoappointto
creditorstotheamountofthelegallyenforceabledebtandtoreasonablyequivalentvaluefor
contractualdebt.Otherwise,apowerholdercouldintheoryborrow$1fromanyoneand/or
81
Treas. Reg. §20.2041-3(b)
See PLR 2012-03033, and discussion thereof in separate IRA “see through trust” checklist CLE materials
developed by author. This PLR addressed the effect of a release creating such a limitation for “see through trust”
purposes of identifying the oldest beneficiary applicable, but it did not discuss whether, after such a limitation, the
power was still a GPOA and what the later tax effects might be. Pursuant to the plain language of the statute and
Regs, it is still a GPOA, but at some point you have to wonder whether the IRS would argue such GPOAs are
illusory – how many creditors out there are young individuals? While this trick is probably not good practice for
drafting new GPOAs, the counsel submitting this PLR were quite clever and successfully threaded the needle –
although the IRS did not rule on that aspect in the PLR, the GST tax will probably still be avoided, because either
the remaining power or the completion of the gift caused by the release at death will cause estate inclusion.
83
IRC §1014(c), IRC §691
82
34
promisetopayunlimitedamountsinexchangeforsomepeppercornofvalidconsiderationto
enableanappointmentofalltheassetstowhomevertheywished.84
Inaddition,any“consent”provisionshouldensurethattherearebackupsanddefaults
toensurethattheconsentingpartyhasabonafideabilitytoact.85Thiswouldentailnaming
alternates(myrecommendation)and/orallowingatrustee,trustprotectororlocalcourtto
appointanonͲadverseconsentingparty(whichmightbeacoͲtrustee).Forexample,ifthereis
nowaythe"consenter"COULDconsent,andthedefaultinitsabsenceweretodenythe
appointment,thentheIRSmayhaveanargument(albeitweak,consideringtheprecedent)
thattherewasnoGPOA.WhatifachildwhowouldbeanadversepartyistrusteeorcoͲ
trusteeandnevergetsaroundtoappointinganonͲadversetrustee?WhatifthenonͲadverse
partyisdeadorincapacitated,renounces(orworse,disclaims)theirpowertoconsent,oris
simplyneverinformedoftheexistenceoftheirconsentpower,orneverreturnsthetrustee’s
phonecalls,letters,emails(allverypossible)?Thoseproblemscanbedraftedaround.For
instance,thedocumentcanpermitanagent/guardiantoactforincapacitated"consenter",
youcannamealternates,and,ofcourse,youshouldprobablyhavethedefaultbetoALLOW
exerciseratherthandenyit.
Forinstance,adefaultmightbetoallowthedecedent'sGPOAtobeexercisedunless
awrittenacknowledgmentofthe"consent"powerisreceivedfroma"consenter",orthe
trusteehasactualknowledgethattheconsenterhasbeeninformed,withinsomany
months.Thenyouwouldneedlanguagetoallowagent/guardianconsent,andlanguageto
triggerorevenappointanalternate"consenter"undercertaincircumstances.Youcouldhave
merereceiptofacknowledgmentdenytheeffectivenessoftheGPOAunlessconsentistimely
granted,ordraftitasavetopower.Thenyouhavea"default"ofsortsthatmakesitclearthat
theGPOAisneverillusory.Carefuldraftingcanensureitisclearthatthecapabilityofexercise
isalwaysthere.
84
Actually, the Restatement, Third, Donative Transfers, §19.2 discusses the concept of a “fraud upon the power”
as voiding any shenanigans to circumvent the intention of the creator of the power by attempting to appoint to
impermissible beneficiaries, so extreme manipulations would probably not succeed anyway, but why tempt it?
85
It is unclear whether a “consenting party” would be as liberally found as a GPOA powerholder, logically it
should follow the jurisprudence cited in footnote 56 above, but, like Crummey powers, why not be safe and ensure
the power is acknowledged? See Rev. Rul. 81-7 for the IRS take on present interests– but the IRS consistently
loses cases in this area even with shoddy trust administration, and it is a completely different statute.
35
h.
CouldtestamentaryGPOAassetsbesubjecttocreditorsofaninsolvent
powerholder’sestate,orsubjecttostatespousalelectivesharestatutes?
Whileonlyahandfulofstateshavespecificstatelawimpactingcreditoraccessto
testamentaryGPOAs,commonlawisgenerallyquitefavorableastowhetherandwhena
testamentarygeneralpowerofappointmentsubjectstheappointiveassetstothedonee
powerholder’screditors.86Inbankruptcytheassetsareclearlynotsubjecttocreditors.87It
maydependonwhetherthepowerisexercisedorwhetheritismerelyallowedtolapse.
Herearethreesourceswiththegeneralrules.Thethirdcitationisfromanattemptby
theNationalConferenceofCommissionersonUniformStateLaws(NCCUSL)tosteerstatelaw
toamorecreditorͲfriendlyposition. Ithasonlybeenpassedinonestate,Colorado,butis
beingintroducedinthreemoreasofSept2014:
§13.2CreditorsoftheDoneeͲͲUnexercisedGeneralPowerNotCreatedbyDonee.
Appointiveassetscoveredbyanunexercisedgeneralpowerofappointment,created
byapersonotherthanthedonee,canbesubjectedtopaymentofclaimsofcreditors
ofthedonee,orclaimsagainstthedonee'sestate,butonlytotheextentprovidedby
statute.88
§13.4CreditorsoftheDoneeͲͲGeneralPowerExercisedbyWill.
Appointiveassetscoveredbyanexercisedgeneralpowertoappointbywill,createdby
apersonotherthanthedonee,canbesubjectedtothepaymentofclaimsagainstthe
donee'sestate.89
86
For a creditor-friendly state, see Cal. Prob. Code §682(b): “Upon the death of the donee, to the extent that the
donee’s estate is inadequate to satisfy the claims of creditors of the estate and the expenses of administration of the
estate, property subject to a general testamentary power of appointment … is subject to the claims and expenses to
the same extent that it would be subject to the claims and expenses if the property had been owned by the donee.”
For debtor-friendly, see South Dakota CL §55-1-26: “Judicial foreclosure of beneficial interests, powers of
appointment, and reserved powers prohibited--Creditors may not reach powers of appointment or remainder
interests. Regardless of whether or not a trust contains a spendthrift provision: (1) No beneficial interest, power of
appointment, or reserved power in a trust may be judicially foreclosed; (2) No creditor may reach a power of
appointment or a remainder interest at the trust level. The creditor shall wait until the funds are distributed before
the creditor may reach the funds; and (3) No power of appointment is a property interest.” Rhode Island: § 34-2213. “Powers as subjecting property to creditors: Except to the extent that a donee shall appoint to his or her estate
or to his or her creditors, §§ 34-22-11 and 34-22-12 shall not be construed to subject to the claims of creditors of
the donee the property which the donee is authorized to appoint.” Similar, Alaska Stat. § 34.40.115, New York:
N.Y. EPT. LAW § 10-7.4
87
For a recent bankruptcy case discussing why non-presently exercisable (testamentary) and non-general powers
do not cause inclusion of appointive assets in a bankruptcy estate, see Casey v. Schneider (In re Behan), 506 B.R.
8 (Bankr. D. Mass. 2014), as well as 11 U.S.C. §541(c)(2)
88
Restatement of Property, Second, Donative Transfers, §13.2
89
Restatement of Property, Second, Donative Transfers, §13.4
36
§502.CREDITORCLAIM:GENERALPOWERNOTCREATEDBYPOWERHOLDER.
(a)Exceptasotherwiseprovidedinsubsection(b),appointivepropertysubjecttoa
generalpowerofappointmentcreatedbyapersonotherthanthepowerholderis
subjecttoaclaimofacreditorof:****(2)thepowerholder’sestate,totheextentthe
estateisinsufficient,subjecttotherightofadecedenttodirectthesourcefromwhich
liabilitiesarepaid.[subsection(b)referstoHEMSstandards,i.e.,nongeneralpowers]90
Surprisingly,theUniformProbateCodealsoseemsprotectiveoftestamentaryGPOAs
asagainstnonͲspousalcreditors.91Ifyourstatelawisunfavorabletodebtor/decedents
holdingtestamentaryGPOAs,likeCalifornia,itmaybepreferabletousetheDelawareTax
Traptechniqueifthereisafearthatapowerholder’sestatemaybeexposedtolawsuitsor
insolvency.Thistechniqueuseslimitedpowersofappointmentonly.Alternatively,limitthe
testamentaryGPOAshouldthepowerholder’sestatebeinsolvent.92
Inotherstates,aspecificstatute,liketheRhodeIslandorAlaskastatutescitedabove,
maygivecomfort.
Moststatesprobablycurrentlyfollowthecommonlawelucidatedby§13.2ofthe2nd
Restatementcitedabove,whichgivesprotectiontoinsolventpowerholderestateswherethe
powerremainsunexercised.93Butthreeconcernsmaystillariseevenforthesestates:
1)whatifthestatesubsequentlypassestheUniformPowerofAppointmentAct
(UPAA)?IfyourstateisdebatingtheUPAA,itmaybeanopportunitytoamend§502priorto
90
Uniform Power of Appointment Act, §502 at www.uninformlaws.org, based largely on Restatement, 3d, §22.3. It
has only been passed in one state, Colorado, but is being introduced in three more as of Sept 2014
91
See Uniform Probate Code §6-102, comment 3: “The definition of ‘nonprobate transfer’ in subsection (a)
includes revocable transfers by a decedent; it does not include a transfer at death incident to a decedent’s exercise
or non-exercise of a presently exercisable general power of appointment created by another person. The drafters
decided against including such powers even though presently exercisable general powers of appointment are
subject to the Code’s augmented estate provisions dealing with protection of a surviving spouse from
disinheritance. Spousal protection against disinheritance by the other spouse supports the institution of marriage;
creditors are better able to fend for themselves than financially disadvantaged surviving spouses. In addition, a
presently exercisable general power of appointment created by another person is commonly viewed as a provision
in the trust creator’s instrument designed to provide flexibility in the estate plan rather than as a gift to the donee.”
92
See discussion of PLR 9110054 in section III.m. below and sample clauses in appendix
93
Some states may have related case law not even in the Restatement, such as the Ohio Supreme Court’s decision
in Schofield v. Cleveland Trust Co., 21 N.E.2d 119 (Ohio 1939), protecting non-probate trust assets from probate
estate creditors
37
passage,asmanystatesdidwithvariousprovisionsoftheUniformTrustCode.Colorado,the
onlystatetohavepassedtheAct,omittedtheentireArticleconcerningcreditorrights.94
Fromapracticalandpublicpolicystandpoint,atestamentarygeneralpowerisquite
differentfromoutrightownership,especiallyiftherearevariouslimitationsandconstraints
onthepower,suchasnonͲadversepartyconsentrequirements,asdiscussedherein.
2)
Whatifthepowerholderchangesstateofresidency?Forinstance,from
RhodeIslandtoCalifornia.Whichstatelawappliestothepowerofappointment,thedonor
orthedoneeofthepower?ThenewUPAAattemptstochangethecommonlawinthis
regard.Atcommonlaw,theapplicablelawofthedonorapplied,butundertheUPAA,the
applicablelawofthestateofthedoneewillapply.Canthisbechanged?Canweimportor
declareaparticularstatelawtoapplyandwoulditholdupasagainstcreditors?
3)
Whatifthepowerholderactuallyexercisesthepower?Evenifitisexercisedin
favorofnonͲcreditorappointees,suchaschildrenorcharities,thismaytriggertheapplication
ofthecommonlawruleinRestatementSecond¶13.2discussedabove.
Sincefuturelawisalwaysuncertain,aswellastheresidencyofthepowerholder,and
whetherthepowerholdermightexercise,itmaybeprudenttotakeseveralstepstomitigate
againsttheseriskswhendraftingtestamentaryGPOAs:
1) Allowatrusteeortrustprotectortoamendaccordingtochangesincircumstance.
2) Limitthescopeofthepowerbycreatingaprerequisite,caporthreshold
preventingGPOAsforsubstantiallyinsolventestates. By“substantiallyinsolvent”,
ifthepowerholder’sestateisinsolventby$10,suchthatacreditorcouldseize
only$10ofassetssubjecttothepowerholder’sGPOA,wouldyouwanttovoidthe
GPOAentirely,forgoingupto$5.34millionofbasistothwarta$10debt?Isuggest
preventingaGPOAonlywherethecostoutweighsthebenefit.95Theclausemight
onlybeactivatedifUPAA§502,Ca.Prob.Code§682(b)orequivalentisapplicable.
3) Draftlimitedandgeneralpowersseparately,sothattheGPOAdoesnotallow
appointmenttoanyonebutcreditors.Wouldexercisingalimitedpowertoappoint
94
http://tornado.state.co.us/gov_dir/leg_dir/olls/sl2014a/sl_209.htm (Part 5, which would be Article 5 of the
UPAA, being “reserved”)
95
See various clauses in appendix
38
tochildren/trustbedeemedanexerciseofaGPOAunderstatelawwherea
concurrentoneexists?Uncertain,butitcan’thurttoseparate.
4) RequireconsentofanonͲadversepartyorpartiestoenableexerciseofaGPOA.
SpousalElectiveShareRights
VariousspeakersatHeckerlingandotherconferencesmayhavescaredattendeesinto
believingthatthirdpartyͲcreatedformulatestamentaryGPOAsriskinvokingspousalstatutory
sharerightsshouldthesurvivingspouseremarry(or,intheeventanotherdownstream
beneficiaryhasasimilartestamentaryGPOA).96Thisdoesnotappeartobethecase.97
Despitethefalsealarmsonthisissue,youmightcircumscribetheformulaGPOAto
preventapplicationifthepowerholderweretomovetoastatethatlaterenactsanewstatute
thatgoesbeyondthecurrentstateofthelawtoincludesuchthirdͲpartycreated
testamentaryGPOAs.Myownsuggestionwouldbetoignorethisindraftingtheformula
GPOAascurrentlya“nonͲissue”,butnotethesettlor’sconcernaboutfuturelegislation
expandingthespousalelectivesharetoanystatementofmaterialpurposeortrustprotector
oramendmentclausethatoutlinesthescopeofpotentialfutureamendments.
Whileyoumaybeabletoavoidthirdpartycreditorissueseitherbyresidingoutsideof
CA,notexercisingtheGPOA,orthroughdrafting,andspousalelectivesharestatutesmaynot
betheissuesomethinkitis,youshouldstillexamineanypre/postnuptialagreementsor
contractstomakeawillthatmightaffectpropertyrights/divisionbasedonacontracting
party’s“taxableestate”,whichcouldconceivablybeoverlybroadlydefinedsoastoinclude
suchassets.AwellͲdraftedcontractwouldprobablyexcludesuchassetsanyway,butitmerits
examinationnonetheless.
96
E.g., comments by Paul Lee, Jeff Pennell, as well as Heckerling comments that they are “too complicated”
See Uniform Probate Code § 2-205(1)(A), with Example 1 in the UPC commentary precisely on point. This
section is unaffected by the 2008 proposed amendments to the UPC. It contrasts with presently exercisable or selfcreated powers. While I did not research all states, I have yet to find one that would bring third party created
testamentary powers into an augmented estate, unless they were accompanied by presently exercisable GPOAs,
which would be rare and certainly not recommended herein. Many state statutes, like Ohio’s which only applies to
probate estate assets, have holes in them wide enough to drive a truck through, but even those non-UPC states with
broadly inclusive statutes exclude such appointive assets. E.g. see Fla. Stat. 732.2045(h), N.Y. EPTL §5-1.1A(b)(1)(H) and citations in ACTEC’s 2004 survey of state spousal elective share statutes, including non-UPC
states, at http://www.actec.org/resources/publications/studies/study10.pdf . I welcome any corrections if there is a
state out there holding otherwise.
97
39
i.
UsingtheDelawareTaxTrapInsteadofaGPOAtoOptimizeBasis
InourexamplesofJohnandJaneDoeabove,wepresumedthattheOptimalBasis
IncreaseTrustusedaformulaGPOAtocauseestateinclusionandincreasedbasis.However,
thereisalsoatechniquetoaccomplishthesameresultwithalimitedpowerofappointment.
ThisinvolvesIRC§2041(a)(3),colloquiallyknownastheDelawareTaxTrap(“DTT”):98
“(3)Creationofanotherpowerincertaincases
Totheextentofanypropertywithrespecttowhichthedecedent—
(A)bywill,or
(B)byadispositionwhichisofsuchnaturethatifitwereatransferofproperty
ownedbythedecedentsuchpropertywouldbeincludibleinthedecedent’sgross
estateundersection2035,2036,or2037,
exercisesapowerofappointmentcreatedafterOctober21,1942,bycreating
anotherpowerofappointmentwhichundertheapplicablelocallawcanbevalidly
exercisedsoastopostponethevestingofanyestateorinterestinsuchproperty,or
suspendtheabsoluteownershiporpowerofalienationofsuchproperty,fora
periodascertainablewithoutregardtothedateofthecreationofthefirstpower.”
Theapplicationofthisrule,inconjunctionwithvariousstates’rulesagainst
perpetuities,iscomplex.Whilemanystateshaveenacted“savingsclauses”intotheirstatutes
(orpassedaUniformAct)thathasclosedofftheabilityofanLPOAtotriggerthisinmost
instances,thereisonemethodusuallyleftoutofthesesavingsstatutes,andthatappearsto
beavailableinmoststates.Iwillreferthereadertomorelearnedarticlesonthesubject,and
concentrateonthemethodoftriggering§2041(a)(3)whichisthemostlikelytobeavailablein
thevastmajorityofstates.99
98
See also Treas. Reg. §20.2041-3(e). There is a gift tax analog, §2514(e), but triggering gift tax only increases
basis to the extent of gift tax actually paid, so this paper will primarily discuss the estate tax variant.
99
For your specific state, see Howard Zaritsky’s ACTEC 50 State and D.C. Survey of Rule Against Perpetuities
Law, specifically p 8-10: http://www.actec.org/public/Documents/Studies/Zaritsky_RAP_Survey_03_2012.pdf.
There is also good discussion in Estate of Murphy v. Commissioner, 71 T.C. 671 (1979) (analyzing an LPOA
appointment to a trust that contained another LPOA and finding under Wisconsin rule against perpetuities law
§2041(a)(3) was not triggered). See also Using the Delaware Tax Trap to Avoid Generation Skipping Transfer
Taxes, Johnathan Blattmachr and Jeffrey Pennell, 68 Journal of Taxation 242 (1988),
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1954062. While the DTT was not considered or discussed for
this type of planning, this is not the fault of two of the sharpest estate planning minds in the country, rather, the
exclusion was only $600,000 at the time. See also A Practical Look at Springing the Delaware Tax Trap to Avert
Generation Skipping Transfer Tax, James P. Spica, 41 RPTL Journal 167, Spring 2006; The Delaware Tax Trap
and the Rule Against Perpetuities, Stephen Greer, Estate Planning Journal Feb 2001. Revising the RAP, Patricia
Culler, Probate Law Journal of Ohio, March/April 2012.
40
Generally,ifJaneinourexamplehadalimitedpowerofappointmentwhichpermitted
appointmentinfurthertrust,andJaneappointedthoseassetstoaseparatetrustwhichgives
abeneficiaryapresentlyexercisablegeneralpowerofappointment(sometimesreferredtoas
a“PEGpower”),thiswouldtrigger§2041(a)(3),causeestateinclusion,andthereforean
increasedbasisunderIRC§1014,justasastandardGPOAwould.100
Thus,Jane’sWill(ortrustorotherdocument,ifpermittedbyJohn’strust)would
appointanyappreciatedassetstosucha“DelawareTaxTrapping”trustasdiscussedinthe
abovesections,andotherassetsoutrightortoanotherordinarytrust.TreasuryRegulations
outlineexamplesofspecific,partialandtargeteduseoftheDelawareTaxTrap(“DTT”)asthis
articlerecommends:
“Thus,ifadecedenthasapowertoappointbywill$100,000toagroupofpersons
consistingofhischildrenandgrandchildrenandexercisesthepowerbymakingan
outrightappointmentof$75,000andbygivingoneappointeeapowertoappoint
$25,000,nomorethan$25,000willbeincludableinthedecedent'sgrossestateunder
section2041(a)(3).”101
Indraftingmode,usingtheDTTisprobablynotanoptimalstrategytoemployfor
John’strust,becauseitwillnecessarilyrequireJanetodraftanewWill/Trustinvokingthe
LPOAandanewappointivetrustwithtermsthatonewouldordinarilyavoid.Givinga
beneficiaryapresentlyexercisableGPOAimpairsassetprotectionmuchmorethana
testamentarypower,anddestroysanychanceofsprayingincomeormakingtaxͲfreegifts,nor
doesitallowavoidanceofstateorfederalestatetaxationoravoidanceofastepdowninbasis
atthechild’sdeath.102
100
See discussion in ACTEC survey and articles cited in the above footnote. All of those, plus other sources I
consulted, conclude that this should trigger §2041(a)(3) under most states’ RAP. This seems counterintuitive for a
tax provision that is intended to attack delayed vesting and avoiding transfer tax, since a beneficiary holding a
typical PEG power appears the de facto owner and would not be “GST-exempt” absent further planning, but that
appears to be the conclusion of both accomplished authors and Treasury’s own examples on this page.
Query whether a power of appointment may be crafted under state law so as to trigger a new vesting period and
§2041(a)(3), yet not be a GPOA under §2514/§2041 or state creditor protection law, such as a power limited to
ascertainable standards, or a power only exercisable with the consent of an adverse party. Without researching,
my guess is that states would have closed what would have been quite a dangerous tax trap years ago.
101
Treas. Reg. §20.2041-3(e)(2). There is a near identical gift tax reg at Treas. Reg. §25.2514-3(d)
102
Contrast lifetime GPOAs in Restatement of Property, Second, Donative Transfers, §13.2 and §13.5 with the
testamentary variations in §13.4 (state law), §13.6 (bankruptcy). Whether it’s a testamentary or lifetime (presently
exercisable) GPOA makes a difference in bankruptcy. See 11 U.S.C. § 541(b)(1).
41
Withalloftheabovenegatives,usingtheDTTtoharvestthebasiscouponprobably
hasmorerealisticapplicationinthecontextofpreexistingirrevocabletruststhatalready
containanLPOA,asdiscussedinPartVII,andshouldprobablynotbeusedinplanningmode
toaccomplishoptimalbasisadjustments,especiallysincemanypractitionersandclientsrely
ondisclaimerfunding,whichkillstheLPOAnecessaryforaDTT(unlesslimitedasdiscussedin
PartIV).However,ifthetrustforchildrenpaysoutrightanyway,andnodisclaimerfundingis
anticipated,thisroutemaybetheeasiest,andmostflexible,totake.
j.
DraftingAlternativestoCurbthe“PEGPower”yetstilltrigger§2041(a)(3)
Practitionersmightevencraftalapsing“Crummey”powerintotheappointivetrustso
thatiftheGPOAlapses,assetsflowintoaselfͲsettled,incompletegiftdomesticasset
protectiontrustwithsitusinOhio,Delawareorotherpermittedstate.AswithCrummey
powers,aportionmay“hang”,orvariousnonͲPEGpowersmayberetainedtoavoidany
completedgiftbythelapse.Mypersonalpreferredroutewouldbetoavoid“bakingin”the
DAPT,buttoinsteadstronglyencouragesuchanappointmentandtomandatethattrust
fundsbeusedtopayattorneyfeesand/ortrusteesetupfeesassociatedtherewith.Itmay
alsobepossibletousenonͲvoting,restrictedLLC/LPsharestoeffectivelycurbaspendthrift
beneficiary,andusethe5%lapseprotectiontoeffectively“freeze”theestateastoPEG
powerholder’sappointiveassetsovertime.103
AnothercounterͲintuitivetechniqueapowerholdermayusetotriggertheDTT,but
stillprotectfromanimprovidentorspendthriftbeneficiarywouldbetoonlygrantthe
beneficiaryalifetimeincomeinterestcoupledwitha“presentlyexercisable”GPOAoveronly
theremainderinterest.Thisisstilldeemeda“presentlyexercisable”GPOA.104Inanearlier
versionofthisarticle,Ihadinitiallyopinedthatthistechniquewouldprobablycauseonly
partialinclusionbasedonactuarialvalueoftheremainder.Iwaswrong,anditisclearthata
stepupinbasisoverthe100%oftheappointedassetsisavailable:
“(2) For purposes of the application of section 2041(a)(3), the value of the property
subject to the second power of appointment is considered to be its value unreduced
by any precedent or subsequent interest which is not subject to the second power.
103
IRC §2514(e) – the so called “5 and 5” lapse protection.
See Restatement Third Property, Wills and Other Donative Transfers, §17.4, comment a, illustration 1, and
draft Uniform Power of Appointment Act, §102, comments re ¶14. It is not testamentary because the powerholder
can make an irrevocable transfer of the remainder, effective immediately.
104
42
Thus, if a decedent has a power to appoint by will $ 100,000 to a group of persons
consisting of his children and grandchildren and exercises the power by making an
outright appointment of $ 75,000 and by giving one appointee a power to appoint $
25,000, no more than $ 25,000 will be includable in the decedent's gross estate
under section 2041(a)(3). If, however, the decedent appoints the income
from the entire fund to a beneficiary for life with power in the beneficiary
to appoint the remainder by will, the entire $ 100,000 will be includable in
the decedent's gross estate under section 2041(a)(3) if the exercise of the
second power can validly postpone the vesting of any estate or interest in the
property or can suspend the absolute ownership or power of alienation of the
property for a period ascertainable without regard to the date of the creation of the
first power.”105
RememberthatyoucannotuseanonͲadversepartyconsentifthegoalisalsoto
qualifytheDTT/estatetriggeringforthemaritaldeduction(thiswouldberare,however,since
LPOAsusuallyexcludesubsequentspousesaspotentialappointees,butitispossible–imagine
theLPOAinthebypassorotherinheritedtrustisbroadenoughtopermitappointmenttoa
spouse,inwhichcasethepowerholdercouldappointtoaDelawareTaxTrappingGPOA
maritaltrustforthesurvivingspousegettingafullstepupwithoutcausingestatetax–thisis
advantageofLPOA/DTToverformulaGPOAs–seediscussionbelow).NonͲadverseparty
consentmayalsomaketheGPOAnot“presentlyexercisable”,requiredfortriggeringtheDTT.
TheformulaGPOAwouldbemoreadvantageousthanusingthePEG/DTTbecauseof
betterestate/gift/GSTsheltering,abilitytosprayincome,andsuperiorthirdpartysettledtrust
protection,butusingthePEG/DTTtechniquescanoffersubstantialprotectionsand
advantagesnonetheless.Ideally,stateswillamendtheirRuleAgainstPerpetuitiesstatutesto
permitoptingintoaregimethatwouldallowLPOAscreatingfurtherLPOAstotriggertheDTT,
obviatingtheneedtousePEGpowers.106
k.
AmendingorCraftingDelawareTaxTrapSavingsClauses
PractitionersmaylegitimatelyfearthattheDelawaretaxtrapmightbetriggered
accidentally,overassetsthatwouldgetastepdowninbasis,orworse,oversomanyassets
thatadditionalestatetaxiscaused.Thelatter,ofcourse,hasbeentheconcernhistorically.
105
Treas. Reg. §20.2041-3(e)(2), there is a nearly identical gift tax regulation at §25.2514-3(d)
See http://www.actec.org/public/Documents/Studies/Zaritsky_RAP_Survey_03_2012.pdf, ironically, even
Delaware has foreclosed this use for GST exempt trusts, the very situations where it will now most often be useful.
According to the survey, Kentucky and Wisconsin have the most useful (or, treacherous, if dealing with an
inadvertent appointment and large estates) statutes, in that appointing to a trust that grants a testamentary GPOA
can also trigger 2041(a)(3), which would at least improve upon the asset protection/control issues.
106
43
ThisiswhymoststateshaveclosedtheloopholeexceptinthecaseofaPEGpower.Some
trustdocumentsattempttoclosetheDTTaltogether,includingwhatthestateswould
otherwiseallow,sothatanyattemptedappointmenttriggeringtheDTTwouldbenulland
void(aka“afrauduponthepower”).Hereisoneexample:
"Mybeneficiarymaynotexercisethistestamentarylimitedpowerofappointmentto
createanotherpowerofappointmentthat,undertheapplicablelocallaw,canbe
validlyexercisedinordertopostponethevestingofanyestateorinterestinthis
propertyforaperiodascertainablewithoutregardtothedateofthecreationofthe
firstpower.”
ThispreventsusinganLPOAtoappointtoatrustwithaPEGpower.However,we
shouldnotcompletelyforeclosetheuseoftheDTTinourtrusts.It’slikeusinga
sledgehammertoswatafly.Weshouldmerelypreventtheinadvertentexercisethattriggers
estatetax(ormoreestatetaxthanissavedinincometax).Therefore,wecouldmodifythe
abovewithsomethinglike:
“Unlessmybeneficiaryspecificallyindicatesanintentiontooverridethisparagraphor
for2041(a)(3)toapplytohisorherexerciseofthetestamentarypowerof
appointmentgrantedherein,….”
Thisrequiresanaffirmativeoptinginbythepowerholder.Ofcourse,youcouldalso
addacaptothispower,andalimitationonappointiveassetssubjecttothe,butabasic
specificoptͲinshouldbeadequateprotection.Limitationsbeyondthismaybedetrimental–
asdiscussedabove,theremaybecaseswheretriggeringasmallstateestatetaxisworthitto
getalargeroverallincometaxbenefit,or,Congressmayonedaylowertheestatetaxrate.
l.
AddressingtheKurzcaseandotherPotentialAttacksonFormulaGPOAs
SomepractitionersmaypreferusingtheDelawareTaxTrapforanotherreason
altogether.Theymayfearthatthesurvivingspouse’scontrolofhis/hernetestatevalue
(eitherthroughspending,orbyleavingassetstocharity/spouse),maypermitindirectcontrol
ofthevalueoftheappointiveassetsinthebypasstrustsubjecttotheformulaGPOAprovision
andhencecouldtriggeroverͲinclusion.
Hereisanexampleofthetheoreticalargument:JohnleavesJane$4millioninatrust
withaformulaGPOA(optimalbasisincreaseprovisionasdiscussed).Shehas$4millionofher
ownassetsand$6.5millionapplicableexclusionamount.Atherdeath,John’strustcaps
44
Jane’sGPOAat$2.5million,basedonherremainingapplicableexclusionamount.Mightthe
IRSargue,however,thatJanecouldhavespentallhermoney,orleftittocharity,thusde
factobeingabletocontrolthedisposition(i.e.,GPOA)ofall$4millionofJohn’strustdespite
thefactthatJanehasnopowertocontrolordirecttheexcess$1.5million?
Formulafunding/channelingclausesbasedonasurvivingspouse’savailableGST
amounthavebeenusedfordecadesinGSTnonͲexempttrustswithoutsuchspecious
arguments.107Strangely,itseemsthesamecommentatorsthatlaudorevenusethe
techniqueforGSTplanningforthewealthyseemtodisparagetheideaforincometax
planningforthemereupperͲmiddleclass.
Whatabouttrustprotectorprovisionsthatallowadding/amendingPOAs?Couldthis
abilitysomehowtaintthetaxeffectivenessoftheformulaGPOA?Probablynot,sincePOAs
aredeemedgeneralornonͲgeneralbasedontheirscopeattheapplicabletimeinquestion.108
m. PLRs9110054,9527024–ApprovalofFormulaGPOAstoOptimizeGST/EstateTax
TheIRShasviewedverysimilarandarguablymorecomplexformulaGPOAsfavorably.
UnlikesomePLRs,theseappeartobeonsteadygroundbasedontheregulationstheycite.
AlthoughtheseclauseswereusedtocauseestatetaxationinlieuofGSTtaxation,theconcept
andissuesarepreciselythesame.Let’sexaminePLR9527024first:
“Inaddition,underArticleIVͲDͲ3ofthetrust,achildwhohasapowerofappointment
exercisablebywillmay,byawillspecificallyreferringtothispowerofappointment,
appointtohisorherestatetotheextenttheaggregateofthefederalestateandGST
taxdueasaresultofthechild'sdeathcanbereduced.Theamountofproperty
subjecttothepowerwillbeincludibleinthechild'sgrossestateunder§2041.Tothe
extentthepropertyisincludibleinthechild'sgrossestateandsubjecttofederal
estatetax,thechildwillbecomethetransferorofthepropertyforGSTpurposes.
Accordingly,asaresultofArticleIVͲDͲ3,noGSTtaxwillbedueatachild'sdeath
(assumingthatthechilddoesnotappointthepropertytoaskipperson)unlessand
untilthemarginalrateoffederalestatetaxinthechild'sestateequalstheGSTtaxrate
(themaximumfederalestatetaxrate).Thetrustwillnotbesubjecttofederalestate
taxinthechild'sestateexcepttotheextentinclusionofthepropertyresultsina
reductionoftheaggregatetaxes.”109
107
See, e.g., Howard Zaritsky, Carol Harrington and Lloyd Plaine’s treatise Generation Skipping Transfer Tax,
various forms channeling distribution of “the largest amount, if any, of my wife’s available GST exemption”
108
“If the settlor of a trust empowers a trustee or another person to change a power of appointment from a general
power into a nongeneral power, or vice versa, the power is either general or nongeneral depending on the scope of
the power at any particular time.” Comments to Uniform Power of Appointment Act, §102
109
PLR 9527024
45
LikeanOBITclause,theefficacyandadministrationofthisPLR’sGPOAdependsandis
blatantlyrelyingonthepowerholder’soutsideassets,estateplanandapplicableexclusions.
PLR9110054hasasimilarformulaGPOA,butisevenmorecomplexbecausethe
taxpayerswereinCalifornia,which,asdiscussedinSectionIII.h.above,subjectstestamentary
GPOAstothepowerholder’sestate’screditorstotheextenttheestateisinsolvent(hencethe
secondparagraphquotedbelow).ThepertinentdiscussionoftheformulaGPOAsanctioned
inthatPLRisbelow,withboldandbracketedlanguageadded:
“Underparagraph7.3.3,intheeventthatthebeneficiaryofaNonͲGSTTtrust
predeceasesthefulldistributionofthetrustestate,thebeneficiarywillhavethe
powertoappoint("thePower")infavorofoneormoreofthecreditorsofthe
beneficiaryand/orthecreditorsofthebeneficiary'sestatesomuchofthetrustestate
thatmaybeundistributedatthetimeofthebeneficiary'sdeathas:(1)would
otherwisebedistributedtoa"skipperson"asdefinedinsection2613oftheInternal
RevenueCode,withrespecttoX;and(2)doesnotexceedtheAppointmentAmount.
Underparagraph7.3.3.1oftheXTrust,theAppointmentAmountisdefinedasthe
amountwhichisthelesserof(1)theportionofthetrustestatewhichisnotexempt
fromgenerationͲskippingtransfertaxor(2)anamountwhich,whenaddedtothe
beneficiary'staxableestate(computedasifthePowerhadnotbeengrantedbased
uponvaluesofthebeneficiary'sestate),willcauseonedollar($1.00)tobesubjectto
federalestatetaxinthebeneficiary'sestateatthehighesttaxratethenineffectas
setforthinsection2001oftheInternalRevenueCode.
TheXTrustalsoprovidesthat,intheeventthattheliabilitiesofthebeneficiary's
estateexceedthevalueofitsassets(baseduponvaluesasfinallydeterminedinthe
federalestatetaxproceedingsofthebeneficiary'sestateexcludingthePower),no
Powerisgrantedunlessthesumof(i)thefederalestatetaxesandstateinheritanceor
estatetaxeswhichwouldbepayablebyreasonofthebeneficiary'sdeathcomputedas
ifthepropertyappointablebythepowerhadbeenincludedinthebeneficiary'sgross
estate,(ii)theGSTTwhichwouldbepayablefromthetrustbyreasonofthe
beneficiary'sdeathcomputedasifthepropertyappointablebythePowerhasbeen
includedinthebeneficiary'sgrossestateforfederalestatetaxpurposes,and(iii)the
excessoftheliabilitiesofthebeneficiary'sestateoveritsassets,excludingthePower
shallbelessthanorequaltotheGSTTwhichwouldbepayablefromthistrustby
reasonofthebeneficiary'sdeathcomputedasifthePowerhadnotbeengranted.
CaliforniaCivilCodesection1390Ͳ3(b)[note–thisstatuteisthedirectpredecessorto
CaliforniaProbateCode§682,withsimilarimport,discussedinSectionIII.h.]enables
thecreditorsoftheinsolventestateofadoneeofageneralpowerofappointmentto
reachtheassetssubjecttosuchpower.Accordingtothetaxpayer,thesecondpartof
theformulawhichcalculatestheextentoftheXTrustoverwhichthePowermaybe
exercisedisintendedtonullifythePowerifthenettrustestatewithoutthePower
46
afterpaymentoftheGSTT,willexceedthenettrustestateifthePowerisgrantedto
aninsolventdonee,afterreductionofestatetaxesandpaymentofcreditors.
Eventhoughthepowerisexpressedintermsofaformula,thepowermeetsthe
statutorydefinitionofageneralpowerofappointmentbecauseitisexercisableby
thebeneficiaryaloneinfavorofoneormoreofthecreditorsofthebeneficiaryorthe
creditorsofthebeneficiary'sestate,andthepowerisnotlimitedbyanascertainable
standard.Weconcludetherefore,thatthepowercreatedbyXunderparagraph7.3.3
oftheXTrustisageneralpowerofappointmentwithinthemeaningofsection
2041(b)oftheCode.
Undersection20.2041Ͳ3(b)oftheregulations,apowerwhichbyitstermsis
exercisableonlyupontheoccurrenceofaneventorcontingencywhichdoesnotin
facttakeplacepriortothedecedent'sdeathisnotapowerinexistenceonthedateof
death.[note,thisistheregulationinterpretedbytheKurzcasesdiscussedinSection
III.n.below,andcitedbysomeasaworryaboutformulaGPOAs]
Inthepresentcase,thepowerofappointmentisexpressedasaformula:***
Underthisformulatherearecontingenciesthatmayresultinthenonexistenceof
thePoweruponthedateofthebeneficiary'sdeath.Ifthesecontingenciesdooccur,
thatis,iftheliabilitiesofabeneficiary'sestateexceedthevalueofitsassetsandthe
taxesthatwouldbepayableifthePowerhadnotbeengrantedarelessthanifthe
Powerhadbeengranted,thePowerwillnotbegranted.Insuchacase,the
beneficiarywillnotpossessapowerofappointmentatthetimeofdeath.
Althoughwedonotknowatthistimewhetherthebeneficiarywillpossessageneral
powerofappointmentatthetimeofthebeneficiary'sdeath,wecanconcludethat
theamountoftheXTrustpropertythatwillbeincludibleintheestateofeachdonee
ofthePower,byreasonofthePowerwillbethemaximumamountoverwhichthe
Powermaybeexercisedpursuanttotheprovisionssetforthabovethatareprovided
inParagraph7.3.3and7.3.3.1oftheXTrust.
PLR9110054isarathercleverformulaGPOAthatbothminimizestheGSTandestate
taxwhenconsideredtogether,butalsodoesnotaddaGPOAifitwouldotherwisejeopardize
thepowerholder’sestatetocreditors.TheOBITisinmanywaysanexpansiononthese
formulaGPOAs,butexpandedtoapplybeyondGSTnonͲexempttrustsforsuperiorincometax
results.WhilethethrustofthisOBITwhitepaperhasbeenspousesandGSTexempttrusts,
theGSTlanguageinthetrustsinthePLRsabovemightbeconsideredincreatingformula
GPOAsfordownstreambeneficiaries,and,ofcourse,anyGPOAsoverGSTnonͲexempttrusts.
Ascitedelsewhereherein,Treasuryhasgivenexamplesoftaxminimizingformula
clausesintheQTIPanddisclaimerrealm,andregulationsunder2041and2514seemclearin
theabilitytocaporlimitGPOAsastospecificassets.However,thereissomefacile
47
plausibilitytotheargumentandacasethatonthesurfaceappearstohelpit(oratleastcan
confusepractitioners),solet’sdistinguishthecase,discusswhythe“ballooningGPOA”
argumenthasnomerit,andhowtoeasilyavoiditanyway.
n. AddressingtheKurzcasesRegardingContingentGPOAs
IntheEstateofKurz,husbanddiedleavinghiswifeamaritaltrustwithanunrestricted
lifetimeGPOA,andifthatwereexhausted,alifetime5%withdrawalpoweroverthebypass
trust.110Theestatearguedthatthe5%powerwasnotintheestatebecauseofacondition
precedentnotbeingmet.Treas.Reg§20.2041Ͳ3(b)providesthat:
“Apowerwhichbyitstermsisexercisableonlyupontheoccurrenceduringthedecedent’s
lifetimeofaneventorcontingencywhichdidnotinfacttakeplaceoroccurduringsuchtimeis
notapowerinexistenceonthedateofthedecedent’sdeath.Forexample,ifadecedentwas
givenageneralpowerofappointmentexercisableonlyafterhereachedacertainage,onlyif
hesurvivedanotherperson,oronlyifhediedwithoutdescendants,thepowerwouldnotbein
existenceonthedateofthedecedent’sdeathiftheconditionprecedenttoitsexercisehad
notoccurred.”
However,allthewifehadtodowasaskforfundsforthemaritaltrustandshewas
entitledtothe5%fromthebypass.Itwouldnotsurpriseanytaxpractitionerthatboththe
taxcourtandtheappellatecourtconcludedthatthewifeheldaGPOAͲshecouldeffectively
accessthe5%ofthebypasstrustatanytime,foranyreason,withoutaffectingherestate,
duringherlifetime.
Thetaxcourt’srationalewasthatthe“contingency”wasillusoryandlackedany
independentnonͲtaxconsequenceorsignificance.Theappellatecourtpreferredatestthat
lookedthroughtheformalitiestodeterminehowmuchwealththedecedentactually
controlledatdeath.Itlookedtotheexamplesintheregulationquotedabove,andnotedthat
thoseexamplesofcontingencieswerenoteasilyorquicklycontrolledbythepowerholder,
“somethingthatdependsonthecourseofanentirelife,ratherthanasinglechoicemadein
theadministrationofone’swealth.”
IncontrasttoKurz,aformulaGPOA“OBIT”clauseisnotalifetimeGPOA–it’s
testamentary.Moreimportantly,unlikeKurz,itisnotsubjecttoaconditionprecedent,nor
doesthecappingoftheGPOAhingeatallonTreas.Reg.§20.2041Ͳ3(b)–itispursuantto
110
Estate of Kurz, 101 T.C. 44 (1993), aff’d 68 F.3d 1027 (7th Cir. 1995) – I suggest reading both the district court
and appellate court opinions, even though the latter is more controlling.
48
othertreasuryregulationscitedherein.111Additionally,unliketheabilityofabeneficiaryto
withdrawatwillasinKurz,whichtheappellatecourtdeemed“barelycomeswithinthe
commonunderstandingof‘eventor…contingency’”,theabilityofanOBITformulaGPOA
powerholder(ifitwouldotherwisebecapped)toincreasetheirtestamentaryGPOAwould
requiregivingawayorspendingasignificantportionoftheirassets(quiteunlikeKurz)–a
significant“nonͲtaxconsequence”ifthereeverwasone.Let’stakeapartthe“ballooning
GPOA”argumentintwoparts–thepurportedcontrolbylifetimegiving/spending/debt
incurrence,andthepurportedcontrolbytestamentarycharitable/maritalbequest.
If,assomewouldargue,thesurvivingspouse’sabilitytoenlargetheformula
testamentaryGPOAbybankruptingthemselvesconstitutescontrol,thenarguablyevery
beneficiaryofanirrevocabletrustwithameanstestedprovisionshouldbedeemedtohavea
defactogeneralpowerofappointment.E.g.,Jimmy,anirrevocabletrustbeneficiary,was
usedtoalifestylespending$200,000/yraftertax.Thetrusteehaspaidhimlittleifanything
previouslyunder“health,education,maintenanceandsupportinthelifestyleinwhichheis
accustomed,takingotherresourcesavailableintoaccount”.Jimmyquitshisjob,spendsallhis
moneyonexpensivegenetherapy,gambling,drugsorwhatever.He’snowarguablyentitled
to$200,000/yrfromthetrust,eventhoughhecouldadoptafrugallifestyle,getajoband/or
subsiston1/10that.Underthedefactocontrolargument,JimmywouldhaveaGPOAover
thetrustoratleastoverthepresentvalueof$200,000/yrifthetrustislarger,butweknow
hedoesn’t,becauseJimmy’sabilitytoindirectlyaccess/controltheamountofappointive
assetsavailableunderthetrustee’sfiduciarypowerofappointmentistrumpedbythemore
specificandclearerrulesofIRC§2041/§2514whichclearlydonotcauseJimmytohavea
powerofappointmentinspiteofhisindirectcontrol,evenifJimmyweretrustee!
WhatoftheabilityofapowerholdertoindirectlyaugmenttheirGPOAvia
marital/charitablebequest?Thiscertainlysoundslikethemoreplausiblelineofattack.
Again,let’sstartwithanexample:Sandraisawidowwith$7millionAEAand$7millionestate
whohasaformulaGPOAovera$4.5millionbypasstrust,lefttoherbyherlatehusband
111
E.g., Treas. Reg. §20.2041-1(b)(3): “Powers over a portion of property. If a power of appointment exists as to
part of an entire group of assets or only over a limited interest in property, section 2041 applies only to such part or
interest” See also, Treas. Reg. §25.2518-3(d) example 20,quoted and discussed on page 20, footnotes 43, 44
49
(assumethecapisbasedonnetestateaftermarital/charitabledeductions).IfSandragives$2
milliontocharity,shewouldotherwisehave$2millionofadditionalbasisincreasing“coupon”
touseoverthebypasstrust,ifshegives$4.5milliontocharity,shewouldintheoryhave
controloverallofit.Dittoifshemarriesandleavestheequivalenttohernewhusband.Does
herabilitytocontroltheamountoftheGPOAmeanitisallinherestateevenifshemakesno
charitablecontribution?
NotifweproperlyunderstandthegoalandtheorybehindIRC§2041andestate
taxationofGPOAs,espousedbyKurzandothercases.TaxationofatestamentaryGPOAmust
looktothevalueofwhatassetsitpermitsthepowerholdertotransfertothepowerholder,
powerholder’sestateorcreditorsofeither,atthetimeofdeath.112Eventakentogether,
underanyscenarioabove,Sandra’spowertotransfertothatexpandedclassofappointeesis
stilllimitedto$7million(AEA).Yes,shemayhavethelimitedpowertocontrolmoreby
donating$4.5million,butanyadditionalcontrolisatmostanindirectLIMITEDpower,since
anyamountsabovetheAEAwouldnecessarilyhavetogotocharityandmaynotgotothe
powerholder,powerholder’sestateorcreditorsofeither.Undernocircumstanceorplausible
interpretationwouldshehavethepowertogive$11.5milliontothatclass.
Otherdetractorsofformulapowersarguethatvariousexpensesanddeductionsthat
mightdelaythedeterminationofthevalueoftheappointiveassetsmakeaformulaGPOA
“indeterminable”and,therefore,nullandvoid.CouldBillGatesleaveafortunetohiswife
MelindainaGPOAmaritaltrustandherestatelatersimplyclaimthattheamountis
“indeterminable”atthedateofdeathbecauseofthealternatevaluationdate,expenses,
debts,varioustaxelectionchoicesoranynumberofissuesthatwillultimatelydeterminethe
netvalueofappointiveassetssubjecttotheGPOA?Goodluckwiththatargument!
QTIPregulationsspecificallypermitformulaelectionsthatrefertothetaxableestate,
eventhoughlateractionsbyatrustee/executorclearlyaffecttheultimateamountpassingto
theQTIP!113OBITformulasaresimilartodisclaimerandQTIPformulasintheregulations.
112
This is essentially paraphrasing the 7th Circuit’s Kurz opinion, at page 1029
Treas. Reg. §20.2056(b)-7(h) Ex 7: [After example of a “zeroed out” QTIP formula]*** “The value of the
share qualifies for the marital deduction even though the executor's determinations to claim administration
expenses as estate or income tax deductions and the final estate tax values will affect the size of the fractional
share.”
113
50
Despitetheaboveanalysis,manypractitionerswouldpreferavoidingeventhehintof
aKurztypeargumentagainstformulaGPOAcaps,andanyargumentthatthepowerholder
controlstheamountdirectlyorindirectly.First,avoidcallingyourclauseacontingentGPOA,
toavoidtemptinganinaptcomparisonofaformulaclauseoverspecificassetstothe
completelydifferentconcept/regulationofcontingentGPOAsanalyzedintheKurzcases.114
Second,drafttheformulaGPOAtoavoidconsideringanymarital/charitablebequestbya
powerholder,evenifitmightinrarecasesreducetheamountthatmightbeincludedina
powerholder’sappointiveassetsandpotentiallyreducethestepup.WhiletheformulaGPOA
theIRSapprovedinPLR9527024containednosuchlimitationsorrestrictions,aconservative
practitionershouldprobablyignoreanycharitable/maritaldeductionotherwiseavailableto
thepowerholder’sestateintheGPOAcappingformulauntilthereisclearerpositive
precedent.115Inmostestateplans,thisisunlikelytomakemuch,ifany,difference,sowhy
takeachance,evenifit’sremoterisk?
Somemayalsofearsomekindofpublicpolicyargumentsimilartothegifttaxformula
valuationadjustmentcasesandrulings.116However,attorneyshavebeenusingvaluation
formulasintrustsfordecadesnow,effectingbypass/marital,GSTsplitsorotherwise,without
anyintimationthattheyareagainstpublicpolicy,nottomentionthatTreasuryhasmany
formulaexamplesinitsownregulations.Evenasidefromthat,therecentgutting(oratleast,
mauling)ofthepublicpolicyargumenthasbeenquiteproͲtaxpayerlately,evenatthe
appellatelevel,withmuchmoreegregiousfacts,underMcCord,Petter,Christiansen,Hendrix
andWandry.
UnlikeaGPOA,theDelawareTaxTrapisonlyapplicabletotheextentofEXERCISE–
thereisnosuchthingasmereexistenceofanLPOAoralapseofanLPOAcausinginclusion
underIRC§2041(a)(3)justbecauseitcouldhavebeenexercisedtotrigger§2041(a)(3).
Therefore,usingtheDelawareTaxTrapOBITtechniqueiscompletelyimmunetotheKurzor
114
E.g., see the otherwise excellent client-friendly summary of the idea in July 2014 newsletter by the law firm
Day Pitney LLP at http://www.daypitney.com/news/docs/dp_5344.pdf#page=1
115
Thanks to California attorney Terence Nunan for pointing out this conservative drafting option. See his article
Basis Harvesting, Probate and Property, Sept/Oct 2011, and sample language in appendix with both options
116
See, Commissioner v. Proctor, 142 F2d 824 (4th Cir. 1944), cert. denied, 323 U.S. 756 (1944), and two
subsequent revenue rulings wherein the IRS will not give effect to subsequent trust changes or subsequent formula
valuation changes based on IRS reassessment of valuation. Rev. Rul. 66-144 and Rev. Rul. 86-41.
51
“powerholdercontrol”argument.Hence,manyattorneysmaypreferit,despitethe
advantagesofformulaGPOAs,forthoseestatesthatwouldlikelybesubjecttocapping.Pros
andconscomparingthetwotechniquesarediscussedbelow.
SomemayfearthatusinganLPOAtoappointtothesamebeneficiariesaswould
inheritbydefaultmightbeillusoryordisregarded.Afterall,what’ssodifferentfrom
appointingtotrustswithPEGpowersgrantedtochildrenandadefaultthatdistributesto
themoutright?Thankfully,Treasuryguidanceshouldpreventthisresult.117
117
Treas. Reg. 20.2041-1(d): “However, regardless of local law, a power of appointment is considered as
exercised for purposes of section 2041 even though the exercise is in favor of the taker in default of appointment,
and irrespective of whether the appointed interest and the interest in default of appointment are identical or
whether the appointee renounces any right to take under the appointment.”
52
Comparing/Contrasting Formula GPOA v. LPOA/Delaware Tax Trap
o.
Issues Favoring Use of Delaware Tax Trap/LPOAs over Formula Testamentary GPOAs
-
SpousalUseofLifetimeLPOAs/GiftTaxͲWhensomeoneexercisesalifetimeLPOA,
thereislesschanceofgifttaxexclusionbeingused.UnlesstheappointmenttriggerstheDTT,
orunlessincomeismandatedpayabletothepowerholder,thereisnogift,whereasexercising
alifetimeLPOAraisescomplicatedissuesifthoseassetsareotherwisesubjecttoaformulaor
cappedtestamentaryGPOA–wouldIRC§2514triggerataxablegifteveniftheappointed
assetswereinsurance,cashorlosspropertynotsubjecttothetestamentarypower?
-
AccessbyPowerholder’sEstate’sCreditors–Thereisnoassetprotectionissueifa
powerholder'sestateisinsolventandatestamentaryLPOAisexercised(orlapses)–creditors
havenoaccess.However,ifthepowerholderhadatestamentaryGPOA,dependingonthe
state(e.g.CAallowscreditoraccess),andpotentiallywhethertheGPOAisexercised,creditors
ofthetestamentaryGPOApowerholder’sestatemayhaveaccess(seePartIII.h.).
-
SubsequentAmendments/Releases/NonͲQualifiedDisclaimers/Decanting–
Generally,LPOAscanberemovedorlimitedwithoutgift/estatetaxissue,bydecanting,
reformation,release,trustprotectororotherwise.WhiletherearePLRsholdingotherwise,
anyremovalorlimitingofatestamentaryGPOA,evenwithacourtapproval,mighthave
gift/estatetaxeffectsunder§2514.
-
Easiertogobeyondformulawherever/wheneverinclusionmaybedesirable–
BecausetheLPOAinthedocumentwouldnotbelimitedbyformula,itcaneasilybeusedto
causeinclusionbeyondestatetaxexclusionamountifdesiredforspecificcircumstanceor
changeintaxcode.Asdiscussedinthesectiononstateestatetaxes,theremaybecases
wherepayingstateestatetaxisdesirablebecausetheoverallincometaxessavedby
beneficiariesoutweighthestateestatetax.Infact,ifCongressweretochangethetaxcode
again,thiscouldalsobetrueofthefederalestatetax.ItalreadyissomewhatͲconsiderlow
basiscollectiblestaxedtoabeneficiaryinahightaxstate(31.8%federal+upto13.3%)with
noestatetax(40%federal).
53
-
Actionsofthepowerholder/trusteeirrelevant.Asdiscussedherein,thereisaweak
argumentthattrustee’sinvestmentpolicy,powerholderspendingorestatedevise,pursuant
totheKurzcaseorotherwise,couldbeinvokedtooverridethecapandcausemoreassets
thandesiredtobesubjecttoaformulatestamentaryGPOA.TheLPOA/DTTtechniqueis
completelyimmunetothesearguments,since§2041(a)(3)istriggeredonlyuponandtothe
extentofexercise.
Ͳ
ThebeneficiarieshavemorepostͲmortemcontroloverestatetaxation/basis–A
recipient/appointeemightdisclaimaPEGpowerinatrustfundedthroughtheexerciseofan
LPOAthatwouldotherwisetriggertheDelawaretaxtrapandaffecttheupstream
taxation/basisadjustment,butitisimpossibleforrecipientstoaffectwhetheraGPOAisheld
atdeathornot.Thiscouldbeimportanttoflexiblyallowincreasedinclusionforstateestate
taxpurposestoyieldfederal,stateand/orlocalincometaxbenefitsbyadditionalstepup,or
preventoverͲinclusion.Disclaimerscanbemadepartialorbyformula.118
Forexample,JaneDoehasthelimitedpowertoappointtotheJaneDoeDelawareTax
TrappingTrustfboMargaret,whichgrantsMargaretaPEGpower(presentlyexercisable
generalpowerofappointment).TotheextentJaneappointstothistrust,andMargarethasa
PEGpower,ittriggersIRC§2041(a)(3)–theDelawareTaxTrap.But,whatifMargaretmakes
aqualifieddisclaimeroftheGPOA,whichrelatesbacktoremoveherpowerabinitio?Shecan
disclaimtheGPOAandevenremaintrusteeandbeneficiaryaslongasherdiscretionislimited
toanascertainablestandard.119ThisappearstoallowMargaret,thebeneficiary/appointee,
toeliminateanyestateinclusionduetotheDTT,andhenceanybasisadjustment,by
qualifieddisclaimer.NonͲqualifiedrenunciationsaredisregarded.120
118
119
E.g. Estate of Christiansen v. Comm., 586 F.3d 1061(8th Cir. 2009)
Treas. Reg. 25.2518-3(d)(6) – a qualified disclaimer is not a taxable release. Treas. Reg. 25.2518-3(a)(1)(iii):
(iii) Powers of appointment. A power of appointment with respect to property is treated as a separate interest in such property
and such power of appointment with respect to all or an undivided portion of such property may be disclaimed independently
from any other interests separately created by the transferor in the property if the requirements of section 2518(b) are met. See
example (21) of paragraph (d) of this section. Further, a disclaimer of a power of appointment with respect to property is a
qualified disclaimer only if any right to direct the beneficial enjoyment of the property which is retained by the disclaimant is
limited by an ascertainable standard. See example (9) of paragraph (d) of this section.
120
Treas. Reg. 20.2041-1(e): “However, regardless of local law, a power of appointment is considered as exercised
for purposes of section 2041 ***irrespective of whether *** the appointee renounces any right to take under the
appointment.” Presumably, Treasury did not mean “disclaims” instead of “renounces” here.
54
-
Youcangiveyourmosttrustedbeneficiariesadefactovetopower,allowingmore
familycontrolandmorepostͲmortemflexibility.Forexample,ifIestablishatrustformy
wife,remaindertomydaughters,Imightwantmydaughterstohaveavetopower–to
requiretheirconsentforanyappointmentbymywife–whoknowswhatundueinfluenceshe
mightencounterwithoutme!Remember,however,estateinclusion/GPOAstatusisnot
triggeredunder§2041(a)(2)and§2041(b)ifIrequireadversepartyconsent.PerhapsIdon’t
haveatrustworthypersontobea“nonͲadverseparty”,orIfearcreditorsorothersmight
browbeatorundulyinfluencethe“nonͲadverseparty”Ͳandtheywouldhaveabsolutelyno
fiduciarydutywhatsoevertomydaughters(andthey,norecourse).But§2041(a)(3)doesnot
relyonadefinitionofageneralpowerofappointmentin§2041(b)–itpertainstotheexercise
ofalimitedpower.Ifmydaughtersdeterminethatforassetprotection,dynastic,GSTor
otherreasonsthey’djustassoonnotallowtheappointment,orwouldliketolimitthe
appointmenttotheDelawareTaxTrappingTrusttocertainassets,theycanifIallow.
Infact,thisevenallowsmydaughtertopickandchoosetheassetstoreceivethenew
basis(thepowershouldbeclearthattheconsentingpartycanconsentornotastoeach
particularasset).Itgivesanadditionalbackupprotection.Forexample,ifmydaughterand
herhusbandhadtaxissuesbuttheydidnottellhermother(notuncommoninfamilies)it
wouldbeidealtoforegothestepupinbasisaffordedbyappointingtoatrustwithaPEG
powerforthebettercreditorprotectionofanongoingdiscretionarytrustwithoutone.While
apowerholdercandisclaimPEGpowers,somestates(andIRSliens),donotfollowthe
relationbackdoctrineastocreditorprotection,sorequiredconsentmaybesuperior.121
-
AnLPOA/DTTcanbeusedbyaQTIPaswell.ThispointisabitnonͲsequitur,butIfelt
worthamentionherewhilediscussingDTTnuances.Whywouldsomeonewanttotrigger
§2041(a)(3)whenQTIPassetsaregoingtobeincludedunder§2044anyway?Aggregation.
AsdiscussedinPartII.d.,ifaspousehasahomeandanLLCbothworth$1million,each50%
ownedoutright,50%intrust,thebeneficiarieswillget“discounted”adjustmentstobasis,
shavingoffhundredsofthousandsofdollarsofvaluablebasisͲinclusionunder§2041should
leadtoaggregationoverridingtheQTIP’ssegregationofvaluation.
121
See various cases and statutes cited in footnote 24, notable exceptions – Medicaid look back, tax liens
55
Issues Favoring Use of Formula Testamentary GPOAs over Using LPOAs/DTT
-
Doesn'trelyonobscure/arcaneruleagainstperpetuitiesnuances.Expertsseemto
agreethatappointingtoatrustthatgrantssomeoneapresentlyexercisableGPOAtriggers
§2041(a)(3)becausetheGPOApowerholdercanpostponevesting/suspendalienationwithout
regardtotheoriginalRAPperiod.Howconfidentareyouthatyourstatelaw(ortrust!)does
nothaveasavingsclauseorconstructionthatpreventstriggering§2041(a)(3)?Howdoesthis
interpretationfurtherCongressionalintentofthwartingcontinuedtransfertaxavoidanceif
theGPOAcausesgift/estatetaxinthePEGpowerholder’sestate?(Verylittle,unlessyou
considerthegradualescapevia5/5lapseprotectionof§2514(e)).Whilethistechnique
appearstowork(theregulationsimplysoaswell),thereisnoreportedcaseconfirmingthis.
Theonlyreportedcaseonthisissuefoundthat§2041(a)(3)wasnottriggered.
-
Lessdocumentation/probate/paperwork,lesschanceofsomethingfallingthrough
thecracks.AformulaGPOAdoesn’tevenhavetobeexercisedtogettheintendedbenefit,
buttheLPOA/DTTtechniquerequiresanadditionalexercisingdocument(usuallybywill),
potentiallyaprobatefilingifbywill.Plus,itneedsanewseparate“DTTͲtrapping”trustto
appointto(evenifit’sonlyonepage,orreferringtoanothertrustwithasentenceadded).
-
Betterongoingassetprotectionforbeneficiaries–althoughtheLPOA/DTTtechnique
mightbemorepronetoaccessbyapowerholder’sestate(discussedabove),itismuchmore
likelythatoneofthechildrenhavecreditorissuesthanabypasstrustspouse/beneficiary.
Evenasidefromoutsidecreditors,grantingachildaPEGpowermayjeopardizetheassets(or
evenmorelikely,thegrowthonthoseassets),inadivorce,orsubjecttheassetstoaspousal
electiveshare.122QueryhowaPEGpoweroveronlyaremainderwouldbeviewed.
-
NowasteofGSTexclusion,assetscanexcludedfrombeneficiaries’estates–whena
childorotherbeneficiaryinheritsintrustpursuanttoaformulaGPOA,GSTwillbeallocated,
andifproperlydraftedthesubsequenttrustescapestaxationinthebeneficiaries’estatefor
federalandstateestatetax.Bycontrast,thisisnearimpossibletodoifthebeneficiary
receivesassetswithanattendantPEGPower(w/possibleexceptionforannual5/5lapses).
122
This is contrary to a testamentary power, as discussed in Part III.h. – see citations in that section.
56
-
Childrenorotherbeneficiariescansprayincome–Ifabeneficiaryreceivestrust
assetswithatypicalPEGPower,thereisaforcedgrantortruststatusunderIRC§678(a).Ifthe
PEGpowerislimitedtotheremainderinterest,thentherewouldbeapartialforcedgrantor
truststatusastoprincipal.Whereas,ifabeneficiaryinheritsinastandardtrust,he/shecan
availthemselvesofopportunitiestoavoidstateincometax,shiftincomeandobtainmore
favorableabovethelinecharitabletaxdeductionopportunities(discussedinPartVII).
-
NextgenerationuseofLifetimeLPOAs/GiftTax–Ifabeneficiaryreceivestrustassets
withaPEGpower,anysubsequentuseoflifetimePOAswilltriggeragifttaxandwouldbean
assignmentofincome.Bycontrast,ifabeneficiaryreceivesassetswithoutthatburden,
lifetimeLPOAsandsprayprovisionsmaybeusedforbetterincometaxplanningwithlittleor
nogifttaxburden.
-
NopotentialissueretriggeringDTTifpowerholdermovesstate–Ifasurviving
spousemovesstates,willthenewstateofresidencyhavethesameabilitytotriggertheDTT?
Perhaps,butmaybenot.ItraisesanotherpotentialissuethatformulaGPOAsdonot.
-
ForintervivosSLATs,canreverttoSettlorw/oimpairingprotection–Ifthetrustis
questionisaSLAT(akainterͲvivosbypasstrust),andthedoneespouseappointsbackintrust
totheoriginalsettlor/donorspouse,isthenewtrustconsidered“selfͲsettled”subjecttothe
originalsettlor’s(nowbeneficiary’s)creditors?IfthespouseexecutedaGPOA,shewouldbe
consideredthenewgrantor/settlor,butifthespousemerelyexecutedanLPOA,thiswould
“relateback”andthereforeundermoststatelawstheoriginalsettlorwouldstillbe
consideredthesettlorandthetrustwouldbeaccessibletothesettlorͲbeneficiary’screditors.
ThisfavorstheuseofformulaGPOAsforSLATsandJESTs(seepartV).
NOTE:intheabovesectionandcomparisonIhaveassumeduseofonlythemostcommonly
discussed/acceptedmethodoftriggering§2041(a)(3),whichinvolvesthepowerholder
appointingtoanewtrustwhichgrantsaPEGpower.If,inyourstate,thereisareliableway
totrigger§2041(a)(3)withoutthisgenerallyundesirablefeature(e.g.byappointingtoanew
trustthatcanpostponevesting/ownershipandneednotrefertotheRAPapplicabletothe
57
firsttrustanddoesNOThaveaPEGpower),thenthiswouldtipthescalestowardsusinga
limitedpowertriggering§2041(a)(3)overaformulaGPOA.
Statelawhasinadvertentlybecomeextremelyelitistinthisregard,withRAPsavings
statutesthathurt99.5%ofthepopulationandhelplessthan1%.AccordingtotheACTEC
survey,KentuckyandWisconsinwillapparentlyallow§2041(a)(3)tobetriggeredby
appointmenttoanewtrustwithatestamentaryGPOA.Untilveryrecently,Delawaredidnot
allowmuchmoreleewayeither,becauseitbarredthetriggeringifthetrustwasGSTexempt
(zeroinclusionratio),theverysituationthat99.8%ofthepopulationwillnowwanttouseit
for!However,DelawarejustrecentlyamendedtheirstatutetoallowanoptͲinasthiswhite
paperhasadvocated.123Statebarcommittees/legislaturesshouldconsideramendingtheir
RAPstatutestoallowaspecificreferenceintheinstrumentto“openthetrap”,withan
affirmativeandspecificallyreferenced“optͲin”,similartoArizonaandDelaware.Texas,
FloridaandColoradobarcommitteeshavebeguntodraftproposedlegislationfortheir
bar/legislaturetoconsider.124Morewillcertainlyfollow.IntheAppendixisaproposed
variantofDelaware’slaw,modifiedforuseinOhio.125
123
5 Del. Code Title 25, § 504, amended by 79 Del. Laws, c. 352 (effective August 1, 2014)
ARS §14-2905(C). Thanks to attorneys Mickey Davis (TX), Justin Savioli (FL) and John Debruyn (CO) for
sharing their respective state proposals modifying Tx Stat. Sec. 181.083, Fla Stat. 689.225, Co. Stat. § 15-111102.5. Other state bar committees should strongly consider reviewing these to adapt their own version.
125
25 Del. Code §504
124
58
IV.
Busting Disclaimer Myths and the Conventional Wisdom on Disclaimers:
Why OBITs are Superior to Bypass Trusts for Disclaimer Based Planning
After Congress’ awkward dance with estate tax repeal over the last decade, many
practitioners and clients have embraced disclaimer planning as the goͲto tool for married
couples with identical estate plans (e.g. longͲtime marriage, all children from current
marriage). This usually involves setting up a bypass trust (and potentially marital trust,
depending on design, assets and circumstance) that is ONLY funded if the surviving spouse
makesaqualifieddisclaimeroffundsthatwouldotherwisebeinheritedoutright.
There are several drawbacks to relying on disclaimer funding – inadvertent
disqualification through acceptance or control, limited nine month window (no extensions
unlessthespouseisunderage21),uncertaintywithcertainjointlyownedassets,andquite
simply,thepowerfulinertiacausingawidow/widowerto“gowiththeflow”–especiallywhen
theflowisanoutrightbequest.ForpurposesofthisSection,however,Iwillconcentrateon
anotherimportantdrawbackofdisclaimerplanningandhowtheOBITlargelyeliminatesit.
a.
WhatTypesofPowersofAppointmentSpousesCanRetainPostͲDisclaimer
One of the axioms estate planners are continually taught is that surviving spouses
must disclaim a power of appointment granted in a trust they are disclaiming into. Such a
disclaimerremovesatremendousestate,assetprotectionandincometaxplanningtoolfrom
the surviving spouse’s toolbox. Moreover, this general rule is wrong. The disclaimer
regulationsforspousesaremuchmorenuancedthanthat:126
“If the surviving spouse, however, retains the right to direct the beneficial enjoyment of
a property in a transfer that is not subject to Federal estate and gift tax (whether as
trustee or otherwise), such spouse will be treated as directing the beneficial enjoyment
of the disclaimed property unless such power is limited by an ascertainable standard.”
Thus,ifthespouseistrusteeandretainsadiscretionaryspraypowernotlimitedbyan
ascertainablestandard,ortherighttotransferpropertybypowerofappointmentthatdoes
not trigger estate/gift tax, then the disclaimer would not be qualified. However, this still
leavestremendousopportunitiesforvariousOBITpowersasdiscussedinPartIIIabove.
126
Treas. Reg. 25.2518-2(e)(2)
59
Thus, a GPOA can be retained by a spouse without tainting a qualified disclaimer,
becauseGPOAtransfersareofcoursesubjecttofederalgiftandestatetaxunderIRC§2514or
IRC§2041respectively.AsdiscussedinPartIII,thiswouldideallybeaformulatestamentary
GPOAwithacap.ThereisnoadvantagetoretainingalifetimeGPOA(andarathersevere
assetprotectiondisadvantage). Moreover,anLPOAmayalsoberetained,butonlyifcanonly
be exercised so as to trigger the DE tax trap (IRC §2041(a)(3) and/or IRC §2514(e)), or is
limitedbyanascertainablestandard.Morecreatively,targetedcollateralLPOAsheldbyother
friendlyparties,suchasasibling,couldalsobeincludedandretained,withoutthisconstraint.
60
b.
KeepingTestamentaryPOAsinQTIPsPostͲDisclaimer
Surprisingtomany,atestamentaryLPOAmayberetainedinaQTIP,sinceitwouldbe
inthesurvivingspouse’sestateviaIRC§2044(QTIP).127TheLassiterholdingregardingQTIP
trustssurprisesmanypractitioners–it’srarelydiscussedinarticles,treatisesorCLEs,yetitis
not a mere PLR so holding, it’s a tax court case. Be careful, however, to elect QTIP before
disclaimingintothetrust,ratherthanafter,evenifanadditionalsixmonthsmaybepermitted
(importantforClaytonQTIPs),orbeclearthatanyordinaryLPOAisalsodisclaimedfromany
BypassorsubtrustoverwhichQTIPisnotelected.
So,whileitistruethatadisclaimingspousemustdisclaimordinaryLPOAsinabypass
trust if funded via disclaimer, a disclaiming spouse may retain narrowly crafted ones.128
Appropriately worded “OBIT” LPOAs and GPOAs are therefore still compatible with and
complementary to disclaimer planning. Practitioners should consider creative postͲmortem
planning opportunities in this area – powers might be partially released rather than
completelydisclaimed,forexample(seesampleclauses).Moststatesshouldallowapartial
release/nonqualifieddisclaimerofatestamentaryLPOAunlessthedocumentforbidsit.129
RetentionofLPOAsorformulaGPOAsnotonlypermitmuchbetterbasisincrease(and
avoidingbasisdecrease)atthespouse’sdeath,buttheyalsoopenupmoreflexibleongoing
incometaxplanningopportunitiesdiscussedinPartVIIIofthispaper.
Moreover, even trusts that are not initially planned to be “disclaimer” trusts, may
somedaybeforcedtobe,sinceclientsinevitablyfailtokeeptheirtrustfullyfunded.Sothese
techniques should be kept in mind – disclaimer funding does not mean giving up all POA
flexibilitywhatsoever–itjustrequirestailoringit.
127
There is authority that an LPOA may be retained by a surviving spouse to the extent the QTIP election is made:
Estate of Lassiter v. Commissioner, T.C. Memo 2000-324, p70-74, ruled a disclaimer was qualified despite the
surviving spouse retaining a testamentary LPOA, because the later transfer at the surviving spouse’s death would
be subject to federal estate tax due to the QTIP election, an exception under Treas. Reg. §25.2518-2(e)(2) quoted
above. “We therefore conclude that retention of such a testamentary power does not cause the disclaimer of an
inter vivos power to fail to satisfy the section 2518 requirement when a QTIP deduction will be taken for the trust
to which the powers relate.” A lifetime LPOA should equally be permitted due to IRC §2519 causing a taxable
gift over the entire amount of the transfer, if not the entire trust. A bypass trust, however, can be more targeted.
128
Treas. Reg. §25.2518-2(e)(5) Ex. 5 illustrates why disclaiming spouses may not retain ordinary LPOAs in a
bypass trust in order to be qualified, but Ex. 7 illustrates that disclaiming spouses may retain GPOAs (the “5 and
5” withdrawal power in the example is a lifetime GPOA, aka PEG power, “subject to Federal estate and gift tax”)
129
See, e.g., the Uniform Powers of Appointment Act, §401 and §404, at www.uniformlaws.org, but see Mich.
Comp. Laws §556.118(2) for a counterexample.
61
V.
OptimizingBasisIncreaseatFirstDeathorOtherDeathsviaUpstreamPlanning
a.
CommunityPropertyNuances–TransmutationAgreementsandIRC§1014(b)(6)
Marriedcoupleslivingincommunitypropertystatesautomaticallyreceiveanewdate
ofdeathbasisfor100%ofcommunityproperty(whichcan,ofcourse,meanastepdownin
basisfor100%ofsuchpropertyaswell).130Someproperty,however,perhapsnearlyall,
mightbeseparateevenforthoseincommunitypropertystates–suchaspropertyreceivedby
gift/bequest,orassetsacquiredpriortomarriage.Increasingstepupinbasisatfirstdeathfor
suchseparateproperty(andavoidingdoublestepdownsforcommunitypropertythathas
decreasedinvalue)maybeaccomplishedthroughpostnuptialtransmutationagreementsand
thosevalidunderstatelawarealsobindingonthegovernmentforfederaltaxpurposes.131
Example#1(communitypropertystate):JohnandJaneareontheirsecondmarriage
lateinlifeandthereforehavesignificantseparateproperty.Residentsofacommunity
propertystate,JohnandJanemightenterintoanagreementthat$1millioneachoftheirlow
basispropertyisnowcommunityproperty.Ofcourse,ifJohn’sformerseparateproperty
valueskyrocketsto$2million,andJane’sstaysthesameat$1million,andtheyarelater
divorced,this$3millionis50/50fordivorcepurposes,probablydividedintotwo$1.5million
sharesratherthan$2/$1millionsplithadtheynottransmutedtheproperty.Butmanyclients
couldlivewiththis,whenconsideringthatifonedies,all$3milliongetsanewadjustedbasis
–asubstantialwindfallforthewidow/widowerͲandpotentiallyotherbeneficiaries.
IfacouplemovesfromacommunitypropertystatetoanonͲcommunityproperty
state,assetsacquiredascommunitypropertymayretainthatstatus.132
Transmutingpropertytocommunitystatusisnotwithoutdrawbacks–notonlywould
transfersdecreasetestamentarycontrolandimpactdivisionsinadivorce,butdependingon
thestate,theremayberestrictionsongiftingorgreaterexposuretocreditors.133
130
IRC §1014(b)(6). States and territories with a default community property system are Arizona, California,
Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin and Puerto Rico
131
U.S. v. Elam, 112 F.3d 1036 (9th Cir. 1997)
132
Sixteen states have adopted the Uniform Disposition of Community Property Rights at Death Act as of 2014
(at www.uniformlaws.org) , which provides that on the death of a spouse, the community property rights of the
estate and survivor will be respected: AK, AR, CO, CT, FL, HI, KY, MI, MN, MT, NY, NC, OR, UT, VA, WY.
Other states may honor it under case law: see Restatement, Conflict of Laws, §259, comment b
62
b.
CommunityPropertyTrustsͲCanResidentsofNonͲCPStatesElectCP?
Formarriedcouplesinseparatepropertystates,jointlyownedpropertyisusuallyonly
entitledto50%stepup(ordown).134Thoselivinginseparatepropertystatesmaybeableto
accomplishthesameresultascommunitypropertystateresidentsthroughtheuseofan
AlaskaorTennesseeCommunityPropertyTrust,keeping“loss”and/orqualifiedplanorother
problematicpropertyoutofthetrustandtransferringonlyappreciatedgainpropertytothe
trusttoelectintoacommunitypropertyregime.
Example#2(separatepropertystate):Sameasabove,butJohnandJanehavenever
livedinacommunitypropertystateanddon’tplanto.TheygiftthoseassetsintoanAlaskaor
TennesseeCommunityPropertyTrust,inwhichtheyelecttotreatthepropertyascommunity
property.Thisshouldintheorygivethesameresultasabove.
WhilethereisacompellingargumentthatAlaskaorTennesseeCommunityProperty
Trustsshouldworkequallywell,todatethistechniquehasnotbeentestedinthecourtsor
subjecttoanyIRSruling,eventhoughAlaska’sCommunityPropertyActhasbeenaround
since1998.135TheonlyrecentIRSpronouncement,amereparentheticalinanIRSpublication,
takesnoposition.136Wisconsin’sstatutethatdefaultstocommunitypropertybutallowsa
marriedcoupletooptoutreceivedafavorableIRSrevenueruling.137Thereisnosuchruling
forelectivecommunitypropertytrusts,however.
Moreover,thereisanegativeSupremeCourtcasefrom1943thatdeniedtheincome
taxadvantagesofanearlierOklahomaelectivecommunitypropertyregimeforincometax
splitting.138ConclusionsvaryonwhetherHarmonwouldtodaycontrolforelectivecommunity
propertytrusts’effectivenessforIRC§1014(b)(6),butit’scloseenoughtobedangerous.139
133
E.g. all community property may be susceptible to creditors of only one spouse! Tex. Fam. Code §3.202(d)
IRC §2040(b) will limit estate inclusion of “qualified joint interests” such as joint tenancy or tenancy by the
entireties to 50% (tenancy in common or more than three owner joint tenancies would be under a different general
rule under IRC §2040(a). Community property that also has a right of survivorship would still receive the
generally more favorable basis treatment. See Rev. Rul. 87-98. While rarer every day, you have a different rule if
you run across joint property purchased pre-1977 per Gallenstein v. U.S., 975 F.2d 286 (6th Cir. 1992).
135
Alaska Stat. §34.77.010 et seq, with the community property trust requirements at §34.77.100
136
IRS Publication #555 “Community Property”, page 2
137
Rev. Rul. 87-13
138
Commissioner v. Harmon, 323 US 44 (1944): “The important fact is that the community system of Oklahoma is
not a system, dictated by State policy, as an incident of matrimony.” This certainly applies to TN/AK CP trusts.
139
E.g. David Westfall & George P. Mair, Estate Planning Law & Taxation, §4.01(1) (4th ed. 2001 & Supp. Feb.
2011) (arguing it should not be effective); Jonathan G. Blattmachr, Howard M. Zaritsky & Mark L. Ascher, Tax
134
63
Conflictoflawprinciplesshouldpermitspousestochooseastateotherthantheir
domiciletogoverntheirrespectiveinterestsinproperty,andthatstate’slawsshouldapply
unlessthedomiciliarystatehasastronginterestorpublicpolicyinapplyingitsownlaws
instead.140UsinganAlaskatrusteetoholdlegaltitleandprovidevarioustrusteeservices
(eveniftheymaybelimitedtoinvestmentorcustodialservices),shouldstrengthenthe
argumentthatitisappropriatetoapplyAlaskalaw.
Manycouples,however,maynotbeinterestedinasolutionthatrequiresAlaska
trusteeservicesandattendantfeesandcomplexity,andtheuseofadditionalcounselto
executeoramendthetrust.Furthermore,thiswouldnotappealtoaspousewhohasmuch
moreseparatepropertythantheother,becauseoftheobviousdivorceramifications.There
aresimplyalotofnonͲtaxdrawbackstothearrangement,asidefromtheuncertaintyofthe
taxresultandthecontinuedviabilityoftheHarmondecision.
Additionally,thereisatleastonestateintheunion(probablytheonlystate)thathasa
confusingapparentprohibitiononpostͲnuptialagreements(arguably,a“strongpublicpolicy”
againstthem)–Ohio.141WouldOhio’sstatuteprohibititsresidentsfromenteringintoany
agreementtodeempropertyascommunityproperty?AnAlaskaCPTrustmightbeagood
solutionforrecentOhiotransplantsfromCPstateswhomayseeksolutionstokeepsuch
property’scharacter,becausesuchtransferswouldnot“altertheirlegalrelations”.Butwhat
aboutacouplewhotransferswhatwouldbeseparateormaritalpropertyfordivorce
purposesinOhiotocommunityproperty?Havethey“alteredtheirlegalrelations”ifthe
resultupondivorcewouldlikelybethesame50/50split?HowwouldtheIRSseethis?
Coupleswouldobviouslyintendto“altertheirlegalrelations”fortaxpurposes.Woulda
simpledeclaratoryjudgmentfromanOhiocourtthatsuchanarrangementwillnotviolatethe
statutehelp?Wouldthathavetobedonepriortodeath?Ohio’sstrangelawinthisarea
raisesadditionalquestionsthathavenoclearanswer.
Planning with Consensual Community Property: Alaska’s New Community Property Law, 33 Real Prop., Prob. &
Tr. J. 614 (1999) (arguing it should be). The latter has a better legal argument, despite Harmon, but it’s uncertain.
140
See Restatement, Second, of Conflicts of Laws, §258, comment b, and §270 (regarding trusts). See also
Uniform Probate Code §2-703
141
Ohio R.C. §3103.06 “Contracts affecting marriage. A husband and wife cannot, by any contract with each
other, alter their legal relations, except that they may agree to an immediate separation and make provisions for the
support of either of them and their children during the separation.”
64
65
c.
AttainingAdditionalBasisatFirstDeath–IntegratingOptimalBasisTechniques
ThesoͲcalled“jointGPOA”(fkapoorerspousefundingtechnique)trustproposedby
sometouseinseparatepropertystatescouldbeamoreviablesolution.However,itcould
alsobeadisaster,becauseIRC§1014(e)mayrequireastepdown,butdenyastepup.142
Moreover,itmayuseuptwicethegift/estatetaxexclusionfornogoodreason.Withthese
caveats,itshouldstillbeconsidered.Thissectionwilldiscusswaystoavoidtheseresultsand
tweakforoptimalbasisincreaseresults,andensurethebestchanceforobtainingstepupsin
basisforbothspouse’sassetsatfirstdeath,eveninanonͲcommunitypropertystate.
First,howdoesthisstructuretypicallyworkinthePLRsandarticlesdiscussingthem?
Let’ssayHhas$2millionofpropertyandWhas$2million.143CopyingPLR2006Ͳ04028,H
putshis$2millionintohisrevocablelivingtrust,Wputsher$2millionintoherrevocable
livingtrust.144EachtrustgrantsthenonͲgrantorspouseaGPOAuptotheirremaining
applicableexclusionamount(someGPOAsinthePLRsarepresentlyexercisable,some
testamentary).Thus,ifHdies,Hcannotonlycontroldispositionofhis$2million,butW’s$2
millionintrustaswell(andviceversa).MimickingthePLR,HamendshisWilltoappointW’s
trustassetstohisowntrustathisdeath.ShouldHdie,all$4milliongoesintohistrust.
Whateveryoneagreeson,includingtheIRS:atH’sdeath,W’s$2milliontrustis
includedinH’sestatebecauseoftheGPOA.Wisdeemedtohavemadeataxablegiftby
allowingHtoappointher$2milliontoH’strustforher.
Whateveryonedoesnotagreeon:howthegiftofthe$2millioninW’strust
transferredviaH’sGPOAistreated(doesitqualifyforthemaritaldeduction?Ifnot,isit
partiallyagifttooneself?)andwhetheranadjustmentinbasisisrequired.Inadditionto
thesetwomainissues,therearealsopotentialissueswiththesteptransactiondoctrine,
reciprocaltrustsandstatelawcreditorprotectionissues.
142
See PLRs 2001-01021, 2002-10051, 2004-03094, 2006-04028, TAM 9308002. Many question the holdings
that transfers from the owner-spouse to the decedent-spouse at death qualify for the marital deduction under IRC
§2523. However, other aspects of those rulings are non-controversial, including capping a GPOA to an amount
able to be soaked up by a power holder’s applicable exclusion amount. Regardless, those with smaller estates
probably would not care about the marital deduction and “double use” of exclusion anyway.
143
Thus, this is no longer really a “poorer spouse” technique, the “poorer spouse” problem has largely been
eliminated by portability except for GST exploitation and common disaster scenarios – see Part I of this article.
144
Other PLRs use joint trusts, but my preference, and the preference of most attorneys in non-CP states, would be
to use two separate trusts for better tracing and administration, but the same concepts apply to joint trusts.
66
d.
MaritalDeductionunder§2523forGiftstoSpouseCompleteatDeath
AllofthePLRsandTAMacceptthepremisethatthe$2milliongiftqualifiesforthe
maritaldeduction,eventhoughthedoneespousewouldarguablybedead–theGPOA
becomeseffective,andtherelinquishmentofcontrolbyWtocompletethegift,atdeath.
ThoserulingswerequitefavorabletotaxpayersͲarguablyIRC§2523wouldnotallowthe
deduction.145
However,themaritaldeductionisnowcompletelymootformanyclients,whose
combinedestatesmaybeunderonespouse’sapplicableexclusionamount,especiallywhen
augmentedbyportability.Inourexampleabove,using2013values,denyingthe§2523
deductionwouldcauseWtohave$3.25millionbasicexclusionamountinsteadof$5.25
million(dueto$2milliongiftnotqualifyingforthemaritaldeduction).HerDSUEfromH’s
estatewouldbeeither$5.25million(ifH’sown$2millionandGPOAappointmentwenttohis
wifeoramaritaldeductiontrust),or$1.25million(ifnoneofH’s$4millionqualifiedfor
maritaldeduction),orinbetweenforotherdispositions,partialQTIPelections,etc.Thisstill
givesherbetween$4.5millionand$8.5millionAEA–eitherway,sheisnowherenearhaving
afederalestatetaxissuebythelossof$2milliongift/estatetaxexclusion(ifitisthatmuch,
seebelow)!Eventhiseffectcanbemitigatedwithtechniquesdiscussedbelow.
ThesmartplaybyWmaybe(ifthevaluemerits)toatleasttrytoclaimthededuction
onherForm709gifttaxreturnandattachallrelevantinformation–atleastthereisadecent
argumentandseveralPLRs.Afterall,asdiscussedinPartsIandIIofthisarticle,treasury
regulationsacceptthefictionofsurvivingspousesinqualifyingforthemaritalestatetax
deductioninsimultaneousdeathscenarios,andtherearecasesthatsuggestthegiftatthe
momentofdeathistoasurvivingspouse.146
Furthermore,ifIRC§2523doesnotapply,whoisthegifttoifnottothespouse,and
howmuchistaxable?Thisisneveraddressedinarticlesonthissubject,butitmaybequite
145
Learned attorney opinions of the IRS’s conclusions range from scathingly dismissive - “smoke and mirrors” to
accepting - “common sense suggests that the IRS is correct on the marital deduction issue”, from Clary Redd’s
article Sharing Exemptions? Not So Fast, Trusts and Estates, April 2008 and It's Just a JEST, the Joint Exempt
Step-Up Trust, LISI Estate Planning Newsletter #2086 (April 3, 2013) by Alan Gassman, Thomas Ellwanger &
Kacie Hohnadell, respectively. The issues are much more complex than you would think for a simple technique.
146
Treas. Reg. §20.2056(c)-2(e). See the Bagley and Johnstone cases cited and discussed in 422-429 of Estate
Tax Exemption Portability: What Should the IRS Do? And What Should Planners Do in the Interim? By Mitchell
Gans, Johnathan Blattmachr and Austin Bramwell, 42 RPT Journal Fall 2007.
67
important.Ifyoucannotgifttoacorpse(here,WgiftingtoherdeadH),thenthegiftmustbe
toH’sestateorappointees,whoare–youguessedit–Wandchildren!IfWmakesa$2
milliongifttoacorporationorLLCinwhichsheis40%owner,theIRSlooksthroughtothe
companyownersasdoneesͲitisnotagiftof$2million,itisagiftof60%of$2millionͲ$1.2
million.147Ifaspouseorcharityownsportionsofthe60%itmaybedeductibleforgifttax.148
Ifyougifttoaprobateestate,thegiftisreallytothebeneficiariesofthatestate.IfWinherits
100%ofH’sestate,thenthegiftistoherself,andnottaxable.But,presumably,H’sestate
wouldpourintoatrustinwhichWhasalifetimeinterestplusHEMS.Ifhersharemightbe
valuedat40%,shouldn’ttheresultbesimilartothecorporationdoneeexample?Thisiseasy
tovaluewithasimplenetincomeorunitrust,butiftherearesprayprovisions,LPOAs,etc,
keepinmindthat“ifthedonor'sretainedinterestisnotsusceptibleofmeasurementonthe
basisofgenerallyacceptedvaluationprinciples,thegifttaxisapplicabletotheentirevalueof
thepropertysubjecttothegift.”149
Moreconfusingly,Imentionedabovethatthetruedoneeswouldlogicallybe“H’s
estateORappointees”–whatifthosearenotthesame?Arguably,W’sgiftwouldbetoH’s
estate,nottheappointees,becauseitwasH’sinterveningdecisiontousehisGPOAtoappoint
totheappointees.Thus,ifWwereH’sheiratlawand/orsoleresiduarybeneficiaryoutright
underhisWill,therewouldbenotaxablegift(becauseWwouldbegiftingtoherself),andyet,
Hmayhaveappointedthoseassetselsewhere,toatrustthatmayormaynotincludeW. This
leadsustothemoreimportantsubtopicofhowthestepupinbasisworks,afterwhichwewill
addresswaystointegratethetwostatutesintoplanningandusesavingsclausestoprevent
estatesfromthepotentialnegativeinterpretations.
e.
IntotheWindofIRC§1014(e)–TackingtoIncreaseBasisDespitetheOneYearRule
SomeofthePLRsreferencedbelow,likePLR2006Ͳ04028andPLR2004Ͳ03094,donot
evenaddressIRC§1014(e).PLRs2002Ͳ10051and2001Ͳ01021andTAM9308002under
147
Treas. Reg. §25.2511-1(h)(1)
Of course, these deductions are based on what the donee receives, which, depending on the valuation of the
business before and after, may not increase by the full $1.2 million – it may increase by less.
149
Treas. Reg. §25.2511-1(e)
148
68
similarfactsdidaddressthisissue,andwoulddenythestepup.150Orwouldthey?ThePLRs
merelysaythat“Section1014(e)willapply”–theydonotsayhowandtowhatextent.And
theTAMaddressedanoutrighttospousescenarioratherthanatypicaltrustbequest.
Hereis§1014(e)initsentiretyforbetterunderstanding:
“(e) Appreciated property acquired by decedent by gift within 1 year of death.
(1) In general. In the case of a decedent dying after December 31, 1981, if-(A) appreciated property was acquired by the decedent by gift during the 1-year
period ending on the date of the decedent's death, and
(B) such property is acquired from the decedent by (or passes from the decedent
to) the donor of such property (or the spouse of such donor),
the basis of such property in the hands of such donor (or spouse) shall be the
adjusted basis of such property in the hands of the decedent immediately before the
death of the decedent.
(2) Definitions. For purposes of paragraph (1)-(A) Appreciated property. The term "appreciated property" means any property if the fair
market value of such property on the day it was transferred to the decedent by gift exceeds its
adjusted basis.
(B) Treatment of certain property sold by estate. In the case of any appreciated property
described in subparagraph (A) of paragraph (1) sold by the estate of the decedent or by a trust
of which the decedent was the grantor, rules similar to the rules of paragraph (1) shall
apply to the extent the donor of such property (or the spouse of such donor) is entitled
to the proceeds from such sale.
DidH“acquirethepropertybygift”?Arguably,Hneverreceivedtheproperty–for
thesamegoodreasonsthatargueagainstthemaritalgifttaxdeductionunderIRC§2523–he
wasdeadatthetimeofthecompletedgift,sohowcanacorpsereceiveagift?Quitesimply,
thepropertywasnever“acquiredbythedecedentbygift”.AlthoughCongressisnotrequired
tobeconsistentorevenlogical,theinterpretationofthesetwosectionsshouldbeconsistent
regardingthetaxtreatmentofatransferoccurringatdeath.Eitheracourtshoulddeemthe
recipientaliveatthemomentoftransfer,inwhichcase§2523AND§1014(e)apply,or,you
deemtherecipientdeadatthemomentoftransfer,inwhichcaseNEITHER§2523NOR
§1014(e)apply.
Whilesomepractitionersscathinglydismissedtheformerinterpretationasa“gifttoa
corpse”,itisjustaslogicaltosaythatyoucannothavea“gifttoacorpse”for§1014(e).The
IRSmayultimatelyhavebeenquitesavvytohaveallowedtheformerinterpretation,inthat
150
From PLR 2002-10051 - “In addition, section 1014(e) will apply to any Trust property includible in the
deceased Donor's gross estate that is attributable to the surviving Donor's contribution to Trust and that is acquired
by the surviving Donor, either directly or indirectly, pursuant to the deceased Donor's exercise, or failure to
exercise, the general power of appointment over the Trust property.” PLR 2001-01021 has near identical
language.
69
consistencywouldassurethat§1014(e)alsoapplies,andthatinterpretationmayultimately
bemorevaluabletothefederalfisc.
Let’sassumeHdid“acquire”the$2million“bygift”priortodeath(consistentwiththe
IRS’§2523rulingsinthefourPLRs/TAM)andaddressthesecondprongof§1014(e).Isit
“acquiredbythedonor”?Thesimpleanswerinourcaseis“no”,itisacquiredbyatrustin
whichthedonorisabeneficiary.Buttrustsaresimplylegalfictionsdividinglegaland
equitabletitle,obviouslyWisacquiringpartoftheequitabletitle.Inaddition,PLRs2001Ͳ
01021and2002Ͳ10051citetheCongressionalrecord–§1014(e)shouldapplytoproperty
“acquiredbythedonor…indirectly”.Onerecentprominenttaxcourtcaserulingappearsto
indicatethatatrustbacktoadonor/spousewithinoneyearshouldnottriggerIRC§1014(e),
oratleastthattheIRSandtaxcourtareignoringtheissue.151
IRC§1041(e)(2)(B)contemplatesthispossibilitybyspecificallyincludingsomeonewho
inheritsoutrightthroughanestateortrust“totheextentthedonor…isentitledtoproceeds
fromsuchsale”.Butwhattomakeofthefirstpartofthatsentence–doesitonlyaffectbasis
whensold–whataboutfordepreciationpurposes?WhatabouttaxͲfreeexchanges,
distributions?(aninterpretationrequiringlatertracingmakeslittlesense,andwouldcause
bizarre“springingstepdownsinbasis”,but(e)(2)(B)arguablydoesthis).
Mostarticlesonthissubjectconcludethat§1014(e)applieseither100%or0%inour
exampleofassetsleftintrustforWͲbutbasicequitablelawandtrustvaluationprinciples,
coupledwiththeabovelanguage,arguethatthestepupforappreciatedassetsshouldbepro
ratedbasedonthevaluationoftheunderlyingequitableinterests,basedontheageofthe
donor/beneficiaryandthetermsofthetrust.Inotherwords,perhaps(e)(1)appliesoncethe
estateand/oradministrativetrustissettled,regardlessoflatersales,basedonultimate
equitableownership.Thisisonlymytheory–thereisnoclearguidancehereatall.
Whatifthesurvivingspouseweremerelyadiscretionarybeneficiary?Arguablyin
manystates,asassetprotectionattorneyswilltellyou,aspousewithamerediscretionary
interesthasnopropertyinterestunderstatelaw,andthevalueofthespouse’sinterest
151
Estate of Kite v. Commissioner, T.C. Memo 2013-43, fn 9 – wife funded trust for husband, who died one week
later, assets came back to wife in trust and the tax court noted without discussion that “All of the underlying trust
assets, including the OG&E stock transferred to Mr. Kite in 1995, received a step-up in basis under sec. 1014”
70
shouldbe$0.Manydivorcecourtsandstatemaritaldissolutionlawswillconsidertrustassets
ofadivorcingspouseonlytotheextent“vested”–thetermsofthetrustmakeahuge
difference.However,theIRSisverylikelytoseethisassomeformofequitableownership
withvalue.Inonerecentprivateletterrulingwhereabeneficiarywasadiscretionary
beneficiaryofincomeand/orprincipalandhadnoneedorhistoryofreceivingdistributions,
theIRSneverthelesssaidthisinteresthadsomevalueforgifttaxpurposeswhenitwas
proposedtodistributesomeprincipaltotheremaindermen.152
Andwhatdoesitmeanforaspousetobe“entitledtotheproceedsfromsuchsale”?
Eveninatrustinwhichthespouseisentitledtoallnetaccountingincome,thisdoesn’textend
tocapitalgainsfromasaleofproperty,whichtypicallygetaddedtoprincipal.Undermost
trustdesigns,thespousewouldnotbeentitledtoanyproceedsfromthesale.Isactual
receiptandtracingrequiredfor1014(e)toapply?It’saterriblywrittenstatute.
Buttherearesimpleplanningtechniquesthatavoidtheabovenuancesandensurea
fullstepup.First,ofcourse,practitionersshouldmakesurethatonlythesurvivingspouse’s
shareofassetswherethestepupiswarrantedaresubjecttotheGPOA,soatleastanystep
downisavoided(seesampleclauseinappendixanddiscussioninPartIII).RecallthatIRC
§1014(e),craftily,doesnotapplyto“depreciated”propertyandcannotbeappliedtodenya
stepdowninbasis.
Furthermore,tomakeitclearthatIRC§1014(e)shouldnotapplytotheappreciated
assets,yetretainnearlythesameaccessforthesurvivingspouse,considermakingthe
survivingspouseapermissibleappointeeofsuchtrustunderachildorotherparty’slifetime
limitedpowerofappointment,ratherthanabeneficiary.
Example#2:JohnandJane,withchildrenofthesamemarriage,eachhave$1million
oflowbasisproperty,and$1millionofcashequivalents,retirementplans,annuities,property
withbasishigherthanFMVetc.JohnandJanegiveeachotheraformulatestamentaryGPOA
overeachother’slowbasisproperty(thiscouldbeviajointtrust,butmypreferenceisstillto
152
PLR 201122007
71
useseparatetrusts).Johndies.Heleaveshis$2milliontoanOBITtrustforJane(althoughhe
wouldlikelyleaveretirementplansandannuitiestoheroutright).Janekeepsher$1million
ofcash,retirementplans,annuities,highbasis“loss”property”.JohnappointsJane’s$1
millionlowbasispropertyoverwhichhehadaGPOAtoaPowerTrustwiththeirchildrenas
beneficiariesinapottrust,grantingeachofthechildrenthelifetimelimitedpowertoappoint
(“LLPOA”)incomeand/orprincipaltoJaneforwhateverreason.Thisshouldresultinafull
stepupinbasisdespiteIRC§1014(e)becausethefundsarenotcomingbacktoJanenortoa
trustinwhichsheisabeneficiary.GivingeachchildanLLPOAistopreventtheKingLear
effect–aslongasoneofthechildrenisaCordeliaratherthanaGonerilorRegan,Janeshould
befine.Foranextensivediscussionoftheotherassetprotectionbenefitsof“Powertrusts”
asopposedtoselfͲsettledDAPTs,emailtheauthorforaseparateoutline.
UsingOBIT/JESTtechniquesatthefirstdeathforamarriedcouplebringsupadditional
planningtechniquesandconcerns.First,despitethefourPLRsdiscussed,tobeconservative
weshouldassumethat§2523willnotapply(whichenablesustocircumscribetheGPOAfor
betterassetandfamilyprotectionasdiscussedinPartVabove),andthetechniquewilluse
TWICEtheexemptionamount(e.g.appointing$1millionwillcost$1millionfrombothH’s
andW’sAEA).For90%ofthepopulation,thisisstillawinningdeal,butwewouldbemore
selectivewithassetsoverwhichtheGPOAappliesforthosewithtotalestatesover$5million
–favoringdepreciablerealestatethatgivesthesurvivingspouseataxwriteͲoff,forinstance,
ratherthanartwork,home,etcthatmightnotbesolduntilafterthesurvivingspouse’sdeath.
Let’smodifyourexampleabovewithdoubletheassets.
Example3:JohnandJanehave$4.5millioneach,comprisedof$1.5millionin
QP/IRA/annuities,$800,000vacationhomeinJTWROS,$200,000inart,autosandfurnishings,
$500,000cashequiv,$1millionstockportfolio,$500,000rentalpropertyJTWROSwithlow
basis.AGPOAoveralltheassets,asinthePLRs,couldbedisastroushere,if§2523doesnot
apply,butoftencoupleswon’tneedorusethestepupatfirstdeath–thevacationhome
won’tbesolduntilafterthefirstdeath,andwouldn’tbeentitledtodepreciationanyway,
samewiththeartandcars.So,theGPOAinthiscasemightbemodifiedtoapplytoonlythe
rentalpropertyandstockthathasappreciatedmorethan25%.Let’ssaythatis$1million.If
72
§2523doesnotapply,andJohndies,hisDSUEisreducedby$1million.Forsimplicity,assume
JaneinheritsJohn’sotherassetsoutrightorinmaritaltrust,soherremainingAEAisonly$8.5
millionduetothetwo$1milliontransfers.However,sheobtainedthestepupwhichcould
savehersignificantincometaxesinretirement,andherremainingestateisonly$8million.
Theinefficientuseofexemptionmaybeamootpoint,especiallyifJanedecidestomakesome
charitablebequestsinherestate.Infact,coupleswithoutchildrenoftenhavesignificant
charitableintentions–suchtechniquesshouldbestronglyconsideredforthem,evenwith
largerestates,asnotedabove.
FlexibleProvisionsforLifetimeGPOATrusts(akaJESTs)UsingOBITTechniquesto
AdapttoEitherInterpretationof§2523/§1014(e)
Asdiscussedabove,whenwifegrantshusbandalifetimeortestamentaryGPOAover
her(ortrust’s)assets,atH’sdeath,thereisataxablegiftoftheamountssubjecttothatGPOA
–wejustdon’tknowwhetheritwillultimatelybeinterpretedasagiftinwhich§2523allows
themaritaldeduction(ortheextentof§1014(e)visavistrusts).
Canweadaptourplanningtoeitherinterpretation?Forinstance,acouplemight
preferthatif§2523allowsthemaritaldeduction,suchthat§1014(e)wouldapplyifthe
spouseisthebeneficiaryoftheappointivetrust,thatthespouseisremovedasbeneficiary
altogether,ormadeapurelydiscretionarybeneficiarytobetterensurethestepup.The
survivingspousemayremovehimorherselfasacurrentbeneficiarythroughaqualified
disclaimer,ofcourse,butthatassumesthatyouknowtheanswertothatquestionwithin9
monthsofthedateofdeath(or15months,ifaClaytonQTIPstructureisusedandasixmonth
extensionisgrantedtofiletheForm706).Ordoesit?
RecalltheTreasuryguidancecitedearlierinthisarticleonformuladisclaimers?153
Disclaimersdon’thavetobeoveranentireestateortrustorIRA,theycanbeoveranyasset,
andcanreferenceataxdeterminationthatmaybeyearslaterincoming.Couldthelanguage
beadaptedasfollows,substitutingtheappointiveassetsinquestionfortheentireestate,and
incometaxreferencefortheestatetaxreference:“Thenumeratorofthefractiondisclaimed
153
Treas. Reg. 25.2518-3(d), Example 20: “A bequeathed his residuary estate to B. B disclaims a fractional share
of the residuary estate. Any disclaimed property will pass to A's surviving spouse, W. The numerator of the
fraction disclaimed is the smallest amount which will allow A's estate to pass free of Federal estate tax and
the denominator is the value of the residuary estate. B's disclaimer is a qualified disclaimer.”
73
isthesmallestamountwhichwillallowtheappointiveassetstopasswithanadjustmentto
dateofdeathbasisunderIRC§1014(a)and(b)andfreeofapplicationofIRC§1014(e)andthe
denominatoristhevalueoftheappointiveassets.”IftheIRSsettlesona“gifttospouseat
death”interpretationthatpermitsastepupinbasisevenifthespouseisabeneficiary,the
“smallestamount”disclaimedwillbe$0.IftheIRSsettlesona“gifttospouseatdeath”
interpretationthatwoulddenyastepupunderIRC§1014(e)ifthespousewereabeneficiary,
thenthe“smallestamount”undertheabovedisclaimerwilltheentireamount,thespouseis
removedasabeneficiary(butmightremainapermissiveappointee),andthetrustassetscan
stillachievethestepupinbasis.
QTIPelectionscanbebyformulareferencingthefederalestatetaxsituationofthe
decedent.154Protectiveelectionsarealsospecificallypermitted.155Butthereisnoreasonit
hastobeazeroedͲoutformula,noranyreasonsuchaformulacannotincludemorethanone
factor.So,ifthedecedentͲspouseappointedtoaQTIPableTrustwithClaytonprovisions,
whatiftheexecutormakesaQTIPelectionoversuchamount(numerator)necessarytozero
outtheestatetax,plusanysuchadditionalamountscomprisingoflifetimegifttaxexclusion
usedbythesurvivingspouseasaresultofthedeathofthedecedentspouse?
Alternatively:whatifthetestamentaryGPOAinquestionwereonlygrantedtothe
decedentspouseusinglanguagesimilartoABmaritaltrusts?So,backtoourexample#3,
Jane’strustmightsay“Atmyhusband’sdeath,ifIsurvivemyhusband,heshallhaveageneral
testamentarypowertoappointtheQualifiedAppointiveProperty.QualifiedAppointive
Propertyshallmeansuchproperty,oritsproceeds,inthetrustestatethat,ifgivenoutrightto
myhusbandathisdeath,wouldqualifyforthemaritaldeductionforpurposesofdetermining
thegifttaxpayablebecauseofthetransfermadecompleteatthedeathofmyhusband.”
154
Treas. Reg. §20.2056(b)-7(h): “Example 7. **** D's executor elects to deduct a fractional share of the
residuary estate under section 2056(b)(7). The election specifies that the numerator of the fraction is the
amount of deduction necessary to reduce the Federal estate tax to zero (taking into account final estate tax
values) and the denominator of the fraction is the final estate tax value of the residuary estate (taking into
account any specific bequests or liabilities of the estate paid out of the residuary estate). The formula
election is of a fractional share. The value of the share qualifies for the marital deduction even though the
executor's determinations to claim administration expenses as estate or income tax deductions and the final
estate tax values will affect the size of the fractional share.”
155
Treas. Reg. §20.2056(b)-7(c)
74
Wouldsuchapreconditionpassmuster?Wouldthetrendofthetaxpayervictoriesin
formulagiftingcasessuchasWandry,Petter,ChristiansenandHendrixhelp?Perhaps–but
thoseconcernedvaluationratherthanwhetheragiftqualifiesforadeductionornot.
Ascomplicatedanduncertainasallofthisis,wehavenotevenaddressedwhetherthe
IRSmightmakeotherargumentsregarding§2523,suchaswhetherthedoneedeceased
spousehasavalidlifetimeincomeinterestthatisnot“terminable”atthetimeofdeath,or
whethertheinfamoussteptransactiondoctrinemightapply.Whilethereareplentyofcases
wheretheIRShasargued“prearrangement”betweenspousesandlost,oneofthemost
important“badfacts”foranysteptransactioncasewouldbeinstantaneoussuccessive
transfers–aninevitablefacthere.
Inconclusion,untilthereisfurtherguidance,wealthiercoupleswithestatescloseto
$10millionoraboveshouldsimplyavoidornarrowlytailoruseofthesejointGPOA
techniques,unlessthebulkoftheirestatewillgotocharityattheseconddeathanyway,becauseof
thepotentialfordoubleuseofexclusionasthepriceofthedoublestepupinbasis.They
mightconsideraCommunityPropertyTrustinstead.Forcoupleswithmuchlesserestates,
theremaybelittletolosebyattemptingthesetechniques,especiallyiftheyarelimitedtothe
assetsthatwouldtrulybenefitthesurvivingspouseduringhis/herlifetime(e.g.nearzero
basisdepreciableasset).Ataminimum,thedesignsinthePLRscanbeimproved.Inmy
opinion,theUpstreamCrummeyOptimalBasisIncreaseTrust,discussedinthenextsection,is
farsuperior,becauseitlargelyavoids§2523,§1014(e)andsteptransactionissues.
f.
The“EstateTrust”Alternative
BeforeturningtotheUpstreamOptimalBasisIncreaseTrust,let’sexplainand
comparealesserknownalternativetoJESTsandCPTrusts–theEstateTrust.156UnlikeaCP
TrustorJEST,theestatetrustisaccomplishedbymakingacompletedgiftintrustduring
lifetime(similartotheUpstreamCrummeyTrustdiscussedinthenextsection–see
comparisonchart).Thisenablesthetrusttoescapethepotential§1014(e)oneyeartrapas
longasthedoneespouseoutlivesthedonorbyoneyear.
156
See LISI Estate Planning Newsletter #2094, David Handler & the Estate Trust Revival: Maximizing Full Basis
Step-Up
75
IncontrasttotheUpstreamCrummeyOptimalBasisIncreaseTrust,however,the
amountofthegifttotheEstateTrustcanbeunlimited,duetoqualificationforthegifttax
maritaldeduction.
Howdoesthistypeoftrustwork?Settlortransfersassetsintrustforspouse,and
spousealone–butthetrustdoesnotrequireallnetincomebepaid,likeaQTIPorGPOA
maritaltrustunder§2523(discussedinPartII)–paymentofincomeandprincipalcanbe
discretionary.Thereasonthegiftstillqualifiesforthemaritaldeductionisthatthegiftisnot
“terminable”–anyassetsremainingintrustatthespouse’sdeathmustbepayabletothe
spouse’sestate(notwithpermissionofnonͲadverseparties,orsubjecttoother
contingencies).Thus,steponeisfairlysimpleandeasiertounderstandandaccomplish–
settlortransfers$1millionofappreciatedsecurities,forexample,tospouseinanestatetrust.
Itisclearlyincludedinthespouse’sestate,eligiblefor§1014stepup,subjectto§1014(e)as
discussedabove.
Thetrickierstepishowtoalsoincludethetrustinthesettlor’sestate,toenablethe
assetstoreceiveastepupinbasisateitherspouse’sdeath,whilestillaccomplishinga
completedgiftnecessaryforthemaritaldeductionforthegifttothespouse.Toaccomplish
thistrick,itmaybenecessarytouseanindependenttrustee.Treas.Reg.§25.2511Ͳ2(b)
provides:
“Astoanyproperty...ofwhichthedonorhassopartedwithdominionand
controlastoleaveinhimnopowertochangeitsdisposition,whetherforhis
ownbenefitorforthebenefitofanother,thegiftiscomplete.Butifupona
transferofproperty(whetherintrustorotherwise)thedonorreservesany
poweroveritsdisposition,thegiftmaybewhollyincomplete,ormaybe
partiallycompleteandpartiallyincomplete,dependinguponallthefactsinthe
particularcase.”
However,Treas.Reg.§25.2511Ͳ2(d)providesthatagiftwillnotbeconsidered
incompleteifthedonormerelyreservesthepowertochangethetimeormannerof
enjoymentofthetrustproperty:
Agiftisnotconsideredincomplete,however,merelybecausethedonor
reservesthepowertochangethemannerortimeofenjoyment.Thus,
thecreationofatrusttheincomeofwhichistobepaidannuallytothe
doneeforaperiodofyears,thecorpusbeingdistributabletohimatthe
76
endoftheperiod,andthepowerreservedbythedonorbeinglimitedtoa
righttorequirethat,insteadoftheincomebeingsopayable,itshouldbe
accumulatedanddistributedwiththecorpustothedoneeatthe
terminationoftheperiod,constitutesacompletedgift.”
InthecaseoftheEstateTrust,thedonorwouldretainthepowertoalterthemanner
ortimingofthespouse’sbeneficialenjoymentoftheincomeandprincipal,butwouldnotbe
abletonamenewbeneficiariesorchangetheinterestsofbeneficiariesasbetween
themselves.Thus,agifttoanEstateTrustswillbeacompletedgift,yetbeenoughofastring
totriggerIRC§2038/2036.157Thisstringwouldincludetheability,forinstance,toamendthe
trustagreementtochangethemannerortimingofthebeneficiaryͲspouse’senjoymentofthe
incomeorprincipalofthetrustand(ii)directthetrusteetomakeorrefrainfrommaking
proposeddistributionsofincomeorprincipal(whichpowerwouldbeexercisablebyhisorher
agentunderapowerofattorneyintheeventofincapacity).Retainingthispowerwillcause
thetrustpropertytobeincludedinthegrantor’sestateunder§2038,yetnotsomuchto
impugnthecompletedgift.
TheissueswithEstateTrustsarethatindependenttrusteesarerecommended,rather
thanhusband/wifeasusuallycontemplatedbyJESTtrustsandoftendesiredbyclients.
Moreover,therearelargerholesinthecreditorprotectionandfidelitytotheestateplanthan
JESTorOBITtrusts–thereisnowaytorestrictortieupthesurvivingspouse’sabilityto
completelyandutterlycontroltheestate,orencumberorjeopardizeitwithdebtorliability.
157
IRC §2038 is broader than garden variety revocable living trusts: “To the extent of any interest therein of which
the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full
consideration in money or money’s worth), by trust or otherwise, where the enjoyment thereof was subject at the
date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the
decedent alone or by the decedent in conjunction with any other person (without regard to when or from what
source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is
relinquished during the 3 year period ending on the date of the decedent’s death. Treas. Reg. §20.2038(a)-1 also
makes it clear that mere veto power over distributions or the ability to affect timing can trigger 2038, even if the
ultimate gift may be complete: “Section 2038 is applicable to any power affecting the time or manner of
enjoyment of property or its income, even though the identity of the beneficiary is not affected. For example,
Section 2038 is applicable to a power reserved by the grantor of a trust to accumulate income or distribute it to A,
and to distribute corpus to A, even though the remainder is vested in A or his estate, and no other person has any
beneficial interest in the trust.”
77
g.
“Naked”GPOAs:thePromiseandtheLimitsofUpstreamBasisPlanning
OnemaybetemptedintheunderstandablezealtoexploitGPOAsforbasisplanningto
extendtheconceptevenfurther.CanIgivemy95yearoldpoorgrandmotheraGPOAor
LPOAtriggeringtheDelawareTaxTrapover$5millionofmytrustassets?Howaboutan
entirereligiousordertakingavowofpoverty,scantacquaintancesorotherpoorandhuddled
massesyearningtobefree?TestamentaryGPOAsexistevenifthepowerholderhasno
accesstocorpusduringthepowerholder’slifetime–indeed,thepowerholder’slifetime
interestiscompletelyirrelevant.158Butthereasonthereisdecadesofprecedentinfavorof
findingGPOAseveninthemostextremeanddubiousconditionsisthattheIRSalwayshada
monetaryincentivetosoargue–cansuchprecedentssimplybeabandonedbythecourts?
ForTAMs,PLRs,yes–forcode,regulationsandcourtcases,no.Despiteasurfeitofthelatter,
practitionersshouldbeskepticalinsuchextremeandarguablyabusivecases.
Ultimately,courtswillhavetosortouttheselimits.AnaptanalogyisthecourtͲ
sanctioneduseofCrummeypowers(whichareessentialpresentlyexercisablegeneralpowers
ofappointmentanyway)forthosewithsomemodicumoftrustinterest(socalledCristofani
beneficiaries),asopposedtosocalled“nakedCrummeys”(thosewithnoothertrustinterest
otherthanthePEGpower).So,isgrandmaadiscretionarybeneficiaryordoessheactually
receivesomeincomefromthetrust?AnalogizingtoCristofani,theGPOAshouldbeupheld.
Despiteallthefavorableprecedence,itisprudent(andprobablyinkeepingwithsettlor
intent),thatapowerholderhasatleastsomediscretionaryinterest;ultimately,otherGPOAs
maybeignoredasshamtransactions.
Outrightupstreamgiftsareunrealistic,impracticalandundesirableonmanycounts–
whatiftheupstreambeneficiarydoesnothavegoodautomobile,umbrellaorlongͲtermcare
insuranceormightdisinherityouinfavorofyourbrotherorthelocalchurch!Grantinga
GPOAtosomeoneoverrevocabletrustassetsisadisaster–ataxablegiftatdeath,andno
stepupinbasisundertheoneyearrule.Obviouslythebestprotectionfromthoserisksisto
useadiscretionarytrustcoupledwithanarrowlycraftedtestamentaryGPOAoralternatively,
anarrowlycraftedLPOAtriggeringtheDelawareTaxTrap,ratherthanoutrightgifts.
158
IRS Technical Advice Memorandum (TAM) 2009-07025
78
h.
TheUpstreamCrummeyOptimalBasisIncreaseTrust159
“[O]ne of the major purposes of the federal gift tax statute [is to protect] the estate tax and the income tax”160
The$5.34million(andrising)estateandgifttaxexclusionismorethanjustanestate
andgifttaxbenefit.For99percentofthepopulation,itisnowmoreappropriatelyconsidered
anincometaxplanningtool.Manyplannersusedtocolloquiallyrefertotheestatetax
exclusionasa“coupon”nottobesquanderedwhenexplainingthebenefitsofbypasstruststo
saveestatetaxes.Weshouldequallyseethisamountasanincometaxshiftingandbasis
increasing“coupon”nottobewasted.
Let’sexplore“upstream”planning:whyspouses,parents,grandparentsand/orother
olderrelativesshouldbeconsideredasbeneficiariesofCrummeytrusts,evenforsmaller
estates,andwhythesesametrustsshouldgrantthesesamebeneficiariesoptimizedpowers
ofappointment.Suchplanningmayalsogetaroundmanyoftheissuesinvolvedintryingto
achieveanincreaseinbasisatthedeathofthefirstspousetodieforacouple’sassetseven
whentheassetsarenotcommunityproperty,discussedinPartVofthispaper.
Let’sstartwithacommonplanningscenarioandexampleofthetechniqueandthen
analyzethepossibilities,issuesandlimitations:
Example:JohnandJaneareintheirlateͲ60s,married,with3children,5grandchildren
and2parentsstilllivingintheir90s.Togethertheyhavean$8millionestate,partofwhichisa
$1millionfullydepreciatedpropertywithonly$100,000basisownedbyJohn.Johngifts
$140,000toastandardgrantorCrummeytrust(aka,aspousallifetimeaccesstrust,orSLAT)
forhiswifeandfamily.However,unlikeanordinaryCrummeytrustthatonlynames
“downstream”relatives,JohnalsoincludeshismotherandfatherinͲlaw.Eachbeneficiaryhas
Crummeypowers.ThetrustpurchasesJohn’srealestatefor$1million,withasmalldown
paymentandaremainingnoteattheapplicablefederalrate(AFR)orhigher.161Withclear
revenuerulingsonpoint,thisinstallmentsaleistypicallyignoredforincometaxpurposes.162
159
Portions of this section were published in The Upstream Crummey Optimal Basis Increase Trust, May 2014
issue of CCH Estate Planning Review
160
Dickman v. Commisioner, 465 US 330, 338 (1984)
161
This technique could certainly be done with other non-depreciable property or use continuing annual Crummey
gifts, but this article will keep the example stark and simple in order to more easily follow the concepts.
162
Rev. Rul. 85-13, 1985-1 CB 184, most recently followed by IRS in CCA 2013-43021.
79
Atfirstblush,thistransactionistheexactoppositeofwhatwehavebeenadvisingin
recentyears:lowbasisassets(especiallythosesubjectto28percentor25percentfederaltax
rates)areoftentheworstassetstogiveandremovefromsomeone’sestateinmanycases.
Moreover,Johnis“freezing”hisestateandloweringthepotentialbasisstepupwhenhe’s
nowhereclosetoneedingafreezetosaveestatetaxes.IsJohnnuts?ButwhatifJohndoes
somethingquitedifferenthere:histrustgrantshiswife,motherandfatherͲinͲlawanarrowly
craftedtestamentarypowerofappointment.Likeover99percentofthepopulation,hiswife,
motherandfatherͲinͲlawhavesmallerestatesthantheiravailableapplicableexclusion
amount.163
Whenoneofthemdies,thebuildingwillbeincludedinthedecedent’sgrossestate
underIRC§2041andreceiveanewbasissteppeduptothefairmarketvalueoftheproperty
pursuantto§1014(providedoneyearhaspassedand§1014(e)wouldnototherwiseapply).
Let’ssayitsvalueincreasesto$1.1millionbythattime(ifnocapitalimprovementsaremade,
thebasismayreduceevenfurtherifitisdepreciable).Iftheappointivetrustcontinuesasa
grantortrustastoJohnorJane,orappointstoeitherofthemdirectly,theycannow
depreciatethebuildingwiththenew$1.1millionfairmarketvaluebasis.
Thepowercanbegrantedtoonlythefirsttodie(areversetontine),164toavoidany
issueswithalapseoftheremainingpowers,butofcourse,similarpowersmightarisein
subsequentappointivetrusts,allowingacascadingincreasingbasiswithadditional
disregardedpurchasesbetweenthesettlorsandtheirgrantortrusts.
Thepowercouldbeageneralpoweroralimitedpowerexercisedinsuchawayasto
triggertheDelawareTaxTrap.Eitheronecanbeverynarrowlycrafted,asdiscussedinPartIII.
Althoughtherearedifferencesbetweenthesetwomethodsofestateinclusion,eitherone
mayachievethesameresultofastepupinbasis.Whichmethodtochoosemaydependon
163
The appointive assets subject to the power would typically be capped to the powerholder’s available applicable
exclusion amount, or to the available state estate tax exemption.
164
A “tontine” is an annuity, insurance or trust arrangement wherein all the benefits go to the last survivor of the
pool. They were quite common hundreds of years ago but more likely encountered by readers today in novels or
in episodes of M*A*S*H or The Simpsons. I do not know if there is a historical precedent for a “reverse” tontine
where the first beneficiary’s to die’s estate receives the spoils rather than the last survivor’s, but that is the concept
here.
80
statecreditorandassetprotectiontrustlaw,thefinancialpositionoftheparentandthe
importanceofcontinuingassetprotectionand/orcontroltothesettlor.
ToensurequalificationfortheannualexclusiongiftundertheCrummeycaseandits
progeny,theattorneymightconsiderdenyingapplicationofthetestamentarygeneralpower
ofappointmenttoanyamountofthetruststillsubjecttoawithdrawalpower(whichtypically
lapses30Ͳ60daysafterthegift).Otherwise,thereisaremotechancetheIRScouldargue
therewasno“presentinterest”duetothepossibilityofapowerholderdyingbeforethe
beneficiaryhadanexercisablerighttodemandthegift.Thistackmaybeoverlyconservative
–thereisnocasedenyingtheannualexclusionforanysimilarprovision,thedeathwould
probablybeconsideredanactofindependentsignificance,it’snotsodifferentfromthe
remotechanceofsomeonestealingthemoneyorlosingthefundswithabadinvestment,and
theIRScan’thelpbutloseeveryCrummeycaseittriestoattack.Nevertheless,inmostcases
thisprovisionwouldnotimpairanybenefits.
Anothermethodofensuringapresentinterest,yetenablingatestamentarypowerthat
couldstillstepupthebasisintheassets,wouldbeusealimitedtestamentarypowerof
appointmentthatcouldonlyappointtoatrustwhichkeepstheexistingwithdrawalright
intact–asdiscussedinPartIIIofthispaper,becausesuchatrustwouldhaveapresently
exercisablegeneralpowerofappointment(Crummeypower),theexerciseofthelimited
powerofappointmentwouldtriggertheDelawareTaxTrapundermosteverystatelaw.
Ifthepowerholderdieswithinoneyearofthegift,astepupisdeniediftheassetscome
backtoJohnorJaneoutright,underIRC§1014(e).Iftheassetspasstoatrustforeitherof
themwithinoneyear,theissueismuchmurkier,anditmaywelldependonthetermsofthe
trustandeven,surprisingly,whetherthepropertyissold.165Toavoidsomeofthoseissues
John’strustmayrequireaoneͲyearcuringperiodbeforeanytestamentaryGPOA/LPOAis
effective,thepowerholdermayappointthepropertygiftedwithinoneyeartoanonͲdonor
childandbequeathotherpropertyofequalvaluetothedonorchild,thesuccessorsmight
simplyavoidsaleofpropertyuntilthenextdeathandstillexploittheadditionaldepreciation,
165
See Part V, and more recent LISI Estate Planning Newsletter #2192, Jeff Scroggin: Understanding Section
1014(e) & Tax Basis Planning, and LISI Estate Planning Newsletter #2194, Jeff Scroggin & Michael Burns on Tax
Basis Planning: The Basics, LISI Estate Planning Newsletter #2203, Alan Gassman, Christopher Denicolo and Ed
Morrow Response to Jeff Scroggin’s Commentary
81
orsimplytakecarethatanypermittedappointmentwithinoneyearwouldnotinclude
paymenttothemoutrightortoatrustforthemthatmightbedisqualifiedforastepupin
basis.Butevenifsomeassetscomebacktothedonorwithinoneyear,aretheythesame
assets?Werethoseappreciatedassets“acquiredbygift”asrequiredby§1014?Arguablyno
Ͳifadonorputsincash,andwhatcomesbackisrealestateacquiredbyFMVpurchase,the
plainlanguageof§1014(e)isnottriggered.
Butwait!Don’t“badthings”happenifsomeonedieswithanotetoagrantortrust
outstanding?Therehasbeenspiriteddebateamongpractitionersaboutwhetherthedeathof
asettlorofanirrevocablegrantortrustinthemidstofrepaymentofaninstallmentsalenote
withthesettlortriggersincometaxonthesaleatdeath.Andthereisaregulationtotrigger
gaintotheextenttheoutstandingliabilitiesowedbythetrustexceedthetrust’sbasisinthe
assetsifsuchstatuschangesduringthegrantor’slife.166Thankfully,neitherwouldbeanissue
here,unlessJohnweretodiefirst.167
Whyisn’tthepowerholder’sdeathasnegativeforincometaxpurposesasthedeathof
thesettlor?Well,foronething,thebasisincreasestothefairmarketvaluedateofdeath,so
thetrust’sliabilitieswouldunlikelyexceedthebasis,unlessthevaluehadgonedown
precipitouslypostͲgift.But,moreimportantly,itishighlylikelythattheparentpowerholder
(orJohn,vialapseprovisionsinthetrust)wouldstructureanyappointmentorlapsesothat
thetaxpayerdoesnotchangeforincometaxpurposesanyway.
Howdoesthefamilymakethishappen?Well,thereisthestartlinglysimplesolutionthat
theparentGPOApowerholdercanappointthetrustassetstoJohnoutrightdirectly,168orto
Jane,hiswife.169Ortoarevocabletrustorothertrustthatwouldqualifyasagrantortrustfor
themduetoawithdrawalpoweroveralltaxableincomeand/orprincipal,asdiscussedinPart
VIII.
166
Reg. §1.1001-2, ex. 5.
To mitigate against that event, John might purchase life insurance and of course, if John becomes terminally ill
or death is not sudden, he or his agent under a power of attorney would repurchase the assets before his death and
cancel the note, substituting cash or even better, assets otherwise destined to be in his estate with higher basis than
fair market value. But the odds of John dying before the other three without warning are extremely slim.
168
This ability should not compromise the asset protection or completed gift status of the initial gift.
169
Provided John and Jane are still married, this does not necessarily cancel the note or transaction for state
property law, but Code Sec. 1041 expressly ignores sales/exchanges between spouses, which would of course
include grantor trusts as to spouses as well, per Rev. Rul. 85-13
167
82
ButwhatifJohnandJanewantcontinuingtaxorassetprotectionbenefitsofan
irrevocablewhollydiscretionarytrust?IfthepowerholderparentdiesandexercisesaGPOA
toatrustforJohnorJane,itisclearthatthepowerholderisthenewgrantorandthetrust
couldonlycontinueasagrantortrustastothemifabroadIRC§678(a)powerapplies,which
wouldeliminatesome,butnotmost,ofthecreditorprotectionandestatetaxbenefitofthe
newappointedtrust.170Ordinaryexercisesoflimitedpowersofappointmentclearlyhaveno
effectonthegrantorforincometaxpurposes.171
However,iftheGPOAmerelylapses,oralimitedpowerisexercisedinsuchawayto
triggertheDelawaretaxtrapunderIRC§2041(a)(3)orinclusionasanintervivosQTIP,the
issueismuchmurkierͲwouldthisbeanindirectgratuitoustransferper§1.671Ͳ2(e)?The
merelapseofaGPOAdoesnotappeartooverride§§671Ͳ677forgrantortrustpurposes,not
onlybecauseofitsconspicuousabsenceofmentioninparagraph(e)(5)ofTreas.Reg.§1.671Ͳ
2,butalsounderthesubsequentexample9,whereintheexerciseofaGPOAclearlychanges
thegrantor,butthemerepresence(andpresumably,lapse)ofonedoesnotoverridethe
originalsettlorbeinggrantorunderIRC§§671Ͳ677.Lapsesarenotnecessarily“transfers”.
LPOAstriggeringtheDelawareTaxTrapareequallyuncertainastowhetherthey
overridetheoriginalsettlor’sgrantortruststatus.Does“generally”inthestatuteimplythere
areexceptions?Shouldlimitedpowersthataretreatedlikegeneralpowersfortaxpurposes
betreatedmorelikeexercisedGPOAsforincometaxpurposes?
170
See Reg. §1.671-2(e):
(1) For purposes of part I of subchapter J, chapter 1 of the Internal Revenue Code, a grantor includes any person to
the extent such person either creates a trust, or directly or indirectly makes a gratuitous transfer (within the
meaning of paragraph (e)(2) of this section) of property to a trust. ********
(2) (i) A gratuitous transfer is any transfer other than a transfer for fair market value.
****
(5) If a trust makes a gratuitous transfer of property to another trust, the grantor of the transferor trust generally
will be treated as the grantor of the transferee trust. However, if a person with a general power of appointment
over the transferor trust exercises that power in favor of another trust, then such person will be treated as the
grantor of the transferee trust, even if the grantor of the transferor trust is treated as the owner of the transferor
trust under subpart E of part I, subchapter J, chapter 1 of the Internal Revenue Code.
****
Example 9.
G creates and funds a trust, T1, for the benefit of B. G retains a power to revest the assets of T1 in G within the
meaning of section 676. Under the trust agreement, B is given a general power of appointment over the assets of
T1. B exercises the general power of appointment with respect to one-half of the corpus of T1 in favor of a trust,
T2, that is for the benefit of C, B's child. Under paragraph (e)(1) of this section, G is the grantor of T1, and under
paragraphs (e)(1) and (5) of this section, B is the grantor of T2.
171
Reg. §1.671-2(e)(5), above.
83
Thus,iftheparent’sGPOAmerelylapsedattheirdeath,andthetrustcontinuedwith
termsthatkeptJohnasagrantorunderIRC§§671Ͳ677,suchaspowerofsubstitution,
provisionsenablingincometobedistributedtograntororspouse,etc.,butnoprovisionsthat
wouldtriggerestatetaxinclusion,thenweapparentlyhavetheholygrailofastepupinbasis,
whilekeepinggrantortruststatusandstillkeepingtheestateandassetprotectionbenefitsof
thetrust.
But,doesn’ttheIRSignoreeverythinghavingtodowithagrantorandgrantortrustfor
incometaxpurposes,andcouldn’tthisincludeapplicationofCodeSec.1014intheabove
instance?172Rev.Rul.85Ͳ13doesgenerallyignoretransactionsbetweenagrantoranda
grantortrust,buthereCodeSec.2041andCodeSec.1014isapplyingnotbecauseofany
transactionbetweenthegrantorandhistrust,butbecauseofapowerholder’sactionor
inaction.ThesetwostatutesclearlyapplytolapsesoftestamentaryGPOAsaswellas
exercises.173
ButthereisanotherpotentialquirkofCodeSec.1014thatmightapply:ifthepropertyis
acquiredbeforethedecedentpowerholder’sdeath,anystepupisreducedbydepreciation.
Thissecondsentenceofparagraph(b)(9)ismeanttocompensatefor“string”giftsof
depreciablepropertybroughtbackintoadonor’sestate.Wouldthatapplyhere?Itshould
not:readingtheparagraphinitsentiretyitisclearthat“acquiretheproperty”refersto
receivingitfromthedecedent’sdirectorindirecttransfer.Johnwouldnotbeacquiringthe
propertyfromthedecedentbeforethedecedent’sdeathaswitha“string”gift.However,ifa
practitionerfeelsthesecondsentenceofCodeSec.1014(b)(9)couldapplyhere,the
powerholder(orlapse)candevolvetheassetstothegrantor’sspouseJaneinstead(ora
172
Rev. Rul. 85-13, 1985-1 CB 184.
Code Sec. 1014(b)(9): In the case of decedents dying after December 31, 1953, property acquired from the
decedent by reason of death, form of ownership, or other conditions (including property acquired through the
exercise or non-exercise of a power of appointment), if by reason thereof the property is required to be included in
determining the value of the decedent’s gross estate under chapter 11 of subtitle B or under the Internal Revenue
Code of 1939. In such case, if the property is acquired before the death of the decedent, the basis shall be the
amount determined under subsection (a) reduced by the amount allowed to the taxpayer as deductions in
computing taxable income under this subtitle or prior income tax laws for exhaustion, wear and tear, obsolescence,
amortization, and depletion on such property before the death of the decedent.
173
84
grantortrusttherefore),orexercisetheGPOAandforgettryingtolapse,exerciseofaGPOA
bywillcomesunderCodeSec.1014(b)(4),not(b)(9).174
Mosttaxpayerswouldprefertokeepthingssimpleandmorecertainandbehappyto
receivetheassetsbackoutright,orintrustwithapresentlyexercisableGPOA,orsettlefora
trustthatgrantsa§678(a)poweroverincomeonly.Forpoorerfamilieswhereapowerholder
maybeonMedicaidorotherwiseclosetoinsolvent,theuseoflimitedpowersofappointment
andtheDelawareTaxTraptotriggerinclusion/stepupshouldavoidanycreditor/asset
protectionissuesshouldtheparentpowerholder’sestatebeinsolventorsubjecttoclaims.175
Whataboutshamoreconomicsubstancearguments?Incontrasttonamingstrangers,it
ishardlyashamtonameaparentasbeneficiaryofafamilytrust.Millionsofpeopleassist
theirparentsfinanciallyanyway,sowhynotmakethosegiftsfromatrustbestdesignedto
benefittheentirefamily?AnanalogyfordrawingthelinemaybemadeincomparingsoͲ
called“VultureCLATs”usingsicknonͲrelativesasmeasuringlives,whichtheIRSultimately
shutdown,withCLTsthatuserelatives,evensickrelatives,asmeasuringlives,whichis
explicitlyapproved.Likeregulationsthatgovernusinglifeexpectanciesofterminallyill
relatives,§1014(e)effectivelyprevents“deathbedGPOAgranting”.
TheIRShasrepeatedlytriedthesekindsofargumentsagainstFLP/LLCs,Crummeytrusts,
spousaltrustsandothervariousmoreegregiousfactcaseswithoutsuccess.It’swhyevery
estateplanningattorneycomfortablydraftstrustsforspousesandchildrenwithoutfearof
“prearrangement”relatedarguments,eventhoughparentsareoftenforcedbyintestacylaw
tobebeneficiariesoftheirminorchildren’sestates.It’shardlyadamningfactorforanelderly
parenttoappointtrustassetsbacktotheiradultchildanymorethanaspouseappointing
backtotheirspouseinaSLATorintervivosQTIPorachildappointingtotheirparentas
beneficiaryiftheypredecease;rather,it’scompletelynatural.
Toquoteonerecenttaxcourtcase:
Code Sec. 1014(b)(4): “Property passing without full and adequate consideration under a general power of
appointment exercised by the decedent by will;”
175
Testamentary general powers may or may not be subject to a powerholder’s estate’s creditors. Contrary to a
popular myth disseminated by speakers at the recent Heckerling conference, third-party created testamentary
GPOAs and LPOAs are generally not subject to state statutory share laws. See Uniform Probate Code §2-201, §2205(1)(A), Fla. Stat. 732.2045, Bongaards v. Millen, 793 N.E.2d 335 (Sup. Ct. Mass. 2003)
174
85
“Atrustvalidunderstatelawcanbetreatedasanullityforfederalincometaxpurposes
ifitlackseconomicreality,butthiswouldlikelyhappeninonlyanextremecase.Four
factorsdeterminewhetheratrusthaseconomicsubstance:
(1)Didthetaxpayer'srelationshiptothetransferredpropertydiffermateriallybefore
andafterthetrust'screation?
(2)Didthetrusthaveanindependenttrustee?
(3)Didaneconomicinterestpasstotheothertrustbeneficiaries?
(4)Didthetaxpayerrespectrestrictionsimposedonthetrust'soperationassetforthin
thetrustdocumentsorbythelawofthetrusts?”176
Aslongasanindependenttrusteeisused,noneofthesefourfactorswouldevencome
close.Usingafamilymembermightbemorelikelytoimplicatetheotherfactorslisted,butit
wouldstillbeaveryrareandabusivecaseindeedforthetaxcourttoinvalidateatrust–the
Closecaseevenconcernedaprosetaxpayerfoundguiltyoffraud,moneylaunderingand
obstructinginvestigationsandhistrustwasnotbusteddespitedubiouscircumstancesand
individualtrustees.
Whataboutthe“steptransaction”doctrine:couldthisbeappliedtoignorethetaxable
giftandpowerofappointment?Thisjudicialdoctrinegenerallyrequiresseveraltransactions
thataresointerdependentthattheycan’tbeviewedseparately,inordertocollapsethesteps
intooneintegratedtransaction.Acourtmayinvokethisdoctrinewhen:(1)eachstepis
connectedbyabindingcommitment,(2)eachstepismutuallyinterdependent,or(3)aseries
ofcloselyrelatedseparatestepstoachieveanendresultaspartofaprearrangedplanagreed
tobyallthepartiespriortothetransaction.Thefirsttwohardlyapply,butthelastonecould
withenoughbadfacts,suchasadeathbedtransaction,justaswithmanyFLP/LLCortrust
transactions.JustaswithanyotherCrummeytrust,FLP/LLCgift,orspousaltransaction,
partiesshouldtakeprecautionstoavoidanyhintofprearrangementwithanypowerholders.
ButtheIRShaslostmuchstrongercaseswheretransactionsoccuronlydaysapart,withthe
176
Christopher C. Close, et ux. v. Commissioner, TC Memo 2014-25
86
samepartiesinvolved,whenitwascleartoeveryoneinvolvedbeforehandwhatwasgoingto
happen.177
Bycontrast,here,olderpowerholderswouldnotevenbenotifiedofthetrustbeforeits
executionandmanyyearsmaypassbeforeapowerholderdies.Duringthistimetherewould
beongoingtrustadministration,assetmanagementanddistributions.Oldergeneration
powerholderswouldusuallyuseadifferentattorneyfortheirestateplan(andthus,
appointments)aswell.Thereisanotmerelyariskofeconomicchangeofcircumstance
throughtrustadministrationbythetimeapowerholderdies,it’saveryhighlikelihood.This
kindof“prearrangement”isnotsodifferentthansomeoneusingabypassorQTIPtrustand
theIRStryingtodenythemaritaldeductionbyclaimingitwasall“prearranged”topasstothe
couple’schildrenatthespouse’sdeath.Quitesimply,thesteptransactionshouldnotapply
here.Whilenearlyalltrustsaremotivatedinpartbytaxconsiderations,trustsforparents
andspouses,suchasanUpstreamOBITalsohaveastrongindependentpurposeand
economiceffect,ratherthannopurposeoreffectbeyondtaxliabilities.
CourtshavebeenquiteresistanttoIRSattemptstoinveighprearrangement,implied
promiseorconcerttoinvalidateataxeffectclearlypermittedbylaw,evenundermore
dubiouscircumstances.178
AdvisoroftenaskwhetherthissametechniquecanbeaccomplishedbygrantingGPOAs
topowerholdersinrevocabletrusts.Generally,NO–seedetaileddiscussionaboveregarding
JESTtrusts.Notonlywouldthiscauseataxablegifttooccuronthedeathofthepowerholder
fromthesettlortothepowerholderthatwouldobviouslynotqualifyforthemarital
deduction,butitwouldalsofailunder§1014(e)andcauseastepdownandnotastepup,
177
E.g., T. H. Holman Jr., CA-8, 2010-1 USTC ¶60,592, 601 F.3d 763, 770, 772 (2010)
For example, the Fifth Circuit approved disclaimers by 29 devisees of Louise Monroe, some of whom were
unrelated to her, made at the request of her husband's nephew. The disclaimers caused the disclaimed property to
pass to the decedent's husband free of estate tax. Shortly thereafter, the husband made generous gifts to each of the
disclaimants, in many cases equal to the amount disclaimed. The Tax Court had found that the disclaimers were
unqualified because they were the result of an implied promise by the husband to make gifts to the devisees if they
disclaimed. However, the Court of Appeals for the Fifth Circuit reversed that decision, stating that the very
purpose of disclaimers is "to facilitate post-mortem estate tax planning and to increase family wealth on the
`expectation' that there will thus remain more wealth to pass on to the disclaimants in the future." Estate of
Monroe v. C.L.R., 124 F3d 699 (5th Cir 1997)
178
87
becausethetransferwouldbesimultaneous,notjustwithinoneyear.Nottomentionthat
thiswouldbemuchmorelikelythanthe“CrummeyOBIT”tobeasteptransaction.
i.
IntraͲSpousalPlanning:BuildingontheJointExemptStepUp(JEST)Trustconcept
OneofthepotentialissuesinplanningforastepupinbasisforjointGPOAtrusts(aka,
JESTs)istheuncertaintyofwhetherthegifttaxmaritaldeductionwillapplyforthefirst
transferofassetsfromtheoriginalowner/spousetothefirstdecedentspouse.179TheIRS
couldeasilyreversetheirpositiononthemaritaldeductiontakeninseveralprivateletter
rulings,sincetherearegoodargumentsforandagainst.TheCrummeyOptimalBasisIncrease
Trust(OBIT)techniquebasicallyeliminatesthatconcernaltogetherbysubstitutingthemarital
gifttaxdeductionforthisfirstgiftwiththeannualexclusiongifttaxdeduction.180
Let’staketheaboveexamplewithJohnandJaneandassumeinsteadthattheyhaveno
parentsorotherolder“objectsoftheirnaturalbounty”livingthattheywouldwanttoname
asbeneficiaryorgrantapowerofappointment.TheyareinastablelongͲtermmarriage.If
Johnstructuresthesametransactionasabove,thisworkswellifhiswifediesfirst,becauseit
canclearlybeincludedinhergrossestatewithatestamentarypowerofappointmentand
thereisnopotentialissueastowhetherthegrantingofthePOAqualifiesforthemarital
deductionunderCodeSec.2523.UnlikeanintervivosQTIP,wecanalsoavoidstepdownsin
basisandbemuchmoreflexibleinplanning.
Furthermore,thereismuchlesslikelihoodofCodeSec.1014(e)applying,sinceJanewill
probablyliveayearafterthetransfer,andthetrust,ofcourse,canhavespringingGPOAsor
alternativedispositionsifJanediesbeforeorafteroneyearoftheinitialgifttoaddressthat
possibility.
ButwhatifJohndiesfirst?Ifhehasenoughwarningbeforedeath,heorhisagentcan
swapassets,cancelthenoteandideallyputhighbasisassetsinthetrust.Butsometimeslife
(anddeath)cansurpriseus.Couldthefamilyavoidthatriskandtriggerinclusioninhisestate
somehow?
179
This is discussed in It’s Just a JEST – the Joint Exempt Step Up Trust, LISI Estate Planning Newsletter #2086
(April 3, 2013), by Gassman, Ellwanger and Hohnadell
180
IRC §2523 (lifetime marital gift tax deduction), IRC §2503(b) (annual present interest exclusion from gift tax)
88
Actually,triggeringestateinclusioniseasythroughvariousretainedpowers;themore
difficulttaskistriggeringitwithoutmakingthegiftincomplete.Thisistheexactoppositeof
DelawareIncompleteNonͲGrantor(DING)planning,wherethegoalistodeftlycausea
transferforincometaxfilingpurposesbutnotgifttaxpurposes.Itiscompletelyoppositeof
howwetypicallyplannedpreͲATRA,orstillplanforwealthierclients.
Generally,retainingatestamentarypowerofappointmentorpowerofdisposition
makesthegiftatleastpartiallyincomplete.181RecallthisrecentstircausedbyCCA2012Ͳ
08026inwhichtheIRSclaimedthatameretestamentaryPOAretainedisNOTenoughto
makeagiftwhollyincomplete,itmerelymakestheremainderinterestincomplete,andthe
lifetimeinterestiscomplete.182
If,however,atrusteeviadecantingortrustprotectorweretolatergrantalimited
formulatestamentarypowerofappointmenttoJohn,thegiftwillstillhavebeencomplete,
buttherewouldnowbea“string”causingpartialestateinclusiontotheextentofthepower
under§2038.183Ifthereisacaporlimitonthepower(e.g.,astotheappreciatedrealestate,
butnotthecashorlossassets),thislimitwouldcorrespondinglyreducetheassetssubjectto
inclusionunder§2038.184Thisissimilartotherecentrulingoutliningthatonlyaportionofa
GRATisincludedinasettlor’sestateunder§2036shouldtheydieduringtheannuityterm.185
Furthermore,suchapowercouldeasilyberemovedorreleasedlatertoremovetheestate
inclusiontaint,thoughaformulamighteffectivelyavoidtheneedto.186
However,suchchangesrisktheIRSarguingthatthereisaprearrangementwiththe
trustee/trustprotector(ergo,neverreallyacompletegift),orthatitwillsimplyneverbe
accomplished.Ratherthanrelyingonlaterchanges,thesettlorshouldsimplyretainapower
thatcausesestateinclusionoveronlytheintendedassets,yetdoesnotcauseacompletedgift.
Onlythepowerto“changethemannerortimeofenjoyment”wouldberetained.187For
example,thesettlorcouldretainthepowertovetoearlydistributionsofappreciatedassetsto
181
Reg. §25.2511-2, Cessation of Donor’s Dominion and Control.
CCA 2012-08026, in spite of a seemingly contrary treasury regulation at Reg. §25.2511-2(b).
183
It would not cause inclusion under §2041, since a settlor/donor cannot create a general power in him/herself
184
See Reg. §20.2038-1(a).
185
Internal Revenue Bulletin 2008-35 (of course, it could be 100% inclusion, it depends on prior rate of return,
change in 7520; i.e. how much is needed to pay the remaining annuity)
186
Subject, of course, to the three year rule of IRC §2035.
187
Treas. Reg. §20.2038(a)-1 – see further discussion in Part V.f. on page 77, footnote 156
182
89
beneficiaries.Thiswouldinvolve“changingthemannerortimingofenjoyment”,enoughto
trigger§2038astothoseassets,yetnotbesomuchasto“changethedisposition”thatwould
maketheentiregift(oranypartofthegift)incompletepursuantto§2511.188
Attorneysshouldavoidpottruststhatpermitunequaldistributionstobeneficiariesprior
todivision–ifthesettlorcanvetoonebeneficiary’sdistribution,butnotanother’s,thensuch
apowerwouldindirectlychangethedispositionofthetrustaswellasthetiming.Bycontrast,
ifseparateshares/subtrustsareused,orifunequaldistributionsaretreatedasadvancements,
thenanyvetowouldnotchangethedispositionscheme,onlythetiming.
j.
CrummeyOBITs:PreservingBasisofLossProperty,especiallyCommunityProperty
Let’stakeadifferentspinandimaginethatJohnandJanealsohaveawonderfulsecond
homepurchasedattheheightoftherealestateboom–thebasisis$1,000,000,butthefair
marketvalueisnowonly$600,000.IfJohnorJanediesanditisdeemedcommunityproperty,
theentireassetissteppeddowntoa$600,000basis.Thesameoccurseveninaseparate
propertystateifbothdie,orifaspousewhois100percentownerdies.189Ifitisheldinequal
jointtenancywithrightofsurvivorshipandonedies,thebasisisstillreduced,butonlyhalfas
much.190
JohncanuseaCrummeyOBITtopreventanystepdowninbasisatJohnand/orJane’s
death.Thetransactionwouldinessencebesimilartotheabove,absentaGPOAorLPOA
triggeringestateinclusionateitheroftheirdeaths,unlesstheassetincreasesinvalueabove
the$1,000,000basis.Thispreservesthe$1,000,000basisforthetrust/familywholater
inherit,whomightconvertittoaninvestmentassetandlaterselltheproperty.Onequirkto
thecarryoverbasisrulesisthat,ifthefamilysellsthepropertyforanywherebetween
$600,000and$1,000,000(ignoringanylaterdepreciationorcapitalimprovements),thereis
neithergainnorloss.191Ifthefamilylatersellsfor$1.1million,thecapitalgainis$100,000,
not$500,000.Ifthefamily(trustee)latersellsfor$800,000,thereisnocapitalgain(andno
loss),not$200,000ingain.Saving$400,000ofbasiscanbeahugeadvantageforthefamily.
188
Treas. Reg. §25.2511-2; contrast paragraphs (b) “complete”, with (d) “incomplete” – embrace (d), avoid (b)
Code Sec. 1014(b)(6).
190
IRC § 2040(b).
191
IRC § 1015(a)
189
90
Notethatinthisinstance,thedebateaboutwhetheranongoinginstallmentsaletriggersgain
atdeathmightstillleadtosomeuncertaintyastowhetherarealizationeventoccursupon
changetononͲgrantortruststatus(though,presumablynogainintheaboveexample).Thus,
transfertospouse,orcompletingthegiftingusingrepeatedannualexclusiongiftsorgifts
beyondtheannualexclusionmightbeconsidered.
Conclusion–NotlimitedtoCrummeypowersorrealestateholdings
Theaboveexamplesusedoneparcelofrealestateforsimplicity,butthiscouldeasilybe
extendedtoaportfolioofstocksandbonds.Thebeautyofsuchplanningisthat,unlikean
ordinaryportfolio,theestateinclusionorexclusionviaformulapowersofappointmentcan
adapttoasustaineddipinthemarket,aswiththemostrecentfinancialcrisis.Weshouldnot
assumethatclientsandtheirspouseswillnotdieduringamarketdownturn(includingthe
bondmarket,whichisoftenoverlookedbymanyplannersasapotentialsourceofvolatility).
Intheaboveexample,wepresumedthatJohnandJanewouldprefertouseannualgift
taxratherthanlifetimegifttaxexclusion,butwith$10.68million,manytaxpayerscouldmake
upstreamgiftswithimpunityandsimplyforgetabouttheCrummeyannualexclusiongifts,or
supplementthem.
Thenewparadigminfinancialandestateplanningistoviewtheapplicableexclusion
amountasmorethanamereestatetaxbenefit,butasanassettobeusedforincometax
planningaswell.Congressandthecourtshaveappropriatelycalledthegifttaxa“backstop”
totheincometax.Practitionershaveadutytoexplorewhatpossibilitiesfamiliescannow
availthemselvesofwiththatbackstopeffectivelyremovedforover99percentofthe
population.
91
VI. IncreasedAssetProtectionOpportunitiesMimickingDAPTsDuetoLargerExclusion
a.
The“poorman’sDAPT”?–UsingSLATs,“PowerTrusts”andILITsw/OBITclauses
In addition to all of the income tax opportunities offered by the increased gift tax
exclusion,ATRAalsooffersupgreaterassetprotectionplanningopportunities.Considerthis
variantofaDAPTforsmallerestates:Husbandsetsupanirrevocabletrust(akaSLAT–spousal
lifetime access trust) for Wife (which may be defined as whomever he is married to at the
time,sincewedonotneedtoqualifyforthemaritaldeductionasanintervivosQTIPorGPOA
maritaltrust,aka“floatingspouse”).WifehasaformulatestamentaryGPOA,circumscribed
as discussed above. Wife and children have a lifetime limited power of appointment to
appoint to Husband/Father. Merely being a permissive appointee of a limited power of
appointment should not threaten asset protection, even if the donor of the power is a
permissiveappointee.192Ifwifediesfirst,andtheGPOAisexercisedsuccessfullyinfavorofa
trustforthehusband,husbandisnowthebeneficiaryofthetrust,butitisnot“selfͲsettled”,
sincethewifeisthesettlor.193
Unlike intervivos QTIPs or exercises of limited powers of appointment that “relate
back” to the original donor of the power, thesettlor changes at Wife’s death pursuant to a
GPOA (though with a lapse of the GPOA, the issue is murkier and it may only change as to
95%).194ThismeansthatthetrustisnotselfͲsettledifHusbandlaterbecomesbeneficiaryina
trustestablishedbyhisWifeundertheSLAT’sGPOA.Thiseliminatesthemainconcernthat
peoplehavewith“SLAT”planningwithoutaDAPT–thelackofaccessbyasurvivingspouse.
For interͲvivos SLAT (bypass) trust planning, remember the oneͲyear rule in IRC
§1014(e) discussed in Section V of this paper. As discussed in the above section, this can
avoided by structuring the appointive trust differently if the donee/beneficiary spouse dies
192
While this is generally the common law, Ohio clarified its common law with R.C. §5805.06(B)(3)(a) – for
additional CLE material on asset protection aspects of powers of appointment, email author for separate CLE
outline discussing/contrasting the many advantages of “Power Trusts” over DAPTs.
193
See UTC §401, §103(15), Restatement of Trusts, 3d, §10(d), outlining that a POA can be used to establish a
trust and the settlor is the person creating or contributing property to it. This is clear when a GPOA powerholder
appoints to a new trust, but uncertain if a GPOA powerholder merely allows the power to lapse. Is the lapse
equivalent to “contributing property” or not? As discussed herein, §2041 doesn’t even require a competent
powerholder with knowledge, but state law might have a higher bar for being considered a “settlor”.
194
UTC §505(b), for Ohioans, see newly amended Ohio R.C. §5805.06(B)(3)(b) – protection is 100% in Ohio –
note that for GST purposes, the 5% lapse is disregarded and the spouse with the lapsing GPOA would be
considered the transferor of 100% for GST purposes – generally an optimal result. Treas. Reg. 26.2601-1(b)(1)(v)
92
withinoneyearofthetrustfunding,buttheseentirelyavoidthe1014(e)debateifoneyear
passes. Realize – this comes at a cost of double use of gift tax exclusion, unless a
Crummey/Cristofanitypestructureisused,asdiscussedintheabovesection,butevenwith
thatcaveat,mostcoupleshaveplentyofApplicableExclusionAmounttosoakupdoubleuse
ofexclusionfortheirhighlyappreciatedassets–remember,¾ofacouple’sassetsarevery
oftencash,shorttermbonds,IRAs,annuities,qualifiedplansandtheirhome.
Of course, the power of appointment in the SLAT can be structured as a formula
GPOA/LPOAasdiscussedinSectionIIIofthispaper,soasnottoinadvertentlycauseanystep
down in basis, but this use may mean giving up some asset protection as to the LPOA
appointive assets or forcing the use of a domestic selfͲsettled asset protection trust statute
such as the Ohio Legacy Trust Act.195 This is because, if W uses a testamentary LPOA to
appoint back to a trust for H, it would not change the settlor for asset protection purposes
(the“relationback”doctrineapplies).196
Insomestates,youcanaccomplishthesameassetprotectionresultwithanintervivos
QTIP, so that less gift/estate tax exclusion is used, and it could come back to the donorͲ
spouse.197Inotherstates,anintervivosGPOAmaritalmaybepreferredtoachievethesame
asset protection result, but recall that the GPOA for a marital trust must be more open to
use/abuse, and is therefore less protected from the spouse’s undesired exercise and the
doneespouse’sestate’screditors.Furthermore,intervivosmaritaltrustscannotprotectfrom
100%stepdownsinbasisatthespouse’sdeath.
UnlikeDAPTs,whichhavetobedoneincertainstates,usecertaintrustees,andhave
variousuncertainties,requirementsanddrawbacks,SLATswiththesekindsofprovisionscan
be done in any state. For a comparison chart between “Power Trusts” and DAPTs, see
author’sseparateoutline.
GrantortruststatusforsuchatrustafterW’sdeathistricky.IfHestablishesatrustfor
WandsheexercisesaGPOAtoappointbacktoatrustforH,Wisnowthegrantorforincome
195
Ohio R.C. §5816.01 et seq.
Arizona may be an exception. See Ariz. Rev. Stat. 14-10505(E)(3)
197
See footnote 34 for a list of state statutes and further explanation
196
93
taxpurposes,overridingHasthegrantor.198Thisoverridesanyprovisionsorconclusionsthat
wouldotherwisedeemHthegrantorunderIRC§§671Ͳ679,makingitanonͲgrantortrust.199
However,ifWmerelyallowsherGPOAtolapseatherdeath,andthetrustthencontinuesfor
H,itisunclear,perhapsforstatecreditorprotectionlawaswell.200Thismaybeanotherarea
wherestatelaw,estatetaxandincometaxlawdonotnecessarilystrideinlockstep.
b.
ILITs(alsoseesectionontheUpstreamCrummeyOptimalBasisIncreaseTrust)
ILITsshouldnotbeoverlookedinconsideringoptimizingbasisclauses,andcanbenefit
justasmuchasanybypasstrust.Thisisnottoachieveastepuporavoidstepdowninbasis
ontheinsurancepolicy–it’stheinvestmentproceedsaftertheinsurancepolicypaysoff.
Example: John establishes an ILIT for his wife and kids – he’s young, it’s a $2 million
termpolicy.John’sremainingestateis$1million.Loandbeholdhedies.Hiswifetakesthe
$1millioninqualifiedplanandhomeoutright,shehas$10.68millionAEA.Janehasanestate
well under this amount. Over time the ILIT investments triple in value – basis $2.5 million,
FMV$6million.WithanOBITclause,wereallyhavethebestofallworlds–ifJane’sestate
increases over time beyond her AEA (or if sheloses her DSEU amount through remarriage),
the ILIT can shelter funds from her estate, but if her estate remains under her AEA, $3.5
millionofbasisissaved–overamilliondollarsofincometaxsaveddependingonthestate
andbracketsofthebeneficiaries.And,asdiscussedinSectionIII,thisshouldbecraftedsoas
toavoidstepdownsonanylossassetsandapplytothemostappreciatedassetsfirstinthe
event the amount must be capped. Needless to say, language should coordinate with the
bypasstrusttobereadinparimateria.
DINGs (NINGs, OINGs and other INGs). These are generally designed to be in the
settlor’sestateatthesettlor’sdeath,butupondeathcansimplybeappointedtoA/Btrusts
thathave“OBIT”features.SeePartVIIIformoretaxshiftingideasforthesetrusts.
198
Treas. Reg. §1.671-2(e)(6), Example 9 – thanks to attorney Gary Maddox for correcting a typo and suggesting
clarifications to this discussion.
199
Treas. Reg. §1.671-2(e)(5)
200
Treasury could have simply added the words "lapse" or "release" of a GPOA in §1.671-2(e), as in other
sections, but did not. Absent an exercise of a GPOA, it is unclear under what authority a lapse would override H
as the grantor under IRC §671-679 (due to access to income, swap/substitution power, income for insurance or
other administrative power). Therefore, H may still be considered the grantor of the trust for income tax purposes,
since, contrary to the specific language of the regulation, W did NOT exercise her GPOA.
94
VII.
UseofOptimalBasisIncreaseTechniquesbyPreͲExistingIrrevocableTrusts
TheconceptshereincanalsobeappliedtointerͲvivosirrevocabletrustsandtrusts
continuingforadditionalgenerations.Similartechniquescanbeincorporatedindownstream
dynastictrustsforbetterbasisincreasestograndchildrenandbeyond.ThiswouldinvolveGST
considerationsaswell.
Mostimportantly,practitionersshouldnotoverlookthesignificantvalueinadapting
manypreͲexistingirrevocablebypasstrusts(includingintervivosSLATs,orotherirrevocable
trusts)tofullyusethis$5.34million(andincreasing)basisincreasing“coupon”.Thismaybe
donebyvariousways–triggeringtheDelawareTaxTrapusinganexistinglimitedpowerof
appointmentthatpermitsappointmenttotrusts,orchangingthetrustviadecantingorcourt
reformationtoaddalimitedorgeneralpowerofappointment.Generally,nonͲjudicial
settlementagreements(akaprivatesettlementagreements)areprobablynotideal,sinceitis
uncleartowhatextentthosecanmakethenecessarychanges.201UsingLPOAsmayalsobe
preferredoverGPOAs.Thereasonsforthelattertwostatementswillbecomeapparentlater
inthisSection.Choiceoftheseoptionswillnecessarilybetrustandstatelawdependent.
Theadvantagesmaybesignificant.Imaginehowmanycurrentirrevocablebypass
trustsurvivingspousebeneficiarieshavewellunder$5.34millionintheirpersonalestate?
(actually,awidow(er)mighthavequiteabitmoreAEAiftheirspousediedafter2010and
theyelectedDSUEA).
a.
UsingExistingLimitedPowersofAppointmenttoTriggerDelawareTaxTrap
Example:Johndiedin2008,leavinghiswifeJane$2millioninnonͲIRAassetsina
typicalbypasstrust,whichhasnowgrownto$3.5million.Althoughsomeoftheassetshave
beensold,rebalanced,thetrustassetsnowhaveabasisof$2.5million.Jane’sassetsare$2.5
million.Whywaste$2.75millionofher$5.34million“coupon”sheispermittedtouseto
increasebasisstepupforherfamily?Janethereforeamendsherwill/trusttoexerciseher
limitedpowerofappointmentgrantedinJohn’strust,mirroringlanguagediscussedabove:
assetswithbasisgreaterthanFMVorIRDgotoatrustforherchildren(orsimplycontinuein
201
Ohio R.C. §5801.10(C) “The agreement may not effect a termination of the trust before the date specified for
the trust's termination in the terms of the trust, change the interests of the beneficiaries in the trust***”; UTC §111
is much more vague.
95
trustundertheresiduary),andassetswithbasisunderFMV(forwhichJaneandherfamily
desirethestepup)simplygotoasimilartrustforherchildrenthatcontainsapresently
exercisablegeneralpowerofappointment,triggeringIRC§2041(a)(3)andgettingthefamily
uptoanadditional$1millionofbasisfreeofcharge.And,ofcourse,thisexercisecanbe
limitedtoheravailableApplicableExclusionAmountandappliedfirsttothemostappreciated
assetsfirst,cappedtopreventanyestatetaxand/oraccountforanystateestatetax,oreven
chosentoexploittheassetsmostlikelytobesoldbybeneficiariesfirst,asdiscussedabove.
Manybeneficiariesdonothavecurrentassetprotectionissues,assetlevelsclosetoa
taxableestateoranydesiretosprayorgiftinheritedassets.Thus,thevastmajorityofLPOA
powerholdersandtheirprospectiveappointeeswouldprobablyprefertosaveincometax
withahigherbasisthanavoidthenegativesofapresentlyexercisableGPOA.Unlessthereare
currentcreditorsonthehorizon,beneficiariescanalwaysavailthemselvesofselfͲsettledasset
protectiontrustlegislationinOhio,Delaware,Alaskaoroneoftheotherjurisdictionsthat
permitthis.Ifthereare,beneficiariescandisclaimtheirPEGpower.So,inpracticalterms,
themainreasontoforegoanyuseoftheDelawareTaxTrapisifapowerholderwantsto
preserveassetsforgrandchildrenorotherbeneficiaries.
b.
AmendingIrrevocableTrusts–WhytheyareEffectiveatthePowerHolder’sDeath
Butlet’ssayJanedidnothavealimitedpowerofappointment,ordoesn’tlikethe
drawbacksofgrantingthebeneficiariesapresentlyexercisablegeneralpowerof
appointment.Aren’twetaughtafterBoschandsimilarcasesandPLRsthattryingtoreforma
trustforthemaritalorcharitabledeductionpostͲmortem(orpostgift)shouldnotbe
recognized?202Isn’tthisasimilartrendforIRA“seethroughtrust”rulings?203
202
Commissioner v. Estate of Bosch, 387 U.S. 456 (1967) held that a state trial court decision as to an underlying
issue of state law should not be controlling when applied to a federal statute, that the highest court of the state is
the best authority on the underlying substantive rule of state law, and if there is no decision by the highest court of
a state, then the federal authority must apply what it finds to be state law after giving “proper regard” to the state
trial court’s determination and to relevant rulings of other courts of the state. It does not say to ignore state law, as
some practitioners fear. For one of several cases denying the marital deduction for attempts at a post-mortem “fix”
or relying on marital savings clauses, see Estate of Rapp, 130 F.3d 1211 (9th Cir. 1998)
203
Although taxpayers can argue that September 30 of the year after death should be the important date to “fix” a
see through trust by, and I would still argue this in clean up mode, the IRS could argue that, except for disclaimers
that “relate back”, the Code and Regulations require there to be a beneficiary named by the owner/employee
pursuant to the terms of the plan and/or default under agreement to obtain status as a “designated beneficiary” at
the time of death, and if the trust changes terms significantly after that, it is arguably not the same beneficiary
post-reformation that it was at the time of death, hence no DB, even if effective for non-tax law. IRC §401(a)(9)
96
Thesecasesandrulingsthatdenytheeffectsofstatecourtproceedingscaneasilybe
distinguished.Mostofthemconcernedtaxpayerstryingtochangethelegaleffectofwhatthe
trusttermswereatthedeathoftheoriginaltransferor,afterthetaxableevent(i.e.,doesit
qualifyasamarital,charitableorseethroughtrustatdeath).Theydonotconcernwhata
transfereedecedentownedordidn’townatthetimeofatransferee’sdeath.
IRC§2041concernswhatrightsandpowersadecedenthasoverproperty.Iftrust
termschangesoastobelegallybinding,andgrantgreaterrightstothepowerholder,the
propertyrightsheldbythepowerholdermustchange.
InRev.Rul.73Ͳ142,agrantor/decedentestablishedatrustforhiswifeandchildren,
notsubjecttoascertainablestandards,andmistakenlyretainedthepowertoremoveand
becomethetrustee.204Yearspriortohisdeath,hewenttocourttosuccessfullyconstruethe
trusttomeanthathecouldnotbeappointedtrustee(nowadays,wewouldalsopreclude
removalandreplacementwithanyrelated/subordinateparty).205TheIRSruledthatthiscourt
orderhadtaxeffecttonegatetheIRC§2036/2038issuedespitethestatecourtdecreebeing
contrarytothedecisionsinthestate’shighestcourt.WhilethisisnotanIRC§2041case,this
Rev.Rul.bodeswellforsuchproactiveplanningtoaddalimitedGPOAforbettertaxresults.
OnePLRfollowingRev.Rul.73Ͳ142notedakeydifferencewithBosch:“Unlikethe
situationinBosch,thedecreeintheruling[73Ͳ142]washandeddownbeforethetimeof
eventgivingrisetothetax(thatis,thedateofthegrantor'sdeath).”206InthatPLR,astate
courtorderconstruingataxapportionmentclausetoapplytotheGSTnonͲexemptmarital
shareratherthanequitablytobothGSTexemptandGSTnonͲexemptshareswasgiveneffect.
Thiswasgoodproactiveplanningbycounselpriortothetaxingeventtokeepmorefundsina
GSTshelteredtrust.
Liketheaboverulings,anysuchmodificationstoensureanOptimalBasisIncrease
wouldsimilarlyaffectasurvivingspouse’srightsbeforethetimeofhisorherdeath,andwith
currenttrustlawtrends,suchreformationswouldunlikelyevenbecontrarytothestate’s
and Treas. Reg. 1.401(a)(9)-4, A-1. See PLRs 2002-18039, 2005-22012, 2005-37044, 2006-08032, 2006-20026,
2007-03047 and 2007-04033 (allowing reformation to affect tax result at death for IRA/trust), and more recent
trending PLRs 2007-42026, 2010-21038 (contra).
204
Rev. Rul. 73-142
205
Treas. Reg. §20.2041-1(b)(1), Rev. Rul. 95-58
206
PLR 2005-43037
97
highestcourt.Obviously,ifbeneficiariestrytofashionsuchasolutionafterbothparents’
deaths,thiswouldbeunavailingunderBoschandmanyotherdecisions.However,thereis
strongprecedentthatprivatesettlementagreements,courtactionspursuanttostatute,
decanting,trustprotectororothermethodstoaddaformulaGPOApriortothetimeofthe
eventgivingrisetothetax(thesurvivingspouse’sdeath),should(andmust)begiveneffect.
Thereverse,removingaGPOA,isamoredifficultissue,soanyreformationshould
stronglyconsidertheirrevocablenatureofit.Generally,releasingageneralpowerof
appointmentwouldtriggergifttax,andcouldtriggertaxationofanyIRD.207However,inone
recentPLR,theIRSallowedapostͲmortemcourtreformationtoessentiallyremoveaGPOA
withoutadversetaxeffect.208IwouldnotcountonthisresultforeverypostͲmortem
reformationremovingaGPOA,butthePLRisinstructiveastohowtheIRSappliesthe
SupremeCourt’sholdinginBosch.
c.
LimitingAmendmentstoKeepFidelitytoSettlor’sIntent
Anyaddedpowersofappointmentcanlimitappointeestocertaintrusts.Inour
exampleabove,ifJanehadnotbeengrantedalimitedpowerofappointment,thetrustee
mightdecanttoanearidenticaltrustwhichgrantsJanethelimitedtestamentarypowerto
appointcertainassetstotheJaneDoeIrrevocableDelawareTaxTrappingTrust,atrust
establishedwithtermsnearlyidenticaltoherhusbandJohn’strustforthechildren,only
grantingthechildrenaPEGpowercircumscribedusingtechniquesdiscussedabove.Indeed,
thiswouldbeamoreprudentexerciseofthetrustee’sdecantingpower(orcourt’spowerto
amend),sinceitwoulddolessharmtotheoriginalsettlor’sintentionsthanaddingabroad
LPOAorGPOA(indeed,manytrustspayoutrighttochildrenatsomepointanyway).209
While adding a limited lifetime or testamentary LPOA or formula GPOA, consider
changing any “all net income” requirement to a more flexible standard that would allow
spraying and/or accumulating income, and address capital gains, for better income tax
planning(seePartVIII).InarecentPLR,theIRSruledthatsuchamodificationthatremoved
the“allnetincome”requirementwasnotataxablegift,didnottriggergain,nordiditaffect
207
IRC §2514
PLR 2011-32017, see also PLR 2010-06005 approving reform of a GPOA to an LPOA w/o adverse tax effect
209
For a great summary of the more than 20 various decanting statutes and their characteristics, see
http://www.sidley.com/state-decanting-statutes/
208
98
the GST zero inclusion ratio.210 I believe the giving up of net income was not considered a
taxablegiftinthePLRbecauseanyaccumulatedincome,pursuanttothetrustamendment,
was payable to and would be included in the beneficiary’s estate. While this somewhat
curtailed the GST advantage of removing the “all net income” requirement, it may have
allowed high bracket beneficiaries to manipulate state income tax and increase asset
protection.
d.
Gift/EstateTaxEffectofBeneficiaryProcurementorAcquiescencetoAmendment
With all the above arguments that §2041 should still apply equally to
amended/reformed trusts, that is not to say that amendments may not have other effects.
Beneficiaryprocurementorevenacquiescencetotrustamendmentsmayhavedetrimentaltax
andassetprotectioneffects.ThisisarguablyoneofthemostunderͲdiscussedareasofestate
and asset protection planning in light of the tsunami of trust settlement agreements,
amendments and reformations increasingly being used by practitioners pursuant to the
UniformTrustCodeorotherlaw.211
TheSextoncaseisinstructivehere.212Sextoninvolvedanirrevocabletrust
establishedbyafatherforhissevenchildren.Thetrustwasduetoterminatetwentyyears
afterthefather’sdeath,butcouldbeamendedbyamajorityofthetrusteeswithconsentof
2/3ofthebeneficiaries.Thebeneficiariesconsentedtoextendthetrustpasttheoriginal
terminationdate.Onebeneficiary,Bertha,diedaftertheoriginalterminationdatebut
beforetheamendedterminationdate.TheIRSarguedthattheamendmentwasineffective,
butifnotineffective,stillconstitutedatransfersubjecttoIRC§2036.Thedistrictcourtheld,
and7thCircuitconfirmed,thattheamendmentwaseffectivepursuanttothetrustandstate
law,butthathercomplicityinthisamendmentmadeheradefactotransferorfor§2036
purposes.Sinceshehadarighttofundsattheoriginalterminationdate,heracquiescence
wasarelinquishmentofthatright,whichmaybeconsideredatransferofpropertyfor
estate/gifttaxpurposes.Importantly,thecourtnotedhadthebeneficiarynotconsented,
theirargumentthattheamendmentwasnotarelinquishment/transferandthereforehadno
210
PLR 2013-20004, modifications complying with GST grandfathering regs were OK for allocated GSTexempt
This is not to blame the Uniform Trust Code – many such options were probably available under common law
before anyway, or in non-UTC states, but the UTC undoubtedly creates clarification, interest and awareness.
212
Sexton v. U.S., 300 F.2d 490 (7th Cir. 1962), cert denied 371 U.S. 820 (1962)
211
99
taxeffect“mightbepersuasive”–butthebeneficiary’sactiveconsentkilledherestate’scase,
eventhoughtheamendmentcouldhavebeenaccomplishedwithoutherconsent.Another
waytolookatthiscase(notdiscussedintheopinion)istoseeeachbeneficiaryasexercisinga
GPOA(althoughotherparties’consentwasrequired,theymayhavebeennonͲadverse
parties).Ofcourse,thefamilyinSextonwastryingtoavoidinclusion–whatif,asposited
herein,inclusionisthegoal?Notalltransferswithretainedinterestareevil.
Therewasadistrictcourtcasethatheldtothecontraryonsimilarfacts(thoughthe
issuewaswhethertheextendingamendmentcreatedagrantortrustratherthanan
estate/gifttaxcase).213TheBrookscourtfoundthatexercisingsuchpowers(analogizingto
limitedpowersofappointment)grantedbythetrustwerenottransfersofproperty.This
districtcourtcasereasoningwasrejectedbythe7thCircuitinSexton,butitalsolaysoutthe
contraryargumentthatmightbecitedin“cleanupmode”,andmaybeausefulcitationwhen
amendingtruststogainbetterongoingincometaxresultsasdiscussedinPartVIII.
AnotherrecentPLRhighlightsthegifttaxissue:amotherwasthecurrentbeneficiary
(andcoͲtrustee)ofatrustandentitledtoincomeandprincipalonlyatthetrustee’sdiscretion
forHEMS.Shedidnotneednorwantanydiscretionarydistributions,hadnevertakenany,
andneverexpectedto.Herchildrenwereremaindermen.Mother,childrenandtrustees
petitionedlocalcourtforanearlydistributiontothechildren,whichwouldbeallowedwith
consent,aslongasitdidnotfrustratethesettlor’smaterialpurposeofthetrust.TheIRSheld
favorablyonGSTandincometaxresults,butheldthat,althoughthegiftmaybe“nominal”,
thereisstillataxablegiftbythemotherforgivingupherrights,howeverspeculativein
value.214TheIRSofferednoguidanceastohowtovaluesuchadiscretionaryinterest.
Thelesson:procurementorevenactiveacquiescencetocreatingaGPOAorevenLPOA
thatcoulddivestabeneficiaryofapropertyrightcouldbeatransferandtaxablegift.E.g.,
momislifetimebeneficiaryofbypasstrust,remaindertoson.Momandsonagree,pursuant
tononͲjudicialsettlement,thetrustorotherstatelaw,togivemomaGPOA.Asstatedin
discussionsofauthoritycitedabove,theIRSwouldprobablyhavetohonorthischangein
propertyrightsatmom’sdeathifpursuanttostatelaw.However,couldsonbesaidtohave
213
214
Brooks v. Welch, 29 F.Supp. 819 (D. Mass. 1938)
PLR 201122007, see also similar PLR 8535020
100
madeanincompletegiftbyconvertinghisvestedremainderinterestintoavestedremainder
interestsubjecttodivestment?Couldthistrigger§1014(e)ifdonewithinoneyearofmom’s
death?Astohowmuch?Ifthepropertycomesbacktoson,the“gift”wouldbetohimself
(butpotentiallycreatingaselfͲsettledtrustifappointedtohimintrust),butifmomappoints
toherson’schildren,wouldthismaketheson’stentativedefactogiftofhisremainder
interestbyconsentingtotheGPOAcomplete?Thisismerespeculation,andprobablymakes
morethanafewreaders’headsspin.Here’sthenutshell–itissafertoavoidthismorassof
issueswithamendingactionsinitiatedbyanindependenttrusteeortrustprotectoronly.215
e.
AssetProtectionEffectofBeneficiaryProcurementorAcquiescencetoAmendment
Itisonlyamatteroftimebeforesuchargumentsareusedbycreditorsandbankruptcy
trusteestoattackanytrustsamendedinsuchmannerasselfͲsettledtrusts.Therearecases
thatbustsuchamendedtrustswhenthereisnoclearamendmentpowerinthetrustorstate
law,butIwouldcautionthatsuchcasesmightbeextendedeventocasesinwhicha
debtor/beneficiarytakesotheractionstoextendatrustpursuanttostatelaw.216
Ifthecourtorderisretroactivenuncprotunc,asatrustconstructionmightbe,thereis
agoodargumentthatthedebtorshouldbeabsolvedfromanyfraudulenttransferclaims
similartotherelationbackdoctrinegoverningsuchrulesfordisclaimersinmoststates.217
f.
AmendmentsorModificationsAffectingGSTExemption
Couldanyamendments/modificationsaffectGSTexemption?Notundermost
circumstances,butthisisyetonemoreissuetoexaminewhenmodifyingirrevocabletrusts.
OTHERCHANGES.
(1)Amodificationofthegoverninginstrumentofanexempttrust(includingatrustee
distribution,settlement,orconstructionthatdoesnotsatisfyparagraph(b)(4)(i)(A),
(B),or(C)ofthissection)byjudicialreformation,ornonjudicialreformationthatis
validunderapplicablestatelaw,willnotcauseanexempttrusttobesubjecttothe
provisionsofchapter13,ifthemodificationdoesnotshiftabeneficialinterestinthe
trusttoanybeneficiarywhooccupiesalowergeneration(asdefinedinsection2651)
thanthepersonorpersonswhoheldthebeneficialinterestpriortothemodification,
215
See Gifts by Fiduciaries by Tax Options and Elections, cited and discussed on page 24, footnote 56.
Hawley v. Simpson (In re Hawley), 2004 Bankr. LEXIS 173 – finding that an extension of trust by beneficiaries
created a self-settled trust, negating 11 USC §541(c)(2)’s ordinary protection/exclusion of third party spendthrift
trusts, making it accessible to the beneficiary’s bankruptcy estate. For more on busting third party trusts, how such
actions might trigger fraudulent transfers and asset protection, see author’s separate asset protection CLE outlines.
217
See discussion in the Uniform Disclaimer of Property Interests Act, §§6-7
216
101
andthemodificationdoesnotextendthetimeforvestingofanybeneficialinterestin
thetrustbeyondtheperiodprovidedforintheoriginaltrust.218
Butaswe’vesaidbefore,fewerpeoplearewealthyenoughtocareaboutthegift/GST
taxmuchanymore,buttherecouldalsobeargumentsthatamendments/reformationsnot
donebythetrusteeviadecantingorcourtpetitionortrustprotectormightnotbeeffective.
YoucannotcreateaGPOAforyourself,norcanyoucreateaGPOAifitisexercisablein
conjunctionwiththedonorofthepower.219Well,whoisthedonorofthepowerinsuchan
instance?Isitstilltheoriginalsettlor,asitwouldbewithadecantingortrustprotector
powerthatisessentiallyexercisingalimitedfiduciarypowerofappointment?Perhaps,ifthe
reformationisretroactive.Or,mighttheIRSclaimthataspouseandchild,forexample,are
thedonorsofthepowerinsuchinstance?Youwouldbeinabetterpositionwithacourt
orderstatingthatsuchanamendmentismerelyconstruingorreformingthetrusttocomport
withthesettlor’soriginalintentbycreatingtheLPOA/GPOA,sothatitismoreanalogoustoa
decanting/amendmentpursuanttotheoriginaltrustterms.However,thereisnoclear
guidancehere.
g.
Decantingwithmorecommon“HEMSstandard”trustswithoutabsolutediscretion
Thereisanunderstandablemisconceptionthatdecantingcanonlybeaccomplished
withtrustshavingabsolutediscretion.However,manystateshaveadualtrackmodeof
decanting,onelevelofdecantingthatisapplicabletowidediscretion,onethatisnot.Ohiois
illustrative:OhioR.C.§5808.18laysouttwolevelsofdecantinginparagraphsA(absolute
discretion)andparagraphB(lessthanabsolutediscretion).Theformeriswellknown,similar
tomanyotherstatesandevenismeanttocodifyOhiocommonlaw.
Thelatterisamoredifficultcase,butsuchtrustsaremuchmorecommon.Why?
BecausemanycoupleswantedtonametheirspouseasbothbeneficiaryandtrusteeorcoͲ
trustee,sothereiscommonlyaHEMSstandardinBypassTrusts.
ParagraphBofOhio’sdecantingstatutestillpermits“distributingalloranypartofthe
principalsubjecttothepower,andalloranypartofanyincomethatisnototherwise
218
219
Treas. Reg. §26.2601-1(b)(4)(i)(D):
IRC §2041(b)
102
currentlyrequiredtobedistributed,tothetrusteeofasecondtrust.”,butthereisthe
additionalrequirementthat“Theexerciseofatrustee'spowerunderthisdivisionisvalidonly
ifthegoverninginstrumentforthesecondtrustdoesnotmateriallychangetheinterestsof
thebeneficiariesofthefirsttrust.”
Thisofcoursebegsthequestionwhetherthenarrowlycraftedchangesanticipatedby
thispaperwouldmateriallychangetheinterestsofthebeneficiariesoftheoriginaltrust.How
doyoudefinematerial?Iftimepermitsyoucouldgetthelocalprobatecourttoapproveit.
Ofcourse,ifyougotoprobatecourt,moststatesprovidemuchcleareravenuesfor
thetrusteetoaccomplishacourtreformationtoachievetheexactsameresult,withoutthe
uncertaintythata“nonͲabsolutediscretion”decantingentails,soanycourtpetitionmightask
foralternativeremedies:approvethedecanting,butifyoucan’tapprovethedecanting,
reformthetrust.220Thedrawbackstocourtpetitionsvarystatetostate,butareessentially
thesameasforanycourtprocess–istheremuchcost/delay?Willtherebedifficultygetting
allthenecessarybeneficiariesservedandpossiblyguardiansappointedforminorchildrenor
incompetentbeneficiaries?Mightsomeoneobjectatahearing?Decantingavoidsmanyof
theseissues,ifit’sclear,butacourtorderwouldleadtoamuchmorecertainresultwhen
thereisnotabsolutediscretiontodecant.Perhapsthereisastatedecantingstatutethat
wouldclearlyapplyinsuchsituations,butIhavenotexaminedthestatutes(twentyͲtwo
jurisdictionsbylastcount,whichwillsurelyincrease).
h.
Whylegitimatemodificationsaresuperiorto“selfͲhelp”terminations
Speakingaroundthecountryonthistopic,onehearsanecdotalevidenceoffamilies
simplyterminatingABtrustswherethereisnoestatetaxconcern–thequestionposedto
attorneysbeing“sowhatifwejustterminatethetrust?”Despitealltheassetprotection
concerns,andremoteconcernsofgrandchildrensuingtheirparents,etc,thismaynotleadto
theestateinclusion/stepupthatfamiliesbelievetheywouldachieve,sinceitmaybevoid.221
Uniform Trust Code §§411-418. E.g. Ohio R.C. §5804.16 Modification to achieve settlor's tax objectives
“To achieve the settlor's tax objectives, the court may modify the terms of a trust in a manner that is not contrary
220
to the settlor's probable intention. The court may provide that the modification has retroactive effect.”
E.g. N.Y. Estates Powers and Trusts Law § 7-2.4. Act of trustee in contravention of trust. If the trust is
expressed in the instrument creating the estate of the trustee, every sale, conveyance or other act of the trustee in
contravention of the trust, except as authorized by this article and by any other provision of law, is void.
221
103
VIII.
TheIncomeTaxEfficiencyTrust–OngoingTrustIncomeTaxPlanningTechniques
AsmentionedaboveinPartI,thereisanotherincometaxissueafterATRAthatmay
nowdissuadetheaveragecouplefromusingongoingtrustsforplanning.Withthenewtax
regime,unlessweplan,administerandinvestcarefully,theoverallincometaxtothesurviving
spouseandfamilywillbehighereveryyear,sometimesbyaconsiderableamount.
Creative use of IRC §643, §678(a) and/or §642(c) provisions can ensure that capital
gains are not trapped in trust at the highest rates, may get better tax treatment for special
assets, and may even be sprayed to beneficiaries or charities in much lower (or even 0%)
brackets.ThefirstflowchartbelowoutlinestheongoingtaxeffectofthetraditionalABtrust
structureandthesecondflowchartenvisionsmoreefficientvariationsthatwillbediscussed.
John & Mary Doe Trust
(could be joint trust or two
separate trusts)
At John’s Death
John Doe Bypass (Credit Shelter)
Trust Fbo Spouse (& children?)
< $5.34mm (or basic exclusion
amount)
John Doe Marital Trust
Fbo spouse only,
> $5.34mm (or basic exclusion
amount)
Tax Effect to Mary and the Doe Family,
Capital Gains taxed at 23.8%
(long term)/43.4% (short term);
Ordinary income at 23.8%
(QD)/43.4% if not distributed
during Mary’s life
Capital Gains taxed at 23.8%
(long term)/43.4% (short term);
Ordinary income at 23.8%
(QD)/43.4% if not distributed
Theabovereferstotrusttaxratesonincomeexceeding$12,150in2014(thisnumber
is adjusted for inflation). Certain income such as qualified plan or IRA distributions may be
subjecttoalowertopratebecauseitisexemptfromthe3.8%Medicaresurtax.HigherlongͲ
term capital gains rates on depreciation recapture and collectibles are also ignored. “QD”
refers to qualified dividend rate. The trapping of taxable income at trust rates might be
exacerbatedfurtherdependingonstateincometaxationoftrustsaswell.
104
John & Mary Doe Trust
(joint or separate trusts)
With Different Income Tax
Provisions to Shift Tax
John Doe Bypass (Credit Shelter)
Trust Fbo Spouse (& children?)
< $5.34mm (or basic exclusion
amount)
John Doe Marital Trust
Fbo spouse only,
> $5.34mm (or basic exclusion
amount)
All income can be taxed at
spouse's, children's or even
charity's tax rate, to extent
distributed or subject to withdraw
All income can be taxed at
spouse's tax rates if distributed or
subject to withdrawal (no ability
to spray to children or charity)
a.
ChangestoTrustIncomeTaxationWroughtbyATRAandtheACA
First, let’s pause for a refresher on how the new tax regime, including the Medicare
surtax,affectsnonͲgrantortrustsandbeneficiaries,andwhy2013changesthegame.
Forindividuals,the3.8%taxwillapplyin2013tothelesserofnetinvestmentincome
ortheexcessofataxpayer’smodifiedadjustedgrossincome(MAGI)over:
x
$125,000(marriedfilingseparately)
x
$250,000(marriedfilingjointlyandqualifyingwidower)
x
$200,000(single)(individualthresholdsinIRC§1411(b))
The“modified”appliestothosewholiveabroadandusetheforeignearnedincome
exclusion–for99%oftaxpayers,thisisthesameasadjustedgrossincome(AGI),thebottom
lineofForm1040.
Forestatesandtrusts,itappliestothelesseroftheundistributednetinvestment
incomeortheexcessofanestate/trust’sadjusted(notmodified)grossincome(AGI)over
x
$11,950(toptaxbracket,adjustedforinflation)(IRC§1411(a)(2))
“Netinvestmentincome”is
105
“A(i)grossincomefrominterest,dividends,annuities,royalties,andrents,otherthan
suchincomewhichisderivedintheordinarycourseofatradeorbusinessnot
describedinparagraph(2),
(ii)othergrossincomederivedfromatradeorbusinessdescribedinparagraph(2),
and
(iii)netgain(totheextenttakenintoaccountincomputingtaxableincome)
attributabletothedispositionofpropertyotherthanpropertyheldinatradeor
businessnotdescribedinparagraph(2),
[Minus,]
(B)thedeductionsallowedbythissubtitlewhichareproperlyallocabletosuchgross
incomeornetgain.”222
Qualifiedretirementincomeisexcluded,aswellaswages,selfͲemploymentincome,
activebusinessincomeorgainfromasaleofsuchabusiness.223
Therearemanybasicwaysofrestructuringfinancesandinvestmentstoavoidthe
surtax,mostofwhichalsoavoid/deferincometax,suchas:
x
usingtaxexemptinvestmentssuchasmunicipalbonds;
x
usinginvestmentsoraccountswithtaxdeferralfeaturessuchaslifeinsurance,
deferredannuitycontracts,deferredcomporretirementplans;
x
utilizingtraditionaltechniquestodeferrecognition/timingofgains,suchastaxͲfree
exchanges,installmentsalesorcharitableremaindertrusts;
x
investinginassetswithtaxdepreciationfeatures,suchastraditionalrealestateoroil
andgasinvestments;
x
moresensitiveattentiontotaxrecognition,suchasusinglowturnoverfunds,ETFs
and/ormanagingindividualstocksandbonds;
x
acceleratingthetimingofincomerecognitioninto2012,viaRothIRAconversions,
distributingCCorporationdividendsorharvestinglongͲtermcapitalgains;
x
fordecedent’sestate/qualifyingtrusts,electingfiscalyearsending/beginningin
November,2012(thetaxappliestoyearsbeginningafterDec31,2012,soaDec1,
2012ͲNov31,2013fiscalyearallowselevenmonthsof2013incometoavoidsurtax).
222
223
IRC § 1411(c)(1)
IRC §1411(c)(2),(4),(5),(6)
106
Mostofthesetechniquesarenotnewtothesurtaxandhavetraditionallybeenused
forbasicincometaxplanning.Whilesomeareeffectiveplanningforanyyear,overusecan
simplybecomethe“taxtailwaggingtheinvestmentdog”.
Thisoutlinewilldiscussmoreuniqueopportunitiesandpitfallsofthisnewsurtaxand
highertaxratesasappliedtoongoingnonͲcharitable,nonͲgrantortrusts,224throughmore
proactivetrustdrafting,planningandadministration.Withoutsuchplanning,manytrustswill
getstuckpayingataxthatmightbeeasilyavoided(orreduced).First,we’llsetforthatypical
exampleofthebasicproblem,thenexplorepotentialsolutionstoavoidthehighertaxes.
Thefirstexamplebelowassumesthatalltrust/beneficiaryincomeisotherwisesubject
tosurtaxpursuanttoIRC§1411(c)(i.e.,interest,dividends,capitalgains,annuities,rents,
royalties,passiveactivityincome,notretirementincome,municipalbondinterest,active
businessincome,saleofactivebusinessorotherexception)andanycapitalgainsisnotwithin
aspecialtaxratecategory(suchasdepreciationrecaptureor28%rateforcollectibles).225The
$100/$300personalexemptionandothercommondeductibleexpensesareignoredfor
simplicity,aswellasanystateincometaxes.
CONSIDER:Barbara,recentlywidowed,istheprimarybeneficiaryofa$2million
bypasstrustestablishedbyherlatehusband.Herincomeoutsidethetrustis$70,000.For
2013,thetrusthasordinaryincomeof$40,000(whichIhaveassumedtobealsoequaltothe
trust’saccountingincomeanddistributablenetincome(DNI)),shortͲtermcapitalgainsof
$30,000,andlongͲtermcapitalgainsof$70,000.Thetrusteeallocatesallcapitalgainstotrust
principal.Initsdiscretion,thetrusteedistributestoBarbaraalloftheaccountingincome
($40,000)aswellasadiscretionarydistributionofprincipalof$75,000neededforher
support.Thetrustisentitledtoadistributiondeductionofonly$40,000andhastaxable
incomeof$100,000(thesumofitsshortͲtermandlongͲtermcapitalgains).
224
It does not apply to fully charitable trusts or charitable remainder trusts – see page 135 of the Congressional
Joint Committee on Taxation Report JCX-18-10, IRC §1411(e), Treas. Prop. Reg. §1.1411-3(b). This article will
skip discussion of the surtax and higher rates as applied to estates, because it will often be less of a problem, due to
recent step up in basis, higher than usual deductions such as attorney, executor and probate fees, and the fact that
terminating estates pass out capital gains as part of DNI – but estates taking over a year to settle or pouring over
into a trust will involve the same issues.
225
See IRC §1(h) for special capital gains tax rates, IRC §408(m) for definition of collectibles. For an outstanding
article on the 3.8% surtax applied to businesses owned by trusts/estates, see 20 Questions (and Answers!) on the
New 3.8% Surtax, by Richard L. Dees, Tax Notes, August 2013
107
The$75,000principaldistributionisnotordinarilyincludedaspartofwhatiscalledthe
“DNIdeduction”.226Itisthislatteraspectoftrustincometaxationthatisoftenoverlooked
andmisunderstoodbypractitioners,andispotentiallythesourceandtrapforhighertax.
Oncethetrustisover$11,950oftaxableincome(roughly$88,050inthiscase),itistaxedat
39.6%(20%ifLTCG/qualifieddividends),plus,unlessitmeetsanexceptionsuchasIRAor
qualifiedplandistributions,itisalsosubjecttothe3.8%surtax.227
Backtoourexampleandtheneweffectofthehigherratesandthesurtax:beginning
in2013,allofthatshorttermcapitalgains(after$11,950)issubjecttotopincometaxrate
(39.6%),plusthe3.8%surtax.AllofthelongͲtermcapitalgainsissubjecttoatoplongͲterm
capitalgainstaxrateof20%,plusthe3.8%surtax.Canweworksometrustaccounting
alchemyallowcapitalgainstoescapebeingtrappedinthetrust?Inourexample,thismay
allowinvestmentincometocompletelyavoidthesurtaxandlowertaxesonshortͲtermand
longͲtermcapitalgainsaswell.ThiswouldsubjecttheshortͲtermgainstoamere25%or28%
taxinthehandsofthebeneficiary(thelowerratewouldapplyifBarbaraisaqualifying
widowerorremarried),insteadof43.4%(39.6%+3.8%surtax),andsubjectthelongͲterm
gainstoamere15%inthehandsofthebeneficiaryinsteadof23.8%(20%+3.8%surtax).
Potentialtaxsavinginthisexampleifnocapitalgainsistrappedintrust(assuming
remarriageorqualifyingwidowfilingstatus,ifnot,savingsslightlyless):
23.8%Ͳ15%(8.8%)timestotalLTCG($70,000)=$6,160
(amountofoverallLTCGandsurtaxsavingsbytaxingtobeneficiarynottrust)
plus 43.4%Ͳ28%(15.4%)timesSTCG($30,000Ͳ$11,950)=$2,780
(amountofSTCGandsurtaxsavingsfromtaxingtobeneficiary,nottrust)
(forsimplicity,we’llassumethefirst$11,950taxedtothetrustwouldgenerate
approximatelythesametaxiftaxedtothebeneficiary)
TotalPotentialTaxSavings,Annually=$8,940
226
IRC §643(a)(3), Treas. Reg. §1.643(a)-3(a)
For rules on how the surtax applies subchapter J principals to trusts, see Treas. Prop. Reg. §1.1411-3, which can
be found online at http://www.gpo.gov/fdsys/pkg/FR-2012-12-05/pdf/2012-29238.pdf
227
108
Ifabeneficiaryisotherwiseinthehighesttaxbracket(currently$400,000/yrsingle,
$450,000MFJtaxableincome),thenthefactthatincomeis“trapped”inabypass/marital
trustin2013atthehighestbracket,plusa3.8%taxmakesnodifferenceͲshewouldhave
paidthatsameleveloftaxanyway.228Whetherincomeistaxedtothetrustortosucha
beneficiarywouldusuallybeincometaxrateandMedicaresurtaxͲneutral.Mosttrust
beneficiarieswillnotfitinthiselitebracketoftaxableincome,however.And,evenhighͲ
brackettaxpayersmayhavecapitallosscarryforwardsthatcouldsoakupdistributedcapital
gains.
Butifdistributionstandardswouldotherwiserequireorpermitsignificantdistributions
fromprincipaltobemadetothebeneficiary,thenwhynotarrangetheaccountingofthose
samedistributionsinthemosttaxͲeffectivemanner?
Somefamilysituations,suchassecondmarriageswhereasettlorwantsthemaximum
proscriptiononthespouse’sdistributionsandmaximumremainderforbeneficiaries,donot
offermuchinthewayofflexibility.Wearemostlyleftwithstandardincometaxdeferral
techniques.Butformanyfamilies,therearegoodoptionstoavoidthisfateofhigherongoing
trusttaxation,especiallyifweareindraftingmodeorhavenotyetestablishedanyhistoryof
trustaccountingandadministration.
Therearetwomainmethods–1)usingIRC§678(a)toallowthespousetowithdraw
allormostnettaxableincome,specificallyincludingallnetcapitalgainsor,usuallybetter,2)
comingwithinoneofthethreeexceptionsinTreas.Reg.§1.643(a)Ͳ3(b)whichallow
discretionarydistributionstocarryoutnetcapitalgains.229
228
As to state income tax, trusts may pay tax in multiple states, or avoid all state income tax, depending on the
circumstance – see Section VIII.n. on Incomplete Gift Non-Grantor Trusts, which discusses state trust income tax
229
Another less desirable method to pass out capital gains to beneficiaries is for the trust to invest in an entity
taxed as a partnership. Cash distributed from an entity such as a partnership/LLC and paid to the trust is generally
trust accounting income, even if the cash is derived from capital gains - Uniform Principal and Income Act,
§401(b). Thus, because they are “properly allocated to income” pursuant to Treas. Reg. §1.643(a)-3(b)(1), they
may be included in the DNI deduction and pass out to beneficiaries on the K-1 as any other income. This, of
course, does not help if there are “phantom gains” or cash distributions are not sufficiently made from the
partnership to the trust. To structure an entire portfolio in this manner is highly unwieldy. Assuming the other
partner can be found and the fiduciary duties worked out, there would still be issues under IRC §2519 if it were a
QTIP trust, and one can imagine other practical problems in managing a large portion of the trust in this manner –
not to mention the additional tax reporting.
109
b.
IRC§678(a)andthe“BeneficiaryIncomeͲControlledGrantorTrust”
Atrustthatmerelydirectsallnetincomebepaid,orevenpaysalltaxableincome,toa
beneficiary,isNOTtriggering§678–suchtrustsmustreportunderthe1041/KͲ1SubchapterJ
taxregime.230Tobetaxabledirectlytothebeneficiary,andreporteddirectlyonthe
beneficiary’sForm1040,thebeneficiarymusthaveanunfetteredrighttowithdrawthe
taxableincomeinquestion(notlimitedtoanascertainablestandard,orwithrequiredconsent
ofanotherparty).Thispaperwillrefertosuchtrustsas“Mallinckrodttrusts”,orsimply,
“§678(a)trusts”.231Let’sfirstwalkthroughhowIRC§678(a)works,thendistinguishsuch
trustsfromarelatedbutdifferentvariant,the“beneficiarydefectiveinheritor’strust(BDITs)”,
andthenexploresomeofthepossibilitiesandlimitationsofsuchstructures.
IRC§678(a)requiresthatabeneficiarybeconsideredtheownerofanyportionofa
trustwhenabeneficiaryhasthepowertowithdrawincome:
a)Generalrule
Apersonotherthanthegrantorshallbetreatedastheownerofanyportionofatrust
withrespecttowhich:
(1)suchpersonhasapowerexercisablesolelybyhimselftovestthecorpusorthe
incometherefrominhimself,or
(2)suchpersonhaspreviouslypartiallyreleasedorotherwisemodifiedsuchapower
andafterthereleaseormodificationretainssuchcontrolaswould,withinthe
principlesofsections671to677,inclusive,subjecttograntorofatrusttotreatmentas
theownerthereof.
Manypractitionersmistakenlyinterpret§678withoutthe“or”in§678(a)(1),asifit
onlyapplieswhenthebeneficiaryhas(orhad)therighttowithdrawtheentireprincipal
(corpus)ofthetrust.232Thisisacommonlyacceptedmyth,butunderstandable,sincethere
230
In Subchapter J, Subparts A-D, IRC §641-669, control most traditional trust tax accounting, Subpart E is the
grantor trust rules, §671-679.
231
Mallinckrodt Trust is a term named after the seminal case of Mallinckrodt v. Nunan, 146 F.2d 1 (8th Cir. 1945),
which Congress basically codified in IRC§678 in 1954.
232
This is probably due to, but not the fault of, recent popular articles about “beneficiary defective inheritor’s
trust” (BDIT) techniques, which attempt to use third party created trusts with Crummey withdrawal rights and
lapses to create irrevocable trusts post-lapse that are taxed for income tax purposes to the current beneficiary, even
if the beneficiary has no current withdrawal right. Their use is limited because of the $5,000/5% lapse limitation
of IRC §2041, but they are a creative use. Those techniques hinge on using §678(a)(2), in conjunction with
§678(a)(1). This article focuses on a different but related variant of this concept, where the beneficiary has a
current withdrawal right over taxable income. For great “BDIT” material, see Gift From Above: Estate Planning
On a Higher Plane, Trusts and Estates, November 2011, by Richard A. Oshins, Lawrence Brody, Jerome M.
Hesch & Susan P. Rounds; The BDIT: A Powerful Wealth Planning Strategy When Properly Designed and
110
havebeenextremelyfewreportedcasesorrulingsontruststructuresthatonlyallow
withdrawalpowersoverincomeandtreatiseshaveverylittleifanydiscussionofthispotential
variation,forthelogicalreasonthatpractitionersdon’tnormallydrafttruststhisway.233Yet.
Butthereisnoreasontoignorethe“or”inthestatuteandnorequirementunder§678thata
beneficiary/powerholderhaveanypowerovercorpuswhatsoever.Infact,theseminalcase
thatthestatuteitselfwasbasedonhadnobeneficiaryrighttowithdrawunderlyingprincipal.
Forinstance,atrustmayprovidethattheprimarybeneficiaryhastheunfetteredright
towithdrawallnetincome.234Unlessdefinedotherwiseinthetrust,thismeansthe
beneficiaryistaxedonlyonfiduciaryaccountingincome(dividends,interest,rents),butnot
necessarilyalltaxableincome.Forinstance,atraditionalIRAdistributionmightbe100%
taxableincome,butonly10%accountingincome,andcapitalgainswouldnotusuallybe
accountingincomeeither.235Conversely,atrustmightgrantabeneficiaryawithdrawalright
overincomeattributabletoprincipal,butnotaccountingincome,andthiswouldshiftonly
thatincome(e.g.nottheinterest,dividends,rents)tothebeneficiary.236Butatrustcould
easilydefinethewithdrawalrighttoincludecapitalgainsortaxableincomefromaparticular
asset,orallassetsofatrust.Courtsmustlooktothedefinitionofincomeinthewithdrawal
rightunderthetrustinstrument,andifabeneficiarycanwithdrawcapitalgains,thenthe
beneficiarymustreportthecapitalgains.237ItisnotoptionaltoreportunderSubpartsAͲDof
SubchapterJand/orhavethetrustbeliableforthetax.
Implemented, LISI Estate Planning Newsletter #1824 (June 22, 2011), by Dick Oshins, Larry Brody and Katarinna
McBride; A Balanced Solution, Trusts and Estates, May 2011, by Steven Gorin
233
Treatises consulted include Federal Income Taxation of Estates and Trusts, 3rd edition, ¶12.01-12.05, Zaritsky
and Lane, BNA Portfolios 858-2nd and 852-3rd Grantor Trusts: Sections 671-679, by Howard Zaritsky, Income
Taxation of Trusts and Estates, by Alan Acker, and Federal Taxation of Trusts, Grantors and Beneficiaries, by J.
Peschel & E. Spurgeon
234
There are colorable arguments that a sole beneficiary/trustee might also trigger §678(a) even when limited by
an ascertainable standard, but this is debatable and generally unreliable for proactive planning purposes. Most
cases (and you can find many by shepardizing the Mallinkrodt case) find that even the slightest limitation will take
a powerholder out of grantor trust status. This paper will assume there are no forfeiture provisions, consent
requirements, duties or purposes otherwise fettering the right. See pages 17-20 of Howard Mobley’s outline at
http://www.howardmobley.com/articles/FixingBrokenTrusts.pdf and Jonathan Blattmachr, Mitchell Gans and
Alvina Lo’s article at http://ssrn.com/abstract=1511910. Also, read the surprising conclusion of the penultimate
paragraph of Koffmann v. U.S., 300 F.2d 176 (6th Cir. 1962).
235
See Uniform Principal and Income Act, §409, §404
236
Treas. Reg. §1.671-3(b)(2)
237
For example, in U.S. v. De Bonchamps, 278 F.2d 127 (9th Cir. 1960), the court found, in interpreting §678, that
a life tenant should not be taxed on the income because they did not have the sole power to take the capital gains
111
TreasuryRegulationsarequiteclearthat“income”in§678(a)referstotaxableincome,
notaccountingincome:
“(b)SincetheprincipleunderlyingsubpartE(section671andfollowing[26USCS§§
671etseq.]),partI,subchapterJ,chapter1oftheCode,isingeneralthatincomeofa
trustoverwhichthegrantororanotherpersonhasretainedsubstantialdominionor
controlshouldbetaxedtothegrantororotherpersonratherthantothetrustwhich
receivestheincomeortothebeneficiarytowhomtheincomemaybedistributed,itis
ordinarilyimmaterialwhethertheincomeinvolvedconstitutesincomeorcorpusfor
trustaccountingpurposes.Accordingly,whenitisstatedintheregulationsunder
subpartEthat"income"isattributedtothegrantororanotherperson,the
reference,unlessspecificallylimited,istoincomedeterminedfortaxpurposesand
nottoincomefortrustaccountingpurposes.”238
Refusingtotaketheincomeisnotrelevanttotheanalysis,norisrenouncingtheright
topriorincome.239Althoughawithdrawalpowerisprobablyeffectivefor§678(a)regardless
ofabeneficiary’scapacity,itwouldbeprudenttospecificallyallowanagentunderadurable
powerofattorneyorcourtͲappointedconservatororguardiantoexercisetheright.240
Ifatrusthasa5%ofcorpuswithdrawalpower,then5%ofthetaxableincomeshould
bereportedonthepowerholder’sForm1040(regardlessofwhetheritlapsesoristaken).241
Ifthepowerholderhasthepowertowithdrawalupto$30,000fromtaxableincome,thenthat
muchshouldbereporteddirectlyonthepowerholder’sForm1040,subjecttothetrustee’s
grantortrustreportingrequirementsunderTreas.Reg.§1.671Ͳ4.242
Thegranddaddyofallgrantortrustcases,Mallinckrodt,fromwhichCongressbasically
codifiedin1954intoIRC§678,concernedafatherwhoestablishedatrustforhisson,his
son’swifeandtheirchildren.243Theson’swifewastoget$10,000/yr,andthesoncould
upon sale of the underlying asset. “We have concluded that, upon the record before us, the powers of these life
tenants are not the equivalent of a power to vest in themselves the corpus of the estate or the capital gains in
question.” (emphasis added, the court clearly implying that if they could have taken the capital gains, though not
necessarily the entire corpus, it would have been taxed to them).
238
Treas. Reg. §1.671-2 Applicable Principals
239
Grant v. Commissioner, 174 F.2d 891 (5th Cir. 1949).
240
Generally GPOAs are unaffected by a powerholder’s incapacity, see footnote 69, and §678(a) should follow.
241
Rev. Rul. 67-241
242
In Townsend v. Commissioner, 5 T.C. 1380 (1945), the beneficiary, pursuant to a state court order after a
dispute, had the unfettered right to withdraw up to $30,000 annually, and the tax court held this much must be
reported directly on the powerholder/beneficiary’s tax return.
243
Mallinckrodt v. Nunan, 146 F.2d 1 (8th Cir. 1945), this same reasoning is followed in other cases where
beneficiaries had no withdrawal right over the entire principal, but only the income. E.g. Spies v. United States,
180 F.2d 336 (8th Cir. 1950), Goldsby v. Commissioner, T.C. Memo 2006-274 (where taxpayer/beneficiaries
112
withdrawanyincomeabovethat.Thetrusteereportedalltheincome,includingthe
undistributedincomethatthesoncouldhavewithdrawnbutdidnot,anddeductedthe
$10,000distributiontothewife.Thecourtheldthatreportingofincome/deductionforthe
$10,000wasproper,butthattheundistributedincomethatthesoncouldhavewithdrawn,
butdidnot,mustbereportedonhistaxreturnasincome:
[The]“powerofthepetitionertoreceivethistrustincomeeachyear,uponrequest,
canberegardedastheequivalentofownershipoftheincomeforpurposesof
taxation.***incomeistaxabletothepossessorofsuchpower,andthatlogicallyit
makesnodifferencewhetherthepossessorisagrantorwhoretainedthepowerora
beneficiarywhoacquireditfromanother.*** Sincethetrustincomeinsuitwas
availabletopetitioneruponrequestineachoftheyearsinvolved,hehadineachof
thoseyearsthe"realizable"economicgainnecessarytomaketheincometaxableto
him.”244
WhileMallinckrodtdidnotspecifyordiscusswhethercapitalgainswasincludedinthe
trust’sdefinitionofwithdrawableincome,itisclearfromthecasethatifitwere,itwouldbe
taxabletothepowerholder.Anotherirrevocabletrustfromarecentcasehadthisclause:
“ThenetincomefromsaidtrustshallbedistributedbytheTrusteetothebeneficiaries
[petitionerandKathleen],jointlyorthesurvivorofthem,notlessthanonceeachyear
***.Provided,however,theTrusteeshalldistributeonlythatpartofthenetincome
whichisderivedfromCapitalgainsasisrequestedeachyearbythebeneficiariesandif
nosuchrequestbemadethenallofsuchcapitalgainsshallberetainedasapartofthe
Trustfundandbereinvestedasprincipal.”245
Thebeneficiarydidnotrequestandthetrustdidnotdistributethecapitalgains
income,althoughthebeneficiarycouldhaveclearlyrequestedit.CitingMallinckrodt,thetax
courtheldthat:
“Section 678(a)(1) clearlyprovidesthatapersonwiththepower,exercisablesolely
byhimself,tovestthecorpusortheincomeinhimselfwillbetreatedastheownerof
thatportionofthetrustoverwhichhispowerexists.Here,Kathleenandpetitioner
hadthepowerexercisablesolelybythemselvestoreceivetheKingTrusts'capitalgains
attempted to get an individual charitable deduction, arguing that a conservation easement contribution from the
trust came from income taxable to the beneficiary under §678 – the tax court found that 678(a) applied, and a
charitable deduction would be allowed if it came from a taxpayer’s grantor trust portion, but ultimately denied the
deduction since the contribution was not traced to income. The parties and court inexplicable ignored §678(a)(2),
which may have helped the taxpayer get a pro rated deduction).
244
Id. at 5
245
Campbell v. Commissioner, T.C. Memo 1979-495
113
income.Accordingly,pursuanttosection678(a)(1),petitionersaredeemedtobethe
ownersofthecapitalgainsincomefromtheKingTrusts.”246
Thus,withtheplainlanguageof§678(a),regulationsunder§1.671Ͳ2andlongstanding
caseprecedent,it’sclearthatbeneficiarieswithwithdrawalrightsovertrustincome(including
capitalgains)MUSTreportanysuchincomeontheirForm1040–failuretodosomayleadto
substantialpenalties,especiallysincethereisnosubstantialauthoritytoargueotherwise.
Tounderstandthepracticalbasics,let’sgobacktoBarbara’sbypasstrustinour
exampleabove:withafully§678(a)trustinwhichBarbaracanwithdrawalltaxableincome,
includingcapitalgains,Barbarawouldsimplyreportall$140,000oftaxableincomeonher
Form1040regardlessofwhatsheactuallyreceives,andthetrusthasnoincome.247Atrust
couldbepartiallysubjectto§678(a).IfBarbaraonlyhadanunfetteredrighttowithdraw
accountingincome(interest,dividends,rents),then$40,000wouldgoontoherForm1040
(ultimately,thesameasifithadbeenKͲ1’d),anddeductibleexpenseswouldhavetobepro
ratedaccordingly.248Similarly,ifBarbarahadacap,e.g.,upto$100,000–thenshewould
onlybetaxabletothecap,andexpenseswouldbeproratedaccordingly.IfBarbarasends
someofherwithdrawableincometocharity,she(notthetrust)wouldbeeligiblefora
ScheduleAtaxdeductionunder§170.249
Afully“beneficiaryincomeͲcontrolled”or“beneficiaryͲdefective”§678(a)grantortrust
doeshavemorethanafewadvantagesandmaybeusefulinspecificsituations.Forinstance,
itmaybepreferablethatcertainassets,suchasapersonalresidence,nonͲqualifiedannuityor
qualifyingsmallbusinessstock,beownedbya§678(a)trust,becauseofthepreferredtax
treatmentthatindividualForm1040taxpayersmayavailthemselvesofthatnonͲgrantor
trustssimplycan’t.250Themostcommonandpotentiallyvaluablebenefit,§121,isdiscussed
initsownsectionbelow.
246
Id. at 16
Or, more accurately, no income to report under Subparts A-D of Subchapter J, but under Subpart E grantor trust
248
See various portion rules discussed in Treas. Reg. §1.671-2 and §1.671-3, some expenses might be attributed to
the asset producing the income, and some, like a trustee fee, might be prorated.
249
Goldsby v. Commissioner, T.C. Memo 2006-274
250
Arguably, a §678(a) trust should avoid arguments that the trust is not an “agent for a natural person” pursuant
to IRC §72(u). See The Advisor’s Guide to Annuities, by Michael Kitces and John Olsen. Non-qualified
annuities, perhaps even more so than IRAs/Qualified plans, are best left to spouses outright unless the negatives of
outright bequest (higher state estate tax, protection for other family, vulnerable spouse, etc.), outweigh the income
247
114
Surprisingtomanypeople,estatesandnonͲgrantortrustsarenoteligibleforthejuicy
$500,000§179expensingdepreciationdeduction–thataloneshouldbeareasontoallowfor
togglingtoabeneficiarydefectivestatusforportionsofthetrustattributabletoacapital
intensivepassthroughentitybusiness.251GrantortrustsarealsoeligibleScorporation
stockholders,regardlessofwhetherthereisaQSSTorESBTelection,butitcannotbepartially
grantorastoaccountingincomeonly.252Agrantortrustmayallowmuchbettertreatmentof
anysuspendedpassivelossesduetoinsufficientbasisintheScorpstockuponterminationof
thetrust,whichwouldsimplybelosttoatypicalESBTbeneficiary.253Thoughmorerare,
provisionsfortaking$50,000/$100,000ordinaryratherthancapitallossesforsalesofsmall
businessstockareunavailabletotrusts,butshouldbeavailabletoabeneficiaryundera
§678(a)structure.254
Infact,thereisnoreasonthatthetrustcannotprovidedifferentstandardsforincome
fromthesespecialassets(beneficiarywithdrawalasopposedtotraditionaltrustee
distribution),insomecasesasaseparatesubtrust,butyouwouldnotnecessarilyhaveto
(somewhatakintosomepractitioners’preferenceforstandaloneIRAtrusts).
Anotheruniqueadvantageofusing§678(a)overusingDNIdistributionstoshift
incometothebeneficiaryfromthetrustistheabilitytolimitittotaxableincome.Let’s
changeourexampleabovesothat$30,000ofthe$40,000trustincomeisfrommunicipal
bonds–taxexemptincome.A§678(a)powercanbeoverallassetsexceptthemunibonds,
tax benefits potentially lost by using a trust (which will depend on the gain in the contract). For small business
stock exclusion and rollovers, see IRC §1202 and §1045
251
IRC §179(d)(4), although if the income is going to be earmarked to a specific beneficiary, then a QSST election
may solve the issue if an S corp– QSSTs are in many ways de facto §678(a) trusts, see e.g., Treas. Reg. §1.13611(j)(8), but the §678(a) solution may be a good solution for an LLC/LP taxed as a partnership. The generous
$500,000 expensing provision is temporary- the law is due to revert to $25,000 in 2014, but Congress may extend
or modify that amount and there are various bills proposed to do so.
IRC §1361(c)(2)(A) “the following trusts may be shareholders: (i) A trust all of which is treated (under subpart
E of part I of subchapter J of this chapter) as owned by an individual who is a citizen or resident of the United
States.” Subpart E of part I of subchapter J is referring to IRC §§671-679, which includes §678(a) of course. PLR
2012-16034 recently followed this, ruling that a beneficiary-grantor trust created via Crummey power qualifies as
an S corp shareholder. Conservative practitioners may want to file a QSST election as a “belt and suspenders”
approach, but this is a great back up in case that election failed to be properly filed. For most purposes, except
perhaps for sale of the stock (where the QSST would no longer be treated as a grantor trust), it is the same for
income tax purposes.
253
This is contrary to unused net operating losses, which a beneficiary “inherits” upon termination under IRC
§642(h). There is a good argument that suspended S corp losses are personal and not transferred: IRC §1366(d)(1)
and Treas. Reg. §1.1366-2(a)(5)(i)
254
See IRC §1244, Treas. Reg. §1.671-3(a) and (a)(2)
252
115
allowingthetaxͲexemptassetstostaytrappedintrustwithoutrequiringwithdrawalor
deemedwithdrawal(totheextentnoadditionaldistributionsaremade).Thiscannotbedone
withordinarytrustdistributions,whichmustcarryoutnonͲtaxableincomeaswellastaxable
income.
ManypractitionersalreadysegregateIRA/qualifiedplanassetsintoseparateoreven
standalonetrustsforvarioustaxandadministrativereasons.255Taxpayersmayneedtouse
suchspecialassetstofundatrusttoexploitthestate’sestateexclusionamount,andmakingit
abeneficiaryͲdefectivetrustastotheincomegeneratedthereinmaybeasignificantbenefit,
evenifitisslightlymore“leaky”.256Thisassetprotectiondrawbackandinherent“leakiness”
mightbepartiallymitigatedthroughaCrummey/hangingpowerwhereinthebeneficiary
merelyhasapowertowithdrawthetaxableincomeandtotheextentitisnotwithdrawn,the
powerlapsesannuallyover5%.257Nottomentiontheinvestmentpolicyofthetrust.
UnlikeaCrummeyclause,forfeitureprovisions(a.k.a.“cessorprovisions”,usually
embeddedinamorerobustspendthriftclause)canautomaticallycutoffsuchawithdrawal
rightthatisnotneededtoqualifyfortheannualgifttaxexclusionintheeventofcreditor
attack(withappropriatecarveoutforQSST/marital/conduittrusts),oratrustprotector
provisionmightdosoaswell.Tokeepwithinthe§678(a)“sole”powerrequirement,and
improveassetprotection,withdrawalrightscanbelimitedtoawindowintime(e.g.
December15Ͳ31), similarto5/5powerlimitationsoftenused,andsuchprovisionsshould
probablyonlybecomeeffectiveprospectivelysoasnottoimpugnthe“solepower”.
Thereisnoreasonthata§678(a)powerhastobeallornothing,oreventhesame
everyyear!Itcanbemoretargetedthanthetraditionaldistributionstructureunder
255
See Using Separate or Stand Alone Trusts to Receive Retirement Benefits, Edwin Morrow, Journal of
Retirement Planning, Sept 2007
256
For instance, someone in Seattle could easily have a $1 million home, $1 million in other assets, and wants to
fund the entire $2 million to exploit the $2 million because their spouse has the same amount of assets – not
funding the bypass with the home might cause $200,000 or so in additional state estate tax. State-only QTIP trusts
have the same issue. Washington state has a $2 million estate tax exclusion with 10%-20% rates.
257
IRC §2514(e). However, the 5% would pertain to the taxable income available to withdraw, not the entire
principal, as some authors in this area have assumed – see Rev. Rul. 66-87. If a beneficiary has the right to
withdrawal $120,000 of income from a $2 million trust corpus, and does not take it, the lapse protection is $6,000,
not $100,000. The lapse protection may differ for state creditor protection law than federal tax law. In many
states, the protected amount in the above scenario would be $14,000 or $28,000, depending on whether the
original donor was married at the time. UTC § 505(b), though many UTC states double the annual exclusion lapse
protection, as in Ohio R.C. §5805.06(B)(2), and some may omit it (Massachusetts).
116
SubchapterJ,whichdoesnotallowtracingoftypesofincome.Forexample,sayatrustgrants
thebeneficiarytheunfetteredwithdrawalrighttoallincomeattributabletoallassetsexcept
themunicipalbondportfolio,thestockportfolioandtheRothIRA.Thisleavesincomefrom
thoseassets(0%,23.8%forLTCG/QD,0%respectively)intrust,andshiftstaxationoftherent,
traditionalIRAandtaxableinteresttothebeneficiary.Thismaycuttherateonthatfroma
43.4%ratetoalikely15%,25%or28%taxedtothebeneficiary.
Thiswithdrawalpowercouldalsobecapped–e.g.,allincomeattributabletoassets
otherthanthemunibondportfolioabove$12,150,orevenreferenceanexternalcriteria,
thoughitcertainlycomplicatesadministration,suchasincometoapointuntilhis/hertaxable
incomeexceeds$400,000/$450,000topincometaxbracket.Rememberthisalsoforcesa
portioningofanyexpenses,suchasinvestmentmanagement/trustee,attorneyfees,though
directlyattributableexpenses(e.g.realestatetaxesontheresidence)maygowiththe
§678(a)beneficiary(ornonͲgrantortrustportion,asapplicable).258Anystructurewith
withdrawalrightsoveronlycertaintypesofassetswouldhaveissuesifthebeneficiarywere
thecontrollinginvestmenttrustee,andfiduciarydutiesandconflictswouldhavetobeworked
aroundevenwithanindependenttrustee,butit’snotinsurmountable.
Despitetheabovepossibilities,byfarthemostlikelyuseforthisisafamilythatwants
toSIMPLIFYtrustadministrationandaccountingandensuretheycouldnotbe“worseoff”
incometaxwisewithatrust.Thismeansawithdrawalpoweroveralltaxableincome.Sucha
provisioncaneliminateatraditional1041filing,eventhoughgrantortrustsstillhavenominal
reportingrequirements.259
While§678withdrawalprovisionsshifttheincometaxation(andwithit,theMedicare
“surtaxation”),260suchpowersbringupsomenegativeramifications:
-
someslightlydecreasedassetprotection(amountscurrentlysubjecttoanunfettered
withdrawalpoweraretypicallysubjecttothebeneficiary’screditors),butaforfeitureor
shiftingexecutoryinterestclauseand/ortrustprotectormighteasilycutthatoffto
258
Treas. Reg. §1.671-3(a)(2)
See Treas. Reg. §1.671-4 for various alternative methods of grantor trust reporting compliance.
260
Treas. Prop. Reg. §1.1411-3(b)(5)
259
117
preventmuchongoingdamage.Anautomaticprovisionispreferredtoavoidfraudulent
transferissues,butatrustprotectorenablesmodificationwhennothreatisimminent.261
-
slightlyincreasedestateinclusion(amountssubjecttowithdrawalatdeathareina
beneficiary’sestate),butagain,thiscanbemitigatedsothatthewithdrawalrightisnot
untiltheendoftheyear.Abeneficiarywouldbeunlikelytodiewithanyincludibleright.
-
ifassetsarenotwithdrawninagivenyear,itmayresultinapartiallyselfͲsettledtrustas
tothebeneficiary,whichmayhavenegativeramificationsforassetprotectionorestate
taxinclusion.However,abeneficiarymightsimplywithdrawanyamountsabovethe5/5
and/orstatecreditorlapseprotectionandifassetprotectionisdesired,contributeittoan
IRA/QualifiedPlan,lifeinsurance,LLC,DAPT,giftingtrustorotherprotectivestructure.
Mosttaxpreparers(andmanyattorneys)areneithereducatedontheseconceptsnor
preparedtoevaluatesuchtrusts,soif§678(a)provisionsareadded,addanexplanatory
sentenceortwo(inbold,notburiedintheboilerplate)describingtheintentionoftheclause
anditsintendedtaxeffect.Thiswouldalsohelpwithanyfuturereformations.
c. IRC§678(a)–Seizingthe$250,000capitalgainstaxexclusionforresidenceunder§121
Themostcommonofthetaxsavingsopportunitiesof678(a)toencounter,applicable
tothesubͲ$5.43milliondollarestatesaswellasthewealthiest,isthecapitalgainsexclusion
onthesaleofaprincipalresidence.Aprovisiontowithdrawcapitalgainsfromthesaleofa
residence,asdiscussedabove,createsa§678(a)trustastothatassetuponsale.Sucha
provisionastoresidentialpropertyonlyavoidsmanyofthenegativesof§678(a)trusts.For
example,thereisverylittleassetprotectionriskgrantingabeneficiarytherighttowithdraw
capitalgainsincomefromsaleofapersonalresidenceifanindependenttrusteedoesn’tsell
theproperty(assumingthetrustdoesnotrequireit,whichwouldberare)!Atrustmight
allowthebeneficiarytowithdrawnetcapitalgainsfromthesaleofaresidence,buthave
ordinarydistributionprovisionsforallotherassets.
261
For discussion of fraudulent transfer failures using trust protector/decanting see Ferri v. Powell-Ferri: Asset
Protection Issues, Perils and Opportunities with Decanting, Ed Morrow & Steve Oshins, LISI Asset Protection
Newsletter #240, for efficacy of automatic forfeiture (cessor) clauses, see other CLE materials from author.
118
Grantortrustsarepermittedthisexclusionprovidedtheotheroccupancy
requirementsaremet.262Themortgageinterestdeductionshouldalsobeallowed.263AnonͲ
grantortrustisnoteligibleforthe$250,000/$500,000capitalgainexclusiononthesaleofa
personalresidenceprovidedby§121.264Amererighttooccupyandusethepropertyis
insufficienttocausegrantortruststatusnecessaryforthe§121exclusion. Ifthetrustis
partiallyagrantortrust,suchasatrustwithafiveandfivepower,thenthegrantormay
excludethatportionofthegain.265
Thisisnosmallbenefit–withfederallongͲtermcapitalgainsratesat23.8%,theeffect
ofPeaselimitationsatapproximately1.2%foritemizers,andstateandlocalincometaxesat
upto13.3%,therecouldeasilybeataxcostofover$100,000.Survivingspousesmayremarry
andmayown50%outsideofthetrust,soitmaynotjustbe$250,000,but$500,000excluded.
Trusteesmustnormallymakepropertyproductiveofincome,buttrustsroutinely
permitthetrusteetoinvestinaresidenceforabeneficiaryorretainacontributedresidence
andspecificlanguageshouldbeconsideredonthispoint.266
d. ApplicationtoSpecialNeedsTrusts
Itisprobablystatingtheobvious,buta§678(a)powerwouldnotworkinaspecial
needstrustscenario.Althoughintheoryonecouldgivesucha§678(a)powertoasiblingor
someoneotherthanthespecialneedsbeneficiary,thisisprobablycontrarytothesettlor’s
intent,impairsprotectionforthespecialneedsbeneficiary,andmaycausehigherincome
taxationamongthefamilyunit–notonlywouldaspecialneedsbeneficiarygettingaKͲ1bein
262
See Rev. Rul. 66-159, Rev. Rul. 85-45 and PLR 1999-12026, in which the IRS looked through the trust to the
beneficial owner under §678(a) for qualification under IRC §121 and its predecessor. Although in those cases the
beneficiary had a right to withdrawal the entire trust principal, not just the capital gains from the sale of the home,
they should apply to extend the exclusion if all the capital gains are subject to withdraw. This is perfectly
consistent with Treas. Reg. §1.671-3(a)(2) and §678(a).
263
Treas. Reg. §1.163-1(b) (equitable ownership sufficient)
264
Treas. Reg. §1.121-1(c)(3): “(i) Trusts. If a residence is owned by a trust, for the period that a taxpayer is
treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as
the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning
the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange
by the trust will be treated as if made by the taxpayer. See also PLR 1999-12026 (revocable trust eligible – why
someone bothered with a PLR for that is unclear).
265
PLR 2001-04005 (bypass trust w/ 5% withdrawal power eligible for at least 5% of capital gains exclusion as
partial grantor trust, thought the PLR did not discuss the possibility of higher % based on prior lapses/release)
266
Uniform Prudent Investor Act (Restatement of Trusts, 3rd), §181
119
alowerbrackettypically,butqualifyingnonͲgrantortrustsforspecialneedsbeneficiaries(a
“qualifieddisabilitytrust”)evenreceiveanadditionalpersonaltaxexemption.267
e.
ApplicationtoQTIPtrusts?
ThecommonwisdomisthatQTIPrequireallincomebepaidannuallytothesurviving
spouse,thereforeaQTIPcannotbeafully§678(a)trust.Onceagain,thecommonwisdomis
wrong.Ratherthanmandateallincomebepaidannually,maritaltrustscanmerelyrequire
thatthespousebeabletowithdrawallincomeannually.268Asdiscussedabove,thiscanmake
ahugedifferenceunderSubchapterJ.Thisflooroftherighttowithdrawnetaccounting
incomerequiredbyIRC§2056cancertainlybeincreasedtoincludethegreaterofthenet
accountingincomeorthetaxableincome(whichwouldusuallybehigher),includingcapital
gains,orothertaxableincomethatwouldnotbeaccountingincome(e.g.,a$50,000IRA
paymentmightbe$5,000accountingincome,but$50,000taxableincome).
Howviableisthis?Itlargelydependsonwhatthesettlorwouldwant.Many,evenin
someblendedfamilies,wouldbefinewiththis,anditcouldarguablyallowforamucheasier
tounderstandandsimplifiedreportingstructure.Normalpeoplethinkintermsoftaxable
income(WͲ2,1099),not“DNI”and“FAI”.Nosurvivingspousethinksthatthe$50,000IRA
distributionfromthe$1millionIRAshouldentitlehimorhertoonly$5,000of“income”.The
pressuresonthetrusteemightbeslightlydifferent–insteadofasurvivingspouseinsistingon
highͲyield,incomeproducingproperty,thefocusmightshifttorealizinglongͲtermcapital
gains!Likeanythingnew,itwouldrequirethinkingthroughthepriormodusoperandi.But
explainingtheincometaxationtoclientswouldbeinfinitelyeasier.Ifyoudon’tagree,you’ve
nevertakenafiduciaryincometaxcourseortriedtoexplaintrusttaxationtoaclient.
267
IRC §642(b)(2)(C), tied to personal exemption, $3950 in 2014, rather than $100 for typical complex trusts.
Treas. Reg. §20.2056(b)-5(f)(8): “In the case of an interest passing in trust, the terms "entitled for life" and
"payable annually or at more frequent intervals," as used in the conditions set forth in paragraph (a) (1) and (2) of
this section, require that under the terms of the trust the income referred to must be currently (at least annually; see
paragraph (e) of this section) distributable to the spouse or that she must have such command over the income that
it is virtually hers. Thus, the conditions in paragraph (a) (1) and (2) of this section are satisfied in this respect if,
under the terms of the trust instrument, the spouse has the right exercisable annually (or more frequently) to
require distribution to herself of the trust income, and otherwise the trust income is to be accumulated and added
to corpus.” Treas. Reg. §20.2056(b)-7(d)(2) governing QTIPs looks to the above Reg for its definition of the
required income interest: “(2) Entitled for life to all income. The principles of § 20.2056(b)-5(f), relating to
whether the spouse is entitled for life to all of the income from the entire interest, or a specific portion of the entire
interest, apply in determining whether the surviving spouse is entitled for life to all of the income from the
property regardless of whether the interest passing to the spouse is in trust.”
268
120
f.
Transactionsbetweenbeneficiariesandfully§678(a)trustsastobeneficiaries
Manyreadersareundoubtedlywondering–sincethesetechniquescancreatewhatis
consideredagrantortrusttothebeneficiaryastoALLtrustincome,whatistostop
beneficiariesfromengagingininstallmentsales,swapsorothertransactionswiththeirfully
§678(a)trustsunderRev.Rul.85Ͳ13anditsprogeny?269Isn’tthisliketheBDIT(whichrelies
onlapsesofpowersoftheentirecorpusper§678(a)(2)),butwithanunlimitedseedgift,
ratherthanamere$5,000,andwithlessrisk?Isn’tthismuchmorecertainthanan
installmentsaletoacompletedgiftassetprotectiontrustwiththesettlorasbeneficiary,with
itsattendant§2036risk?Isn’tthissaferthanabeneficiarysaletoaqualifiedsubchapterS
trust(QSST),whichisonlyagrantortrustastotheincomeratherthantheentirecorpusifthe
Scorporationstockissold?Comparing“beneficiaryincomecontrolledtrusts”transactions
withinstallmentsalestoBDITs,QSSTsandothergrantortrustswillbeconsideredina
separatearticle.
269
Exceptions may be necessary for QTIP beneficiaries for IRC §2519 reasons, as discussed in Part VIII.k, or
grantor-CLT trust beneficiaries, which may have self-dealing issues
121
g.
UsingTreas.Reg.§1.643(a)Ͳ3(b)
Thebestsolutiontosolvingthecapitalgainstaxtrapinmostcasesistoutilizeoneof
thethreemethodsnotedintheTreasuryRegulationstoallowcapitalgainstobetreatedas
partoftheDNIdeduction.Thiswillallowanydiscretionarydistributionstothebeneficiaryto
carryoutcapitalgainsaspartofDNIsothattheKͲ1cantakecareofthesurtaxandhighertax
rateissuebyputtingthecapitalgainsonthebeneficiary’sForm1040.
OncecapitalgainsarepartoftheDNIdeduction,theycanbecarriedoutontheKͲ1
andtaxedtothebeneficiary.So,howdowegetoutofthedefaultrulethatcapitalgainsare
notordinarilypartofDNI?270Generally,theywillbeincludediftheyare1)allocatedto
fiduciaryaccountingincomeor2)allocatedtoprincipaland“paid,creditedorrequiredtobe
distributedtoanybeneficiaryduringtheyear”.271Theregulationsregardingtheseexceptions
aremorespecificandmeritfullinclusionhere:272
“(b)Capitalgainsincludedindistributablenetincome.Gainsfromthesaleorexchangeof
capitalassetsareincludedindistributablenetincometotheextenttheyare,pursuanttothe
termsofthegoverninginstrumentandapplicablelocallaw,orpursuanttoareasonableand
impartialexerciseofdiscretionbythefiduciary(inaccordancewithapowergrantedtothe
fiduciarybyapplicablelocallaworbythegoverninginstrumentifnotprohibitedbyapplicable
locallaw)—
(1)Allocatedtoincome(butifincomeunderthestatestatuteisdefinedas,orconsistsof,a
unitrustamount,adiscretionarypowertoallocategainstoincomemustalsobeexercised
consistentlyandtheamountsoallocatedmaynotbegreaterthantheexcessoftheunitrust
amountovertheamountofdistributablenetincomedeterminedwithoutregardtothis
subparagraph§1.643(a)–3(b));
(2)Allocatedtocorpusbuttreatedconsistentlybythefiduciaryonthetrust'sbooks,records,
andtaxreturnsaspartofadistributiontoabeneficiary;or
(3)Allocatedtocorpusbutactuallydistributedtothebeneficiaryorutilizedbythefiduciaryin
determiningtheamountthatisdistributedorrequiredtobedistributedtoabeneficiary.”
Let’sdiscusstheseoutoforder,takingtheeasiestand“cleanest”first.Thesecond
method,(b)(2),isverystraightforward.Thetrusteesimplytreatscapitalgainsconsistentlyas
partofthebeneficiary’sdistribution.Ideally,languageinthetrustwilladdressthis,which
270
See Treas. Reg. §1.643(a)-3(a) for this default
IRC § 643(a)(3)
272
Treas. Reg. 1.643(a)-3(b)
271
122
mightevengivesomecoverincasethetrusteefailedtobeconsistent.273Fornewestatesand
trusts,thisisquiteeasy.Foranexistingtrust,thereisaquestionwhetheritcanchangethis
practicewheninprioryearsithasbeenconsistentlyNOTtreatingcapitalgainsaspartofa
beneficiary’sdistribution.274Potentialremediesofamendmentsanddecantingwillbefurther
discussedbelow.
Thethirdmethod,(b)(3),ismoreproblematic.Itcanbedividedintotwomethods–
thefirstisto“actuallydistribute”capitalgains.Thispresumablymeanstracingtheproceeds.
So,thetrusteetakestheproceedsfromthesaleandgivesthenetcapitalgaintherefromto
thebeneficiary.Thissoundseasierthanitis.Forinstance,whatifprincipaldistributionsare
neededearlyintheyearandcannotwaituntillaterwhenthenetgainscanbedetermined?
Whatabout“phantom”capitalgains?
Inlieuoftracing,thethirdmethodalsoallowscapitalgainstobepartofDNIifthe
trusteeusescapitalgains“indeterminingtheamountthatisdistributedorrequiredtobe
distributed”.Veryfewtrustswouldusecapitalgainsaspartofadistributionprovisioninthis
manner.Forinstance,atrustmightsaythat“gainsfromthesaleofaparticularbusiness
propertyshallgotobeneficiaryX.”Intheory,thetrustcouldmandatethat“thetrusteepay
all(orX%)ofnetincomeandnetcapitalgainstothebeneficiary”toinvokethissection,butif
thesewerethegoals,itwouldmakemoresensetouse§678(a),not§1.643(a)Ͳ3(b)(3).
273
Example: "To the extent that discretionary distributions are made from principal, the trustee shall make them
and/or account for them in the books, records and tax returns of the trust in the following order:
1) from any current year net short-term capital gains, except those net gains attributable to disposition of property
held in a trade or business not described in IRC §1411(c)(2), or attributable to disposition of an active trade or
business as described in IRC §1411(c)(4);
2) from any current year taxable income attributable to assets described in IRC §1411(c)(1)(A)(i), such as an
annuity payment, that was allocated to principal.
3) from any current year taxable income attributable to a qualified retirement plan distribution described in section
401 (a), 403 (a), 403 (b), 408, 408A, or 457 (b) allocated to principal
4) from any remaining current net short term capital gains not described in paragraph 1
5) from any current long-term capital gains, except those net gains attributable to disposition of property held in a
trade or business not described in IRC §1411(c)(2), or attributable to disposition of an active trade or business as
described in IRC §1411(c)(4);
274
Most recently, the IRS recognized this problem but was quite cold-hearted about it: “If the tax imposed by
section 1411 had existed in the year that an existing trust or estate had first incurred capital gains, the fiduciary
may have exercised its discretion differently. The commentators request that the final regulations allow a fiduciary
a “fresh start” to determine whether capital gains are to be treated as part of DNI. The final regulations do not
adopt this suggestion.*** the potential for fluctuations in the effective tax rate on capital gains is a factor that is
foreseeable by fiduciaries making these elections.” You should have known something like ATRA would pass?!!!!
From page 33-34 of the final §1411 regulations at https://s3.amazonaws.com/publicinspection.federalregister.gov/2013-28410.pdf
123
Whatifthetrusteedoesn’tmandatethatcapitalgainsbeusedindeterminingthe
distribution,butthetrusteesimplystates“IherebyswearIconsideredcapitalgainsto
determinehowmuchtodistributefromthistrustthisyear”?Someattorneysaremore
optimisticthanIthatmeretrusteepolicycanbereliedontocomeunder(b)(3),butarguably
itonlyrequires“utilizationbythefiduciary”,notanyrequiredmandateinthedocument.275
Perhapsitwouldbemorecertainifthetrustdocumentspecificallyrequiredoratleast
permittedthetrusteetoconsidercapitalgains,somethinglike“inexercisingthetrustee’s
discretiontodistributeprincipal,mytrusteemay[shall?]consideranycapitalgainsrealizedby
thetrustasarelevantfactorindetermininganyamountpursuanttoitsdiscretionary
decision.”Detractorsmightsaythatusing“shall”restrictsthetrustee’sabilitytoNOT
considercapitalgainsinfutureyearsif(b)(3)weredesiredtobeavoided.AnonͲjudicial
(private)settlementagreementmaybeagoodsolutionheretoaddsuchasentence.
Thefirstmethod,(b)(1),offersmoreflexibilitythanthelattertwo,butpotentially
offersmorecomplexityandliabilityforthetrustee,becauseitinvolveschangingthescheme
ofprincipalandincomeallocationandrequiresadditionaltrusteediscretion.
Formanymoderntrusts,thedistinctionbetweenprincipalandincomeis
anachronistic.Thesedistinctionsareoftenmeaninglessindeterminingwhatbeneficiaries
receivefromthetrust.However,theyarestillimportantfortaxpurposes.
Corollarytotheaboveregulation,Treas.Reg.§1.643(b)Ͳ1statesthat:
“Inaddition,anallocationtoincomeofallorapartofthegainsfromthesaleor
exchangeoftrustassetswillgenerallyberespectediftheallocationismadeeither
pursuanttothetermsofthegoverninginstrumentandapplicablelocallaw,or
pursuanttoareasonableandimpartialexerciseofadiscretionarypowergrantedto
thefiduciarybyapplicablelocallaworbythegoverninginstrument,ifnotprohibited
byapplicablelocallaw.”276
275
See Including Capital Gains in Trust or Estate Distributions After ATRA - A frequently overlooked regulation
may give fiduciaries more flexibility than they realize, Trusts and Estates, March 2013, by Frederick Sembler.
276
This is in spite of an admonition earlier in the same regulation that “Trust provisions that depart fundamentally
from traditional principals of income and principal will generally not be recognized”. This ability of the fiduciary
to “manipulate” tax consequences through its discretion pursuant to this regulation has generally been respected.
See BNA Portfolio 852-3rd, Acker, A67 and authorities cited therein.
124
Thus,intheory,notonlycouldcapitalgainsbeallocatedtoincome,butitcanbedone
atthetrustee’sdiscretion.Sections103Ͳ104oftheUniformPrincipalandIncomeAct,which
providesthedefaultprincipal/incomerulesinmoststates,allowatrusteetomake
adjustmentstoincomeandprincipal,intheory.However,thedefaultprerequisitesand
rationaleforinvokingtheseprovisionsdonotfitourproactivetaxplanningexampleabove,
wherethegoalissimplytoshifttaxationofthecapitalgainsthatisarguablyalreadybeing
distributedtothebeneficiary.
ButthisdoesnotmeanthatatrustcannotbedraftedtooverrideSection103Ͳ104’s
limitations.Section103(a)(1)firstrequiresafiduciaryto“administeratrustorestatein
accordancewiththetrustorthewill,evenifthereisadifferentprovisioninthisAct”.Section
103(a)(2)furtherpermitsatrusteeto“administeratrustorestatebytheexerciseofa
discretionarypowerofadministrationgiventothefiduciarybythetermsofthetrustorthe
will,eveniftheexerciseofthepowerproducesaresultdifferentfromaresultrequiredor
permittedbythisAct.”Thus,theattorneymerelyhastooverridetheUPIAdefaulttogrant
widerdiscretiontoallocatebetweenprincipalandincome(perhaps,totheextentof
discretionarydistributions),whilekeepinginlinewithbothstatelawandTreas.Regs.
§1.643(b)Ͳ1and§1.643(a)Ͳ3(b).277
Discretiontoexploitsuchadjustmentsisbestdonebyanindependentcorporate
trustee,ratherthanabeneficiary/trustee,especiallyifthereis“allnetincome”language.So,
howwouldourpowertoadjustsolutionworkunderourbypasstrustexampleabove?The
independenttrusteewouldadjustall(ormost)ofcapitalgainstoaccountingincome,thenthe
$75,000distributionbecomespartofDNIandthedistributiondeductionisKͲ1’douttothe
beneficiary,taxedathermuchlowerrates.
277
Example: “Pursuant to Section 103 of the UPIA [or state UPIA citation], I hereby override the state law default
treatment of allocation of capital gains to trust principal as follows: any Trustee not a beneficiary nor “related or
subordinate” (as those terms are defined in IRC § 672) to any beneficiary of a trust may reallocate capital gains
taxable income from fiduciary accounting principal to fiduciary accounting income in the sole discretion of the
trustee. In doing so, the trustee may consider the net tax effect of the allocation to the trust and the beneficiary
together, such as whether leaving capital gains as taxable to the trust would otherwise cause a Medicare surtax or
short-term capital gains rates in excess of the net additional tax effect of a reallocation on a beneficiary’s taxes.”
125
h.
Comparingthethreemethodsunder§1.643(a)Ͳ3(b)
Thesecondmethod(b)(2)isthesimplestandprobablypreferredformostnewtrusts
withoutanyinconsistentpastreporting.Thefirstmethod(b)(1),mayoffermoreflexibility,
buttherewouldbetheadditionalcomplexityofchanginginternaltrustprincipal/income
accounting.Plus,howmuchguidancedowehaveonwhatis“reasonableandimpartial”
(moreanissuefor“allnetincome”trusts)?Thethirdmethod,(b)(3),seemseasier,and
promisingifthetrusthaslanguagerequiringconsiderationofcapitalgainsinthedistribution
decision,butisstilluncertainformytastesasfarashowtheIRSwillactuallypolicethat
“utilization”.
ProblemswithAdaptingIrrevocableTrustswithPriorTaxReportingHistory
Inthecasewhereatrusteehasbeenhistoricallynotbeentreatingcapitalgainsaspart
ofdistributionsinits“books,records,andtaxreturns”,querywhetheraprivatesettlement
agreement,decantingorotherreformationtoprospectivelychangethiswouldhaveany
impact,forinstanceincorporatingsomethingakintothesamplelanguageabove?Arguably,
thetrusteewouldthereafterbeconsistentinitstreatmentofcapitalgainspursuanttothe
newgoverninginstrument.WouldtheIRSpermitaoneͲtimechange?TheIRSmaynot
considerittobeanewtrustforTreas.Reg.§1.643(a)Ͳ3(b)purposessimplybecauseofaminor
administrativeamendment,andmightthereforeregardnewtreatmentofcapitalgainsas
inconsistentwithpriorpractice.Afterall,trusteesdon’ttypicallygetacompletelynewEINfor
suchchanges.Therefore,practitionersmightseekaprivateletterrulingtoadaptexisting
truststhathaveahistoryofnottreatingcapitalgainsaspartofdistributions,oruseoneofthe
othermethodsmentionedherein,suchaschangingtheprincipalandincomescheme.
Impactofchangingtaxburdenonbeneficiarydistributions
IfcapitalgainsareconsideredpartofBarbara’sdistributionandordinarynonͲgrantor
trustrulesareapplied,the$40,000ofaccountingincomeandthe$75,000ofprincipal
distributionisalsotaxedtoherandonly$25,000ofcapitalgainsislefttrappedintrust.
However,becauseofherextrapersonaltaxburden,shewouldprobablyaskforapproximately
$20,000inadditionaldistributionstocompensate,whichwouldlowertheincometrappedin
thetrusttowellunder$11,950.Thus,the43.4%/23.8%highestmarginaltrusttaxrateis
126
completelyavoidedandherpersonalratesof28%/15%wouldbeapplicable.Thiscanleadto
tremendousongoingtaxsavings.Eventheremainderbeneficiariesarehappybecause,
althoughBarbaragot$20,000moreingrossdistributionsunderthisplanning,thetrustsaved
morethanthatintaxes,sotheyarebetteroffaswell.
Whetherthesetechniqueswillsavetaxesdependsonmanyfactors,primarilythetrust
distributionprovisions,stateprincipalandincomelaw,statetaxation,preexistingtax
attributessuchascapitallosscarryͲforwardsofthetrustandbeneficiary,andofcourse,the
beneficiary’sincomeanddeductions.However,inmanycasesoftrustplanningand
administrationforthevastmajorityoftaxpayers,itwillpaytorethinkthetrustboilerplate,
administrationandtaxpreparationasregardstocapitalgainsstartingin2013.
Practitionersshouldreviewthetermsoftheirtrustsfordiscussionofhowcapitalgains
areaccountedforinmakingtrustdistributionsand/orallocatedtofiduciaryaccounting
income.Forexistingirrevocabletrusts,attorneysshouldnotonlyreviewthetermsofthe
trustsastohowcapitalgainsareaccountedfor,buttheyshouldalsoreviewhowthetrustee
hashistoricallyhandledthetreatmentofcapitalgainsregardingthebeneficiary’sdistributions
(Forms1041andKͲ1).Anexperiencedcorporatetrustdepartmentwouldbestensure
consistentdocumentationofthe“books,recordsandtaxreturns”tocomplywiththe
regulationsnecessarytoexploitthesepotentialsavings.
Ifthetrusteehasnotbeentreatingcapitalgainsasapartofthebeneficiary’s
distributions(whichislikely),considerationshouldbegiventoaprivatesettlement
agreementorreformationtoeithercorrectprospectivetreatmentofcapitalgainsonthe
“books,recordsandtaxreturns”ofthetrust,or,better,amendthetrustprovisionsregarding
allocatingcapitalgainstofiduciaryaccountingincomeand/orrequireconsiderationofcapital
gainsinthetrustee’sdiscretionarydistributiondecisionͲmaking.Inthelattercases,a
professionalandindependenttrusteeorcoͲtrusteeshouldbeconsideredtoproperlyexploit
thisflexibility.ProfessionaltrusteesHAVEtopaperthefile,fortheOCCorstateauditorsand
internalaccountingcommittees,withtheirconsiderationsfordiscretionarydecisions.
127
k.
ExploitingSprayPowersandLifetimeLimitedPowersofAppointment
Evenbetterthanhavingcapitalgainstaxedtothebeneficiary,thesettlormaygive
additionalspraypowerstothetrustee,tosprayincometootherbeneficiaries,includingthe
family’sfavoritecharity,donoradvisedfundorprivatefoundation.278Or,probablybetterin
manyways,thesettlormaygivethesurvivingspouseoranotherpartyalimitedlifetime
powerofappointment.279Forinstance,let’ssayBarbarareceivesmoreincomeoutsidethe
trust,puttingherinahigherbracket,anddecidesthatsheonlyneeds$30,000fromthetrust,
butherchildrencouldusefundstopayforgrandchildrenincollege.Sheusesherlimited
powerofappointment,orasksthetrusteeorcollateralpowerholdertospray$80,000toher
children(orgrandchildren)and$20,000tothefamily’sdonoradvisedfundatthelocal
communityfoundationthatJohnhadalsonamedinthetrustasapermissible
appointee/beneficiary.280Whetherthismakessensedependsonthefamilysituation,trust
andbracketsofthepartiesinvolved(andpotentiallytheassets,suchaswhetheranSCorpor
278
Spray powers have practical issues that require careful drafting to protect the primary beneficiary and prevent a
sense of entitlement by secondary beneficiaries. Typically language would be completely discretionary and
instruct the trustee to consider secondary beneficiaries only after consideration of the primary beneficiary’s needs,
or give the primary beneficiary (e.g. spouse) a veto power over secondary beneficiary distributions. Spray powers
may also implicate additional reporting/accounting requirements.
279
This should not cause estate inclusion, nor a taxable gift, if it is properly circumscribed with support obligation
savings clause provision to forbid distribution to someone whom the donee powerholder owes an obligation of
support. See Treas. Reg. §20.2041-1(c)(1)(B). It could trigger a gift if exercised so as to trigger the Delaware Tax
Trap, discussed elsewhere herein. IRC §2514(d). Or, it could trigger a gift if the powerholder has a testamentary
GPOA over the same asset, as discussed elsewhere herein, which is a good reason to add a collateral power held
by a family friend or other nonadverse party.
280
See IRC §642(c)(1) and Regs. The Supreme Court held in Old Colony Trust Co. v. Commissioner, 301 U.S.
379 (1937) that “pursuant to the governing instrument” in IRC §642(c) plainly includes discretionary distributions,
and need not be pursuant to a mandatory requirement. There is some uncertainty, however, from later narrower
decisions from lower courts. Generally, you would be more secure in getting the §642(c) deduction the more
direct, certain and specific the trust’s charitable provision is, but a recent PLR followed the Supreme Court and
permitted it for a discretionary distribution pursuant to a lifetime limited power of appointment. See discussion of
such nuances in Chapter 6.08 of Federal Income Taxation of Trusts, Estates and Beneficiaries by Ascher,
Ferguson, Freeland. Does a lifetime LPOA carry out income, since it is a power over specific property, not
“income” or “principal”? Despite a tentative argument that appointing a specific asset might be a “specific gift or
bequest” under the relation back doctrine and therefore not carry out DNI (Treas. Reg. §1.663(a)-1), other sections
under that regulation indicate that even appointing a specific dollar amount or asset does carry out DNI under the
same rules as any other trustee distribution to a beneficiary. This is the most logical interpretation, but I could find
no specific authority. Regardless, a lifetime LPOA has enormous power and efficacy as a backstop to the trustee’s
spray power, if not as a complete replacement. If the LPOA powerholder is a mandatory income beneficiary,
however, it may be deemed a gift of the lost income. Estate of Regester, 83 T.C. 1 (1984), though contrary is Self
v. United States, 142 F. Supp. 939 (1956). If the powerholder also has a testamentary GPOA it would be
considered a gift as well. Treas. Reg. §25.2514-1(b)(2). A deemed gift may not be a problem with large applicable
exclusion amounts and annual exclusions, but why not allow for both if the spray power is properly circumscribed,
or better, add a limited collateral power if there is a trusted friend/advisor to the family.
128
IRAisinvolved,whichwouldsuggestusingseparatetrustsorsubtrusts).281Therearemany
scenarioswherethefamilywouldbefarbetteroffwiththisspraycapability,potentially
loweringtaxratesby20%ormore.Remember,the0%ratefortaxpayersinthebottomtwo
taxbracketsforLTCG/qualifieddividendswas“permanently”extendedwithATRAaswell.
l.
WhyQTIPsare(probably)terriblefortaxshiftingandwhatcanbedone(maybe)
MaritalandQTIPtrustsgenerallymustrequirethatthesurvivingspousebetheONLY
beneficiaryentitledoreligibleforincome,sotheyaregenerallyterriblevehiclesfortax
shifting.Orarethey?Contrarytothiscommonlyacceptedwisdom,thereisatleastagood
argumentthataQTIPisabletogiveasurvivingspousealifetimegeneralpowerof
appointment(aka5/5power).Thetaxcodeappearstodisallowthisunlessitisonlyto
appointtothespouse,buttwosectionsoftreasuryregulationsappearcontradictory,and
thereisaPLRdirectlyonpointallowingaspousetoappoint5%toherselforothers,witha
rathercompellingrationaletointerprettheregulationinsuchamanner.282IfthePLRand
moreimportantly,suchaninterpretationoftheregulationcanbereliedon,couldthisopen
uptaxshiftingopportunities?
281
IRA “see through trust” rules don’t play well with most POAs and neither do QSSTs. ESBTs force higher rate
taxation regardless of who the distributions are made to, so consider segregating those to separate trusts.
282
The code seems to disallow: IRC §2056(b)(7)(B)(ii): “(II) no person has a power to appoint any part of the
property to any person other than the surviving spouse.”, but we can rely on treasury regulations that are looser:
Treas. Reg. §20.2056(b)-7(d)(6): “The fact that property distributed to a surviving spouse may be transferred by
the spouse to another person does not result in a failure to satisfy the requirement of section 2056(b)(7)(B)(ii)(II).
However, if the surviving spouse is legally bound to transfer the distributed property to another person without full
and adequate consideration in money or money's worth, the requirement of section 2056(b)(7)(B)(ii)(II) is not
satisfied.” How would a GPOA where the spouse can transfer to herself and/or others via gift fit the Regulation?
See PLR 8943005 for an example of the IRS approving a QTIP with a lifetime 5/5 GPOA allowing the spouse to
transfer to herself or others up to 5% of trust corpus annually: “[w]e believe the better reading of the legislative
history would preclude a spousal power of appointment only where the exercise of the power would not be subject
to transfer taxation; i.e., where the power is not a general power of appointment as defined in section 2514 of the
Code. An interpretation requiring that a spouse must first take physical possession of the property prior to a
transfer to a third party, would focus too much attention on the form of the transaction. It is sufficient that the
exercise of the power by the spouse in favor of a third party would be subject to transfer taxation.” Another
regulation, however, seems to contradict the PLR and other Regulation above – Treas. Reg § 20.2056(b)-7(h),
Example 4: “Power to distribute trust corpus to other beneficiaries. D's will established a trust providing that S is
entitled to receive at least annually all the trust income. The trustee is given the power to use annually during S's
lifetime $ 5,000 from the trust for the maintenance and support of S's minor child, C. Any such distribution does
not necessarily relieve S of S's obligation to support and maintain C. S does not have a qualifying income interest
for life in any portion of the trust because the bequest fails to satisfy the condition that no person have a power,
other than a power the exercise of which takes effect only at or after S's death, to appoint any part of the property
to any person other than S. The trust would also be nondeductible under section 2056(b)(7) if S, rather than the
trustee, held the power to appoint a portion of the principal to C.” How can the two seemingly contradictory
regulations and PLR be reconciled? In the former, the spouse’s 5%/$5000 power included the power to appoint to
herself, in the latter, it did not. It is clear that no other party can have such a power. Treas. Reg. 20.2056(b)-7(h)
129
Atypical5/5GPOAwouldbeawkwardandinefficienttoshifttheincometaxation,
sinceanysuchpowerwouldnormallytrigger§678(a),makingsuchincomeoratleasta
portionofittaxabletothepowerholderratherthantheultimaterecipient.However,justas
wemightcrafttestamentaryGPOAsinQTIPsforbetterbasisincreaseforfractionalsharesof
assetsownedbetweenQTIPsandsurvivingspouses,asdiscussedinPartII,wemightbeable
tocrafta5/5powerinaQTIPthatcanmoreefficientlyshiftincome.
Whatifthe5/5powerwasaGPOAforestate/gifttaxpurposes,butnota“solepower”
for§678(a)purposes?Thismaybethebestofallworlds,becauseanunexercised5/5power
ordinarilyisanunholynightmaretoadministerandtrack,becauseeverylapsecreatesa
changingfractionalgrantortrust.283Forexample,apoweronlyexercisablewiththeconsentof
anonͲadversepartywouldbeaGPOAunder§2514/§2041,butclearlybeinsufficientto
triggerbeneficiaryͲgrantortruststatusastothepowerholderunder§678(a).Therefore,such
acircumscribedpowermaybeusedtoshiftincome,ormorelikelyinaQTIP,capitalgains.
Howwouldthiswork?
Backtoourpreviousexample:Barbara’sQTIPtrusthasa5/5GPOApowerrequiring
theconsentofanonͲadversepartytoexercise.Thetrustcorpusis$2millionandhasordinary
incomeof$40,000(equaltothetrust’saccountingincomeanddistributablenetincome
(DNI)),shortͲtermcapitalgainsof$30,000,andlongͲtermcapitalgainsof$70,000.The
trusteedoesnotallocatecapitalgainstotrustprincipal.Thetrusteemustdistributeto
Barbaraalloftheaccountingincome($40,000).Barbaraappoints(ordersthetrusteeto
distribute)$100,000,whichis5%ofthecorpus,toherchildren,whoareinlowertaxbrackets,
andthetrusteeorsomeothernonͲadversepartyconsentstothetransfer.Because§678(a)is
nottriggered,ordinarySubchapterJ(PartsAͲD)principalsapply.Providedthatthetrustee’s
“books,records,andtaxreturns”consistentlytreatsuchdistributionsaspartofadistribution
283
See PLR 90344004 – “During each succeeding year in which A fails to exercise her [5/5] power, A will be
treated as the owner of an increasing portion of corpus of T. For purposes of determining the increase in her
deemed ownership her current withdrawal power for any particular year will cause an increase in the amount of
corpus which she is treated as owning equal to the product of the amount which she could withdraw multiplied by
a fraction the numerator of which is the portion of trust corpus which she is not already treated as owning and the
denominator of which is the total of trust corpus from which the withdrawal could be made. Discretionary
distributions made by the trustee from corpus will be treated as coming from both the portion of corpus which the
beneficiary is treated as owning and from the portion which she is not treated as owning in the same ratio as the
fraction mentioned above.” Have fun with that calculation! This kind of §678(a) trust is the worst of all worlds.
130
toabeneficiary,asdiscussedabove,thetrusteemustsendaKͲ1allocating$40,000ofinterest
anddividendstoBarbaraandKͲ1sforthe$100,000incapitalgainstoherchildren,whomay
wellbeina0%LTCGor15%STCGtaxbracket.284Evenifthekiddietaxappliedtouse
Barbara’shighestincometaxbracket,the3.8%surtaxisprobablyavoided,sincethekiddietax
onlyappliestoincometax,nottheMedicaresurtax.
Barbara,intheexampleabove,wouldtriggerataxablegiftforthe$100,000
transferred–ifshehadthreechildrenandmadenoothergifts,andtheannualexclusionwere
$15,000atthetime,thiswoulduse$55,000ofherapplicableexclusionamount.However,
QTIPshavesomeadditionalquirks:IRC§2519treatsdispositionsofaQTIPasatransferofthe
entireinterestforgifttaxpurposes.285NeitherthePLRnortheregulationmentioned§2519,
norhasanycaselawdevelopedonwhetherthiscouldbeadisposition.Forplanning
purposes,itisprobablyprudenttoassumethatitcouldapply.
ThechiefquestionpointinthisplanningisthereliabilityofthePLR.WhilethePLRis
exactlyonpoint,wecannotrelyonPLRsforprecedent.Whilewecanrelyontreasury
regulations,thetworegulationscitedaboveconflict–theymightbereconciled,butit’shard
tobeconfidentthattheregulationsclearlysupportthePLRenoughforconfidentplanning.
Furthermore,§2519isahugequestionmark–manyclientswouldaccepttriggeringataxable
gift,whichmightevenflyunderanannualexclusion,butnotwanttotriggeragifttaxonthe
entireQTIP.QTIPqualificationisimportantevenifthefamilydoesnotneedthemarital
deductioninthefirsttodie’sestate,becausetheymayberelyingonthattopullthetrustback
intothesecondtodie’sestateforasecondbasisincrease.286
Whynotjustuseabypass(optimalbasisincrease)trustasnotedabove,whichcanget
mostoftheadvantagesofaQTIP,withmuchmorecertainandmorerobustongoingincome
taxadvantages?GettingaPLRwouldprobablyonlymakesenseforawealthyfamily/large
QTIPtobeworththetrouble.Ifyouareinclinedtoadd5/5powersintrusts(whetherthey
aresimplyapowertoappointtoselfonly,asmanyQTIPsdo,ortoselfandothers),atleast
considertheabove§678(a)avoidancetechniquetoavoidaccountingnightmares.
284
Treas. Reg. §1.643(a)-3(b)(2)
IRC §2519(a)
286
IRC §2044 pulls any QTIP trust back into the surviving spouse’s estate for inclusion, allowing §1014 step up
285
131
m.
IRC§642(c)–Seizingbettercharitabledeductionsthroughtrusts
Notably,notonlywouldIRC§642(c)offer“abovetheline”charitabledeductionsfor
thefamilyfromthetrust,uptotheentiregrossincome,notsubjectto20%/30%/50%AGI
limitations,butitoffersabetterdealforinternationallymindedclientswithties/interestsin
foreigncountries–unlikeIRC§170forindividuals,thetrustincometaxcharitabledeductionis
expresslynotlimitedtocharitiesorganizedintheU.S..287Furthermore,unlikeindividuals,and
evenbetterthana65dayelection,atrusteecanevenelecttotreatacontributionasmadein
aprevioustaxyear,iftheelectionismadebytheduedateoftheincometaxreturnand
extensions,orevenlaterifgranted9100relief.288
Unlikecharitablecontributionsfromindividuals,whichdoNOTaffectMAGIornet
investmentincomeoranindividual’s3.8%Medicaresurtaxexposure,thecharitable
contributionfromatrustunder§642(c)DOESreducenetinvestmentincomeforpurposesof
the3.8%surtax.289Itcancarryoutcapitalgainsallocatedtocorpus.290ItcancarryoutIRD.291
Furthermore,theremaybesubstantialstateincometaxbenefitsto§642(c)
deductions,overa§170individualtaxdeduction.Manystatesdon'tgrantindividualsa
charitabledeductionforstateincometaxpurposes,orlimitit,butstates’trusttaxregimes
oftenstartwiththetaxableincomenumberfromfederalForm1041,line22,whichis
calculatedafterthe§642(c)deduction.292Otherstatesallowindividualcharitabledeductions,
buttheyaresubjecttoPeaselimitationphaseouts.293Savinganother5Ͳ10%stateincometax
287
Treas. Reg. §1.642(c)-1(a)(2). The income tax deduction for individuals may be allowed to some foreign
charities in some cases pursuant to treaty, such as Israel, Mexico or Canada – see p. 3 of IRS Pub 526, 597; USCanada treaty, http://www.irs.gov/pub/irs-trty/canada.pdf
288
IRC §642(c)(1): “If a charitable contribution is paid after the close of such taxable year and on or before the last
day of the year following the close of such taxable year, then the trustee or administrator may elect to treat such
contribution as paid during such taxable year.” See also Treas. Reg. §1.642(c)-1(b) and PLR 2013-43002, which
granted 9100 relief to permit election even after the due date w/extensions had passed.
289
Treas. Prop. Reg. §1.1411-3(e)(2) and Treas. Prop. Reg. §1.1411-3(f) Ex. 2
290
IRC §643(a)(3)(B)
291
PLR 2002-21011, but see CCA 2006-44020, which did not permit to pay pecuniary bequest, because the trust
did not “direct or require that the trustee pay the pecuniary legacies from Trust’s gross income.”
292
E.g. Ohio R.C. §5747.01(S), page 5 of instructions for Ohio Form IT-1041
293
E.g., “If some of your itemized deductions have been phased out on your federal return due to federal adjusted
gross income limitations, they must also be phased out on your Idaho return.” – Page 8 of Idaho income tax return
instructions available at http://tax.idaho.gov/forms/EIN00046_10-21-2014.pdf. According to the Institute on
Taxation and Economic Policy, twenty-six states generally follow the federal tax rules for itemized deductions
(with exception of disallowing deduction for state income taxes paid) - Alabama, Arizona, Arkansas, Colorado,
Delaware, Georgia, Idaho, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Minnesota, Mississippi,
132
canbesubstantialstateincometaxsavings,evenifthereisstateͲsourceincome,likesellinga
businessorrealestatelocatedinstate.294Moreadvantagesmayaccrueifthetrust’sdonation
werelargeenoughtoexceedanindividual’s20%/30%/50%AGIlimitations,oriftheindividual
beneficiaryalreadyhadsubstantialcarryforwardsthatwouldlimitfurtheruse.
Furthermore,regulationsspecificallypermitthatthegoverninginstrumentcancontrol
thecharacteroftheincomedistributedvia§642(c)providedit “haseconomiceffect
independentofincometaxconsequences.”295Amereorderingruleisinsufficient,butwecan
accomplishadvantageousresultsbycreatinglimitationsonlifetimelimitedpowersof
appointment(orspraypowers)withsuchconsequences.296 Forinstance,ifthetrustlimitsthe
charities’potentialdistributiontogrossincomefromnetshortͲtermcapitalgains,taxable
interestandrents,ithastheeconomiceffectapartfromincometaxconsequencesbecause
theamountthatcouldbepaidtothecharityeachyearisdependentupontheamountof
shorttermcapitalgains,taxableinterestandrentsthetrustearnswithinthattaxableyear.297
Therefore,inourexample,Barbara’sdonoradvisedfundwouldnotreceiveanylongͲterm
capitalgains,qualifieddividendortaxexemptincome–the$20,000wouldbelimitedto
comingfromtheinterestandshorttermcapitalgains.Whatadeal–thetaxablebeneficiaries
cangettheLTCG/QDeligiblefor15%/0%brackets,whilethecharitygetstheordinaryincome
otherwisetaxedatupto43.4%.
TheIRSissurprisinglylenientwhenitcomestoallocationofthecharitablededuction
whenthereareothernonͲcharitablediscretionarybeneficiaries(i.e.notthoseentitledto“net
income”orsomevariant).ToreturntoourexampleofBarbaraandherfamilybypasstrust
Missouri, Montana, Nebraska, New Mexico, North Carolina, North Dakota, Oklahoma, Oregon, South Carolina,
Vermont and Virginia. Six jurisdictions follow federal rules, but with substantial further limitations: California,
District of Columbia, Hawaii, New York, Utah & Wisconsin. E.g. see California’s additional phase out scheme at
https://www.ftb.ca.gov/forms/2013/13_540.pdf. Ten states do not allow the federal itemized deductions at all:
Connecticut, Illinois, Indiana, Massachusetts, Michigan, New Jersey, Ohio, Pennsylvania, Rhode Island and West
Virginia
294
E.g., both Ohio and New York would indirectly allow a charitable deduction to a non-grantor trust because they
start with taxable income, yet Ohio does not recognize charitable deductions for individuals and New York may
limit itemized deductions to individuals to 25% or 50% based on income. See www.tax.ohio.gov,
http://www.tax.ny.gov/pdf/2012/inc/it201i_2012.pdf
295
Treas. Reg. §1.642(c)-3(b)(2)
296
Treas. Reg. §1.642(c)-3(b)(2), Example 1 shows mere ordering rules to be insufficient
297
Treas. Reg. §1.642(c)-3(b)(2) and Example 2, but proposed Regs under §1.1411-3 do not address whether this
would equally apply for the surtax, see above. However, since most of the surtax follows subchapter J principals,
there is a strong case that it should equally follow in this case to maximize the utility of the charitable deduction.
133
above,ifthetrustee(viasprayorviaBarbaraoranotherparty’suseofalifetimeLPOA)had
donated$140,000tocharityfromthetrust’sgrossincomeinsteadof$20,000(assumingit
wasnotlimitedtoshorttermcapitalgains,interestandrentsaspostulatedabove),theresult
wouldbethatBarbaraorherfamilywouldhavenotaxableincomefromthetrust,despite
receivingsubstantialdistributionsfromit.298
Furthermore,adistributionpursuanttoalifetimelimitedpowerofappointmentmay
alsoqualifyfortheIRC§642(c)deduction.InarecentPLR,thetrusthadthisclause:
“[T]heTrusteeshalldistributealloranyportionofthetrustestate,includingboth
incomeandprincipal,asAmayappoint,atanytimeandfromtimetotimeduringA’s
lifetimeoruponA’sdeath,toanyoneormoreorganizationseachofwhichis,atthe
timecontemplatedforanactualdistributiontosuchorganization,exemptfrom
federalincometaxationunder§501(a)asanorganizationdescribedin§501(c)(3)and
alsoisdescribedinalof§§170(c),2055(a)and2522(a).”(sic)
Inthisruling,theIRSheldthatadistributionofgrossincomefromthetrusttooneor
morecharitableorganizationsmadepursuanttoA’slimitedpowerofappointmentwillbe
made“pursuanttothetermsofthegoverninginstrument”asprovidedin§642(c)(1)and
providedthattheotherrequirementsof§642(c)aresatisfied,suchdistributionfromthetrust
willqualifyforthecharitablecontributiondeductionunder§642(c).299
Whatifthecourt,trustee,trustprotectororparties,throughreformation,decanting
ornonͲjudicialsettlement,amendthegoverninginstrumenttoallowthedistribution?There
isnoreportedcase,butitseemslogicalunderthestatutethatifthisnewagreementisnow
thevalidgoverninginstrumentunderstatelaw,itshouldbeallowed.
Whatifthetrusthasnoprovisiontomakedistributionstocharity,butanFLP/LLC
partiallyownedbythetrustmakesthecontributionfromitsgrossincomethroughits
governinginstrument,andthecontributionpassestothetrustviaKͲ1?Surprisingly,theIRS
willpermitthisaswell,whichalsoopensupfurtheropportunitiestoexploit§642(c).300
Oneuniqueaspectto§642(c)wasnotdiscussedinthePLRs,butmeritsattention.
MostoftheSubchapterJschemetaxingnonͲgrantortrustsignorestracing.Forexample,if
298
Treas. Reg. §1.662(b)-2, Example 1, specifically paragraph (e)
PLR 2012-25004; similar PLR 2009-06008 allowed the 642(c) deduction through exercise of an LPOA
300
Rev. Rul. 2004-5
299
134
thetrusthas$100,000ofincome/DNIanddistributesonlyBlackacrevaluedat$100,000(and
noassetstraceabletoincome),thetrustwillgetadeductionandthebeneficiarywillgetaKͲ1
for$100,000anyway.Suchisnotthecasefor§642(c)–thedistributionmustcomefrom
grossincome,thoughitmightcomefromincomeaccumulatedinaprioryear.301
Thisconceptextendstodistributionsinkind.Whilethecharitablecontributionfroma
trustneednotbeincash,anypropertymustbetraceabletogrossincomeandbasismaystill
berelevant.So,ifthetrusthadpurchasedBlackacrefor$80,000(traceabletogrossincome)
andithadappreciatedto$100,000bythetimeofdistributiontocharity,thedeductionunder
IRC§642(c)isprobablylimitedto$80,000,sinceonly$80,000camefromgrossincome.302
Anotherhurdleisthattheuseof§642(c)islimitedforongoingbusinessincome.IRC
§681limits§642(c)’sdeductioniftheincomewouldbeunrelatedbusinesstaxableincome
(UBTI)ifitwereinthehandsofataxexemptentity.303IfwhatwouldotherwisebeUBTIgoes
toapubliccharity(notaprivatefoundation),thetrustmaybeabletooffset50%ofthe
distribution.304ThisruleisimportanttorememberwhenadministeringasharkͲfinorother
grantorCLATfundedwithcloselyheldbusinessesifthegrantordiesduringtheterm.Since
§642(c)ispartlyunavailableforoffsettingUBTIͲlikeincomefromanScorp,LLC,LPorother
passthroughentityrunninganactivebusiness,thismaybeanotherlogicalcurtailingofthe
scopeofalifetimepowerofappointmentorspraypowertocharity(seevarioussample
languageexamplesinappendix).Plus,it’sareasontostronglyreconsiderprivatefoundations
asrecipientsofsuchincome.
Inshort,withalltheabovetaxplanningideas,wehavetheHolyGrailofincometax
planningavailabletowidows/widowerswithbypasstrusts–theabilitytotrapincomeintrust
ifstatetaxsavingscanbehad,tosprayincometolowerbracketbeneficiaries,andgetabove
thelinecharitabledeductionsthatcanreducetheMedicareSurtax(includinginmanycases,
301
There is a good argument that the “gross income” is simply a quantitative limitation rather than requirement for
tracing, see Federal Income Taxation of Fiduciaries and Beneficiaries, §412.8.3. (CCH 2009), by Byrle Abbin and
Old Colony Trust Co. v. Commissioner, 301 U.S. 379 (1937). However, it is safest to assume in planning that
sourcing is required, since at least one recent court requires it. Crestar Bank v. IRS, 47 F.Supp. 2d 670 (1999)
302
IRS CCA Memo 2010-42023, while it may be debatable, the memo is persuasive in its reasoning
303
IRC §681(a), Treas. Reg. §1.642(c)-3(d) and (e)
304
Treas. Reg. §1.681(a)-2(a) and (b)(3) – it’s a convoluted statute, best understood reading examples in (c)
135
statetaxreductionsevenwhenstatesotherwiselimitordenysuchdeductions).Itcaneven
betailoredinmanycasestoapplytothemosthighlytaxedincome!
Theaboveincometaxshiftingtechniquesrequirethatsomeonedieormaketaxable
giftstononͲgrantortrusts.Whatabouttheother100%ofthepopulationthatpreferstohave
taxsavingsbeforetheydie?Thisbringsustothelastsection.
136
n.
DINGs, NINGs, OINGs – Not just for STATE income tax advantage
(or, How to get a tax deduction for annual exclusion gifts to your kids)
Practitionersmightconsidernotonlyembeddingsuchstrategiesintobypasstrusts,
butinsomecasesmightactivelyusesuchflexibleprovisionsinintervivosirrevocablenonͲ
grantortrustsforbetterincometaxplanning(bothstateandfederal).Forexample,the
recentlyresurrectedDINGstrategyusedtoavoidstateincometaxshouldincludesuch
clauses,andthosewithcharitableintentwhoalreadyhavesubstantialcharitable
carryforwardsmaygetmorebangforthebuckusinganonͲgrantorCLTornongrantortrust
with§642(c)provisionsthatdoesnotqualifyasaCLTinsteadofaCRT/grantorCLT.305
Let’sstartwithaDINGexamplethatdoesnotevenrelyonstateincometaxsavings.306
JohnandMaryarenewlyretiredandwelloff,butnot“rich”.Theynolongerworryabout
estatetax.Theyhave$1millioninrealestate,$3millioninretirementplans,and$5millionin
variousstocks,bonds,andfunds.Theyarewealthyenough,andgenerousenough,however,
tomakeapproximately$50,000inannualexclusiongiftstotheirtwochildren,whohave
youngchildrenthemselves,andtypicallygiveabout$30,000annuallytovariouscharities.
Theygetnotaxdeductionforgiftingtotheirchildren,nostateincometaxdeductionfortheir
giftstocharity,andtheircharitabledeductionissomewhat“phasedout”underthePease
limitationsandcannotbeusedtooffsetthenew3.8%Medicaresurtax.Let’ssaytheirtaxable
incomeisunder$400,000,puttingthemina35%federalbracket,5.41%Ohio,15%capital
gains,plus3.8%surtaxfornetinvestmentincomeotherthanIRAdistributions,etc.
Whatiftheymoved$2millionoftheirnonͲIRAinvestmentstoaDINGtrust?Aside
frombetterassetprotection,let’sfleshouthowwhathappensforincometaxunderthe
abovescenarioifthesamedistributionsaremadefromaDINGtrustinsteadoffromJohnand
Marydirectly.Assumethe$2millionintrustmakes2%taxableinterest,2%dividends,1%
capitalgain(we’llignoreanyunrealizedcapitalgains/losses)=$40,000interest,$40,000
305
See The Art of Avoiding Ohio Income Tax Using Trusts, by this author, May/June 2014 Ohio Probate Law
Journal, and various other articles cited therein, and CLE materials by this author and attorney Kevin Ghassomian
on Incomplete Gift Non Grantor Trusts for upcoming CLE on January 7, 2015 at www.nbi-sems.com.
306
I will refer to “DINGs” or Delaware Incomplete Gift Non-Grantor Trusts” throughout this paper for simplicity
and since the early PLRs used DE law, but you could also have a “NING” or “OING” for Nevada or Ohio, or use
any other DAPT state (VA, MO, AK, UT, etc). NV, OH and DE statutes all permit the settlor to retain lifetime
limited powers of appointment, which were seemingly a factor in the more recent PLRs. Not all states do.
137
dividends,$20,000capitalgain.Thus,atthemostbasiclevel,JohnandMaryhaveshifted
$100,000oftaxableincomefromtheirpersonal1040,tothe1041ofthetrust.
Whenthetrusteedistributesthe$80,000tothechildrenandcharity,thiscompletes
thetaxablegift,butthegiftwillqualifyfortheannualexclusionand/orcharitableexclusion.
Thetrustwillgetanabovethelinededuction,forfederal(andusuallystate,asdiscussed
above)taxpurposesforthecharitablecontribution.Iftwochildrenmake$45,000and
$100,000respectively,theKͲ1forthequalifieddividendsdistributedtothemwillbetaxedat
0%and15%respectively,not18.8%(loweringtheoveralltaxtothefamilyonthe$40,000of
qualifieddividendsfrom$7,520to$3,000,plusmoreifthechildrenliveinastatewithlower
taxesthanOhio).The$10,000ofinterestKͲ1’dtothechildrenchangestaxonthatfrom
38.8%plus5.41%Ohioto15%plusapprox.4%state–cuttingthattaxbymorethanhalfas
well.Thecharitablecontributionismoreadvantageousaswell–avoiding3.8%Medicareand
5.41%Ohiotaxonthe$30,000,nottomentionthePeaselimitations,sothereisanother
$3,000orsobenefitthere.307Notonlythatbutmanytaxpayers,evenmanyhigherincome
taxpayers,donotevenitemizedeductions.308
Wouldafamilybotherwithatrusttoget$10,000taxsavingsannually?Perhaps.The
higherthedonor’sbracket,thelargerthegifts,thelowerthedonee’sbracket=moresavings.
It’slikelythatonlywealthiertaxpayersinthetoptaxbracketwouldutilizethis,sothesavings
intheaboveexamplewouldthenbeabithigher,adding4.6%tothearbitrage(35%Ͳ>39.6%).
StateIncomeTaxationofTrusts–DINGSavings
Ofcourse,theaboveexampledoesnotevencontemplatepotentialstateincometax
savings,whichistoutedastheprimarybenefitofDINGs.Thispaperwillnotdiscussdozensof
states’incometaxlaws–seethevariouscompiledstatecharts.309Thesechartsarean
excellentstartingpointforyourstateresearch,butdonotgointoeverynuanceordiscuss
“sourceincome”limitations,whicharecrucialforcloselyheldbusinesses/realestate.
307
Pease limitations do not apply to non-grantor trusts and estates. IRC §68(e)
According to one study of 2010 tax return data, of those in 15% bracket, only 37% itemize, of those in 25%
bracket, only 65% itemize, of those in 33% bracket, only 70%, rising to 90% for those in the top bracket. See
http://www.urban.org/uploadedpdf/1001486-Who-Itemizes-Deductions.pdf. If your client has paid off their
mortgage, for example, and no longer pays local income tax (or perhaps no state), this becomes more likely.
309
E.g. CCH Multistate Guide to Trusts and Trust Administration, Jeffrey A. Schoenblum, or various CLEs from
Richard Nenno, such as Planning to Minimize or Avoid State Income Tax on Trusts, 34 ACTEC L.J. 131 (2008)
308
138
o. TheDINGͲCRUT
Corporatemergersandtaxinversionsarethehottopicdujour.Theseinversions
typicallytriggergainonthemergerifitgoesthrough,eveniftheclient/prospectdoesnot
wanttosell(despitesomearticlesclaimingthatthisorDonaldSterling'sforcedsaleisakinto
a"condemnation"Ͳwhichiscompletenonsenselikelytoendupwithataxfraudcharge).
Mostreadersarefamiliarwithusingcharitableremaindertrusts(“CRTs”)todefer
taxationͲtheCRTitselfistaxexempt,butpaymentsbacktoasettlor/grantorwillbetaxable
undera4tierorderingsystem,soit'smoreaccuratetosaythatitdefersratherthanavoids
thetax(providedthebeneficiaryliveslongenoughtoreceiveenoughback,ifitisalifetime
CRUT).So,CRUTsareoftenrecommendedtodefergainsonananticipatedsale(aslongas
thetransferisdonebeforeitisa“donedeal”).310
CanthesebecombinedwithaDING,soastodeferthefederaltaxationuntilpayment,
avoidstatetaxationofthepayment,andevenpermitmoreoptimaltaxshiftingandcharitable
deductionsforanyshiftingofthesubsequentpayment?
DINGsoftencannotgetaround"source"income(inͲstaterealestate,closelyheldinͲ
stateLLC/LP/Scorps).However,publiclyheldCcorpslikeAbbVie,BurgerKing,etcarenot
sourceincometoanyonestate.Taxationofthesaleofsuchstocks(anddependingonthe
state,oftenpurestocksalesofLLCs/Scorporationsaswell)typicallyfollowthedomicileofthe
owner,underthelegaltheoryofmobiliasequunturpersonam.Thus,thesemergerscreatea
perfectcandidateforusingeitherDINGtruststoavoidstateincometaxforhigherbracket
taxpayers,orCRUTstodeferfederaltax.
CanyoucombinetheseintoaDINGͲCRUT,withtheDINGasthebeneficiaryofthe
CRUT?YesͲthereisnoprohibitiononanonͲgrantortrustorotherentitybeinganincome
beneficiaryofaCRT.Thiswouldhavetobeaterm,notlifetime,CRUT,ofupto20years.
ThismayallowthebestofbothworldsͲdeferthefederaltax,andavoidthestate
incometax.IncontrasttoatermCRTnamingachild/grandchildasbeneficiary,whichcreates
alumpsumtaxablegiftuponcreation,thismethodcouldusetheannualexclusionforany
annualgiftscomingfromtheDINGtothechildren.
310
As to timing of transfers, see Rev. Rul. 78-197, 1978-1 CB 83 discussion and acquiescence to Palmer v.
Commissioner, 62 T.C. 684 (1974), aff'd on another issue, 523 F.2d 1308 (8th Cir. 1975)
139
IX.
ConclusionͲProsandConsoftheOptimalBasisIncreaseandTaxEfficiencyTrust
MuchoftheplanningandtechniquesfortheüberͲwealthyareunchangedafterATRA
– the increased exclusion amounts merely turbocharge previous gifting techniques. The
OptimalBasisIncreaseTrusttechniquesdiscussedinPartIIIwon’thelpawealthycouplewith
$100millionabit,buttheycanbeextremelyvaluableforsubͲ$10.5millionestates.
The ongoing trust income tax planning techniques discussed in Part VIII apply to all
estatelevels–evenmoresoforwealthierfamilies.Afterall,howmanylowergenerationtrust
beneficiaries, even of wealthy families, always make over $400,000 or $450,000 in taxable
income and are subject to the same tax rates as a nonͲgrantor trust?311 Even those rare
wealthyfamilieswhosechildren/grandchildren/greatͲgrandchildrenallmakeover$450,000in
taxable income are often charitably inclined and should be considering the varied §642(c)
techniquesdiscussedherein.
Formarriedclientswithestatesunderapproximately$10.5million,theOptimalBasis
andIncomeTaxEfficiencyTrustoffersthefollowingadvantagesoveranoutrightbequest,
evenwhereDSUEissuccessfullyclaimed:betterassetprotectionfromcreditors,better
divorce/remarriageprotection,betterprotectionfrommismanagement,bettershelteringof
appreciation/growthfrombothfederalandstateestateandinheritancetaxes,betterplanning
ineventofsimultaneousorclosedeath(potentiallymillionsinsavingsforthoseestateswhere
onespouse’sestateisover$5.25million),betteruseofGSTexclusion,betterincapacity
planning,betterMedicaid/VA/benefitsplanning,avoidanceofstepdowninbasisatsecond
deathandtheabilitytosprayincometochildren/charitiesinlowerbrackets.Thedrawbacks
arethesameaswithanytrustplanning:increasedattorneyfees(andpotentiallypostͲ
mortem,accounting/trusteefees)andcomplexity.The§678(a)variantdiscussedinPartVIII
mayevenalleviatesomeoftheaccounting/taxfilingcomplexity.
TheOptimalBasisandIncomeTaxEfficiencyTrustoffersthefollowingadvantagesover
thetraditionalbypasstrust:betterstepupinbasisatseconddeath,bettercompatibilitywith
disclaimerplanning,betterongoingincometaxtreatmentforthetrustandspouseoveralland
311
Thresholds for single/married filing jointly couples to incur the top 39.6% and 20% long-term capital gains and
qualified dividends rates. See IRC §1 – those adjust for inflation. If someone has $100,000 of itemized
deductions, that threshold may approximate $500,000/$550,000 AGI, since taxable income is calculated after the
standard or itemized deductions.
140
betterincometaxflexibilityandcharitabledeductiontreatmentviasprayprovisionsor
lifetimelimitedpowersofappointment.
TheOptimalBasisandIncomeTaxEfficiencyTrustoffersthefollowingadvantagesover
atraditionalQTIP(assumingamountunderexclusionamount):betterassetprotectionduring
thesurvivingspouse’slife(foraccountingincome),betterleverageofGSTexclusionthan
reverseQTIPifincomeisreinvested(thoughinsomeinstances,QTIPsaremoreGSTefficient),
lesscomplicatedadministration/complianceforretirementplan/IRAbenefits,312betterability
toaugmentorcurtailpowersofappointment,lesschanceoflosingportedDSEUexclusiondue
toremarriage,betterongoingincometaxtreatmentfortheprimarybeneficiary,abilityto
sprayincomeorcapitalgainstolower(or0%)taxbracketbeneficiaries,abilitytosprayorshift
incomewithbettercharitabledeductionsupto100%oftrustAGIwithnoPeaselimitations
andaoneͲyearlookback,abilitytogiftortransactwiththetrustwithouttheIRC§2519gifttax
trap,abilitytoshelterfrom16%Ͳ20%stateestate/inheritancetax,abilitytobetteravoid
inadvertentdiscountingforfractionalinterests,norequirementtofile(orchancetobotch)
Form706tomakeappropriateQTIPelection,noprospectoftheIRSusingaRev.Proc.2001Ͳ
38argumenttodenytheeffectoftheelection,betterabilitytodecant/amend,andthe
preventionofasecondstepdowninbasis.
Justasimportantly,althoughnotextensivelydiscussedherein,ifthesurvivingspouse’s
estate,includingtheQTIPtrust,increasesovertimeabovethesurvivor’sApplicableExclusion
Amount(includingportability),thebypasstrustwillalmostcertainlyhavesavedmorein
estatetaxesthanthepotentialcapitalgainstaxsavingsfromgettingnew(presumablymostly
increased)basis.313Withmanypeopleexpectinginflationtoeventuallyincreasewiththe
recentlyexpandedmoneysupply(quantitativeeasing),realizethathigherinflationovertime
312
QTIPs require spousal net income access/payout from trust AND from IRA/QP owned by trust. Rev. Rul.
2006-26. This makes them “leakier” and wastes GST exemption if QTIP is GST exempt. This creates more
problems administratively, since non-professional trustees do not understand this, especially if inflation reignites
such that internal IRA accounting income becomes likelier to exceed RMDs – could an Atkinson style attack by
the IRS based on improper administration retroactively destroy a QTIP just like a CRT? See Atkinson v.
Commissioner, 309 F.3d 129 (11th Cir. 2002)
313
For illustrations of this savings if investment returns net 11% and the surviving spouse lives 15 or 30 more
years, see Gassman, Crotty, Buschart & Moody On the $28,000,000 Mistake: Underestimating the Value of a
Bypass Trust and Overestimating the Value of Spousal Estate Tax Exclusion Portability, Steve Leimberg's Estate
Planning Newsletter #2061, concluding savings to be…$28 million. While I may have used different assumptions,
the general thrust of the article/spreadsheets is in the right direction and makes a powerful point.
141
exacerbatesthisextensively,sincethelockedinDSEUamountdoesnotadjustforinflation.
Andremember,thefirsttodie’sfamily(QTIP)usuallygetsstuckwiththetaxapportionment–
importantforblendedfamilies.314
Therearesomenarrowsituationsinwhichamaritaltrustwillgeneratebetterestate
taxresultsthananOBIT.315Therearealsosituationsinwhichamaritaltrustwillgeneratea
betteroverallbasisincrease–considertwospouseswhoeachhavenet$5millionestatesand
onesurvivesbyonlytwoyears,allassetsmildlyappreciatewithinflationto$10.5million
total,andthespousedoesn’tsprayanyincometolowerbracketbeneficiariesfromthetrustͲ
theOBITwouldnotsaveanyestatetax,notsaveanyincometax,wouldonlygarnervery
minimalifanystepup,whereasaQTIP(ifportabilityelectedandDSUEnotlost)wouldnot
costanyestatetaxandwouldgarnerslightlymorestepupinbasis.
Tocraftapreciserule,youneedtoknowassetmix,depreciationinfo,dateof2nd
death,thebeneficiary’sdistributionneedsandwhetherapowerholderwouldsprayincome,
taxrates/exclusions(includingstate),inflation,investmentturnover,investmentreturnsand
moretomakeanaccurateprediction.QTIPsusedwithportabilityhaveasweetspotsimilarto
theexampleabove(totalassetsclosetocombinedexclusionbutlittlechanceofeventual
estatetax),butwithsimilarorlargerestatesOBITscouldsavealotmoreestatetaxifthe
survivingspouselivesasignificanttimewithreturnsoutpacinginflation,andwithsmaller
estatesanOBITcangetthesamestepupANDavoidstepdown.
Butbasisincrease(orlackofdecrease)forthefamilyatthesurvivingspouse’sdeathis
aoneͲtimeeventandeventhesebenefitsaretypicallydelayeduntilsale.Thisisprobablynot
nearlyasimportanttothesurvivingspouseastheongoingincometaxefficiencyofthetrust.
ItisherethattheOptimalBasisIncreaseandIncomeTaxEfficiencyTrustoffersthemost
flexibility,controlandefficiencytooptimizetaxbenefitslongͲterm–allofthebenefitsofthe
traditionalbypasstrustbutwithavoidanceofmostofthedrawbacks.Whereasabypass/OBIT
314
Discussed in Part I, see IRC §2207A and your state equivalent, such as Ohio R.C. §2113.86(I)
For the wealthy, a QTIP bequest with full DSUEA elected and reverse QTIP election would nearly always beat
a standard bypass trust if the surviving spouse then immediately fully funded via gift an irrevocable grantor trust
(or released a portion of the QTIP to trigger IRC §2519). This could then exploit installment sales, swaps, etc.
Using grantor trusts funded via gift after the first death enable the use of pre-estate tax dollars to pay the income
tax burden of the grantor trust. Most wealthy couples will have already funded irrevocable grantor trusts during
their lifetimes, but those who haven’t should strongly consider that technique (a typical OBIT could, of course, be
converted to a QTIP if powers disclaimed/released and timely election made – see Clayton QTIP discussion p. 9)
315
142
canbeamendedbydecanting,nonͲjudicialsettlement,trustprotector,trusteeamendment,
UTCprovision,etc.–amaritaltrusthastobeextraordinarilycarefulNOTtoallowany
amendments,howeverwellmeaning,elsethemaritaldeductionwillbedenied.316Wehave
totreadcarefullywithpostmortemamendmentstomarital(orcharitable)trusts.
Asdiscussed,usingtheDelawareTaxTraptomaximizebasisinsomecircumstancesis
saferandcanbemoretargetedthanusingaformulaGPOA,butbothcanprobablybeused
effectively(especiallyifnocapisneededforsmallerestates).However,unlikegeneral
powerswithampleprecedentandguidance,thereisonlyonereportedcaseconstruingthe
DelawareTaxTrap.Thebestofallworldswouldbetohavesomevariantofstatelawthat
clearlyallowstriggeringtheDelawareTaxTrapbycreatingsuccessivelimitedpowersof
appointment,asthedraftlawintheAppendixattemptstomoveforward.
Therewillcertainlybecertainsituationsinwhichsomeofthesetechniquesshouldnot
beused.Qualifiedretirementplan/IRAassetsreceivelongertaxdeferralifleftoutrighttoa
spouse,forexample,soinsomecasesusingportabilityforsuchassetscanbeagoodplan.
Wecancertainlythinkofothers,butmanytaxpayerswillprefervariationsofsomeofthese
incometaxplanningtechniques.317
Many taxpayers have been reticent to pay attorneys for needed amendments to
planningdueto“taxvolatilityfatigue”andfrustrationwithCongress.Thepitfallsofthestatus
quoandthetechniquesdiscussedinthisarticle,coupledwithapparentpermanency,should
give substantial financial incentives for clients to revisit their old estate plan. These
techniquesarenotavailableto“doityourselfers”orgeneralpractitioners–therearenooffͲ
theͲshelf, Nolo Press, TrustsͲRͲUs or other online form books for anyof this. However,any
attorney specializing in estate planning can easily adapt these ideas to provide tremendous
valuetotheirclients.
316
This is why most decanting statutes specifically exclude marital trusts and trust protector/amendment
provisions had better do the same – see PLR 9525002 for a cautionary tale of good intentions gone awry.
317
E.g., would giving the surviving spouse the power to appoint equally to a trust for settlor’s children from prior
marriage which grants them a presently exercisable general power of appointment be all that different from a
default clause that pays to them outright? Would a spouse holding a formula general power really appoint to
creditors to spite remaindermen and would the chosen non-adverse party conceivably consent to that?
143
SpeakerBio
EdwinP.MorrowIII
SeniorWealthSpecialist
KeyPrivateBank
937Ͳ285Ͳ5343
[email protected]
[email protected]
AsoneofKey’snationalwealthspecialists,EdworkswithlocalKeyPrivateBankwealthmanagement
teamsnationwide,advisinghighnetworthclientsonhowtopreserveandtransfertheirwealth.Ed
hasbeenwithKeysince2005.HewaspreviouslyinprivatelawpracticeinCincinnatiandSpringboro,
Ohio concentrating in taxation, probate, estate and business planning. Other experience includes
drafting court opinions for the U.S. District Court of Portland, Oregon as a law clerk. Ed is recent
outgoingChairoftheDaytonBarAssociation’sEstatePlanning,TrustandProbateCommittee.Heis
marriedandresidesinSpringboro,Ohiowithhiswifeandtwodaughters.
Education:
x BachelorofArts(B.A.),History,StetsonUniversity
x JurisDoctorate(J.D.),NorthwesternSchoolofLawatLewis&ClarkCollege
x MastersofLaw(LL.M.)inTaxLaw,CapitalUniversityLawSchool
x MastersofBusinessAdministration(MBA),XavierUniversity
ProfessionalAccreditations:
x LicensedtopracticeinallOhiocourts,U.S.DistrictCourtofSouthernOhioandU.S.TaxCourt
x CertifiedSpecialistthroughOhioStateBarAssninEstatePlanning,TrustandProbateLaw
x CertifiedFinancialPlanner(CFP®),RegisteredFinancialConsultant(RFC®)
x NonͲPublicArbitratorfortheFinancialIndustryRegulatoryAuthority(FINRA)
RecentSpeakingEngagementsandPublishedArticles:
x Author,IncreasingTrustIncomeTaxEfficiencyAfterATRAwithBetterBypassTrustOptions,
ProbateLawJournalofOhio,Sept./Oct.2013,Volume24,Issue1
x Speaker,2013,OhioStateBarAssociationAnnualConferenceonWealthTransferPlanning,Asset
ProtectionandtheOhioLegacyTrust,OptimalBasisIncreasePlanning
x Author,TheOptimalBasisIncreaseTrust,LeimbergInformationServices,March2013
x Author,OptimizingTruststoAvoidtheNewMedicareSurtax,TrustsandEstates,Dec.2012
x Speaker,2012AmericanBarAssnTaxSectionMeeting:EstatePlanningforLargeRetirementPlans
x Speaker,2011PurposefulPlanningInstituteand2011SFSPAnnualTaxSymposium,Exploiting
AssetProtectionandTaxPlanningOpportunitiesafterthe2010TaxAct
x Speaker,2010OhioWealthCounselCLE:AdvancedAssetProtectionPlanning
x Speaker,2009DaytonBarAssociationCLE,ProtectingTrustAssetsfromTaxLiens
x Author,TrusteedIRAs:AnElegantEstatePlanningOption,September2009TrustsandEstates
x CoͲAuthor,EnsuringtheStretch,July/August2007issueofJournalofRetirementPlanning
x Author,UsingSeparateorStandaloneTrustsasQualifiedPlan/IRABeneficiaries,Sept/Oct2007
issueofJournalofRetirementPlanning
144
26U.S.C.§2041–PowersofAppointment
(howpowersofappointmentareincludedingrossestate,sectionsbold/italicizedare
sectionsdiscussedbyauthor,[bracketedcommentsinsertedbyauthor])
(a) In general
The value of the gross estate shall include the value of all property—
(1) Powers of appointment created on or before October 21, 1942
[omitted – but important if you have an old trust]
(2) Powers created after October 21, 1942
To the extent of any property with respect to which the decedent has at the time of his death a general power of appointment
created after October 21, 1942, or with respect to which the decedent has at any time exercised or released such a power of
appointment by a disposition which is of such nature that if it were a transfer of property owned by the decedent, such property
would be includible in the decedent’s gross estate under sections 2035 to 2038, inclusive. For purposes of this paragraph (2),
the power of appointment shall be considered to exist on the date of the decedent’s death even though the exercise of the power
is subject to a precedent giving of notice or even though the exercise of the power takes effect only on the expiration of a stated
period after its exercise, whether or not on or before the date of the decedent’s death notice has been given or the power has
been exercised.
(3) Creation of another power in certain cases [aka the Delaware Tax Trap]
To the extent of any property with respect to which the decedent—
(A) by will, or
(B) by a disposition which is of such nature that if it were a transfer of property owned by the decedent such property would
be includible in the decedent’s gross estate under section 2035, 2036, or 2037,
exercises a power of appointment created after October 21, 1942, by creating another power of appointment which under
the applicable local law can be validly exercised so as to postpone the vesting of any estate or interest in such property, or
suspend the absolute ownership or power of alienation of such property, for a period ascertainable without regard to the
date of the creation of the first power.
(b) Definitions
For purposes of subsection (a)—
(1) General power of appointment
The term “general power of appointment” means a power which is exercisable in favor of the decedent, his estate, his
creditors, or the creditors of his estate; except that—
(A) A power to consume, invade, or appropriate property for the benefit of the decedent which is limited by an ascertainable
standard relating to the health, education, support, or maintenance of the decedent shall not be deemed a general power of
appointment.
(B) A power of appointment created on or before October 21, 1942, which is exercisable by the decedent only in conjunction
with another person shall not be deemed a general power of appointment.
(C) In the case of a power of appointment created after October 21, 1942, which is exercisable by the decedent only in
conjunction with another person—
(i) If the power is not exercisable by the decedent except in conjunction with the creator of the power—such power shall not be
deemed a general power of appointment.
(ii) If the power is not exercisable by the decedent except in conjunction with a person having a substantial interest in the
property, subject to the power, which is adverse to exercise of the power in favor of the decedent—such power shall not be
deemed a general power of appointment. For the purposes of this clause a person who, after the death of the decedent, may be
possessed of a power of appointment (with respect to the property subject to the decedent’s power) which he may exercise in
his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise
of the decedent’s power.
(iii) If (after the application of clauses (i) and (ii)) the power is a general power of appointment and is exercisable in favor of
such other person—such power shall be deemed a general power of appointment only in respect of a fractional part of the
property subject to such power, such part to be determined by dividing the value of such property by the number of such
persons (including the decedent) in favor of whom such power is exercisable.
For purposes of clauses (ii) and (iii), a power shall be deemed to be exercisable in favor of a person if it is exercisable in favor
of such person, his estate, his creditors, or the creditors of his estate.
(2) Lapse of power
The lapse of a power of appointment created after October 21, 1942, during the life of the individual possessing the power shall
be considered a release of such power. The preceding sentence shall apply with respect to the lapse of powers during any
calendar year only to the extent that the property, which could have been appointed by exercise of such lapsed powers,
exceeded in value, at the time of such lapse, the greater of the following amounts:
(A) $5,000, or
(B) 5 percent of the aggregate value, at the time of such lapse, of the assets out of which, or the proceeds of which, the exercise
of the lapsed powers could have been satisfied.
145
GlossaryofTerms318
“Powerofappointment”–apowerthatenablesthedoneeofthepower
(powerholder),actinginanonͲfiduciarycapacity,todesignaterecipientsofbeneficial
ownershipinterestsintheappointiveproperty.
“Donor”–thepersonwhocreatedthepowerofappointment.
“Donee”–thepersononwhomthepowerisconferredandwhomayexercisethe
power.However,Iprefertousetheterm“Powerholder”toavoidconfusion.
“Permissibleappointees”–thepersonsforwhomthepowermaybeexercisedto
benefit
“Appointee”–aperson(orentity/trust)towhomanappointmenthasbeenmade.
“Takerindefault”Ͳperson(s)whowouldreceivepropertyifpowerisnotexercised.
“GeneralPowerofAppointment”(“GPOA”)–apowerexercisableinfavorofthe
donee(powerholder),thepowerholder’sestate,thepowerholder’screditorsorthe
powerholder’sestate.Fortaxdefinition,seeIRC§2041/2514.
“Limited,(akaNonͲgeneral)PowerofAppointment”(“LPOA”)–anypowerthatisnot
ageneralpowerofappointment.Somealsousetheterm“specialpowerofappointment”,a
narrowersubsetofLPOAs–Iwilluse“limitedpowerofappointment”throughoutthisoutline.
“Presentlyexercisablegeneralpowerofappointment”–sometimesreferredtoasa
“PEGpower”,isapowerthatpermitsthepowerholdertoexerciseitwitheffectduringtheir
lifetime,asopposedtoatestamentarypower,exercisableandeffectiveonlyatdeath.
“TestamentaryLPOAorGPOA”–apowerthatisexercisableonlyatdeath,whetherby
will,trustorotherwriting(oftenreferredtoasby“deed”,eventhoughnotrecorded)
“PowerTrust”–atrustinwhichthesettlorgrantsalifetimelimitedpowerof
appointmentinsomeoneotherthanthemselves,andthepermissibleappointeesofthepower
includethesettlor.Thisisnotauniversallyacceptedterm,butIcouldnotthinkofabetter
acronymorabbreviationforit.SeeotherassetprotectionCLEmaterialsbyauthoronthis
topic.
318
Many paraphrased from Restatement of Property, Donative Transfers, 2nd and 3d – see §17.1 et seq.
146
AppendixofSampleClauses,Letters,Charts,Infographics
“Withregardtoexcellence,itisnotenoughtoknow,butwemusttrytohaveanduseit.”
- Aristotle,NichomacheanEthics
“Itisnotthecriticwhocounts;notthemanwhopointsouthowthestrongmanstumbles,or
wherethedoerofdeedscouldhavedonethembetter.Thecreditbelongstothemanwhois
actuallyinthearena,whosefaceismarredbydustandsweatandblood;whostrivesvaliantly;
whoerrs,whocomesshortagainandagain,becausethereisnoeffortwithouterrorand
shortcoming;butwhodoesactuallystrivetodothedeeds;whoknowsgreatenthusiasms,the
greatdevotions;whospendshimselfinaworthycause;whoatthebestknowsintheendthe
triumphofhighachievement,andwhoattheworst,ifhefails,atleastfailswhiledaring
greatly,sothathisplaceshallneverbewiththosecoldandtimidsoulswhoneitherknow
victorynordefeat.”͸TheodoreRoosevelt Page
1)
FormulatestamentaryGPOAwithorderingrules,nonͲadversepartyconsent
AͲ1
2)
FormulatestamentaryGPOAtrackingGSTexclusionavailable
AͲ8
3)
SimpleformulaGPOAwithoutorderingrule
AͲ11
4)
SimpleformulaGPOAwithoutorderingrule,ignoring
AͲ11
anycharitable/maritalbequest/deductionofpowerholder 5)
AdditionalLanguagetocapatestamentaryGPOAintheeventa
PowerHolder’sEstateisSubstantiallyInsolvent
AͲ12
6)
ExerciseoftestamentaryLPOAtotriggerDelawareTaxTrap
AͲ12
6)
SamplelanguagetoretainLPOAindisclaimerfundedtrust
AͲ13
7)
SamplepartialreleasewhereLPOAretainedindisclaimerfundedtrust AͲ14
8)
Samplelifetimelimitedpowerofappointment(includingcharities)
AͲ16
9)
Samplecollaterallifetimelimitedpowerofappointment AͲ19
10) Orderingruleforincludingvariouscapitalgainsaspartofdistribution
AͲ20
11) ProposedstatuteforoptͲinDelawareTaxTraptriggeringforbroadLPOAs
AͲ21
12) DecantingadiscretionarytrusttoaddanarrowGPOAorLPOA AͲ22
13) NoticetobeneficiariesofdecantingtotrustwithLPOA/GPOA(Ohio)
AͲ25
14) DecantinganonͲdiscretionarytrust(HEMS)toaddanarrowLPOA/GPOA AͲ26
15) ChecklistforExistingIrrevocableTrustsforOpportunitiestoStepUpBasis
AͲ30
16) InfographiconeͲpager–WillYourOldABTrustCostYouIncomeTax?
AͲ31
17) “BeneficiaryͲDefective”§678(a)powerforeventualqualificationfor
add
$250,000/$500,000longͲtermcapitalgainstaxresidentialexclusion§121
18) “BeneficiaryͲDefective”§678(a)powerforallincome;formula
add
19) Protector/AmendmentprovisionlimitedsothatanyGPOAmodification/addition
cannotapplybeyondAEAcaportoassetswhere§1014wouldnotincreasebasis
20) TestamentaryformulaGPOAforparent,grandparentor“upstream”beneficiary add
21) SampleformulatestamentaryGPOAforQTIPtrusttopreventfractional
Interestdiscountingandallowconsolidationofassetswithsurvivingspouse
22) Forfeitureprovisionaddedtospendthrift,withcarveoutforQSST,IRA/678a
AͲ31
23) SamplealternatedispositionclausetosaveexclusionifDSUE/706botched
AͲ32
24) FormulaGPOAforGSTNonͲExemptTrustforGSTv.Estatetaxefficiency AͲ33
25) Forfeitureprovisionw/carveoutmarital,QSST,conduitIRA,678(a)
AͲ34
[Note,throughoutthesamplelanguageyouwillnotemypreferenceforsingleratherthan
jointtrusts.Forthoseincommunitypropertystatesorwhootherwiseusejointtrusts,
somelanguagemightbeadaptedforjointtrusts.]
SampleLanguageforFormulaGPOAforBypass(Family,CreditShelter)Trust
SubjecttotheremainingprovisionsofthisSection,myspousehasthetestamentarypowerto
appointacertainportionofassets,betheyallocabletoprincipalorundistributedincome,
remainingintheFamilyTrustatmyspouse’sdeath.Thispowershallapplydifferentlyornotat
alltodifferentassets.Thepotentiallyappointiveassetsshallbeconstrainedandlimitedas
follows:
1) General Power of Appointment – My spouse may appoint certain assets of the Family
Trusttomyspouse’screditors[youcouldalternativelysay“myspouse’sprobateestate”to
thesameeffect,butmystrongpreferencewouldbetosay“creditors”tobetterexcludea
new wife/husband or others “undesirable” to the settlor as potential beneficiary – if a
powerholdercanappointtoapowerholderorapowerholder’sestate,thisisconstrued
to include ANYONE, including new spouse, charity, etc, whereas if a power holder can
appointtocreditorsonly,thepermissibleappointeesareonlybonafidecreditors]319orto
mydescendantsinsuchamountsandsubjecttosuchterms,includingtrusts,asmyspouse
directs. [alternatively, this may be broader and include other uncles, cousins, friends,
charities, etc] [it is highly recommended that you require a nonͲadverse party consent,
whichmightapplyonly toappointmenttocreditors,or,someclientsmayalsowishitto
applytoothernonͲequalappointmentsaswell–e.g.“myspousemayonlyappointtohis
orhercreditorswiththeconsentof___________and/or__________”(thesepersonsor
entities cannot be a beneficiary or “adverse party” – an independent trust company for
instance, may be nonͲadverse), or “Any appointment that is other than equal to my
children or to trusts for my children, per stirpes, may only be made with the consent of
_____________]”. [Alternate #1 definition of potentially appointive assets] The assets
subject to this general power of appointment shall be all assets of the Family Trust,
excluding:
(i) all property that constitutes income in respect of a decedent (IRD), except
employer securities previously received in a lump sum distribution from a qualified
plancontainingnetunrealizedappreciation(NUA)thatwouldalsobeIRDpursuantto
IRC§402and§1014(c).OnlysuchemployersecuritiesthathaveunrealizedgainspostͲ
lumpsumdistributionareeligibletobeanappointiveassetpursuanttothisparagraph,
thosewithoutunrealizedgainspostͲdistributionarenoteligible;
(ii) Roth IRA accounts or Roth variants of other retirement plans such as 403(b),
457(b),or401(k)planaccounts;
(iii) 529PlanAccountsorCoverdellEducationSavingsAccounts(ESAs);
319
See Uniform Power of Appointment Act, §305, Restatement Third of Property: Wills and Other Donative
Transfers §§ 19.13 and 19.14
-1-
(iv) all property that has a cost basis for federal income tax purposes that is greater
than or equal to the fair market value of the property at the time of my spouse’s
death;
(v) alllifeinsurancepolicyorannuitydeathbenefitproceedsownedbyandpayableto
thetrustasaresultofmyspouse’sdeath.
Aftereliminatingtheabovedescribedassetsfromtheappointiveassetssubjecttothis
generalpowerofappointment,ifsuchremainingassets’inclusioninmyspouse’staxable
estateforfederaland/orstateestatetaxpurposeswouldnotincreasemyspouse’sfederal
orstateestateorgenerationskippingtransfertaxliability,assuminganymaritalor
charitabledeductionisdeniedtomyspouse’sestate,thegeneralpowerdescribedabove
shallapplytoallremainingassetsoftheFamilyTrust.
[Alternateversionofabovewithoutthecharitable/maritalreduction]ͲAftereliminating
theabovedescribedassetsfromtheappointiveassetssubjecttothisgeneralpowerof
appointment,ifsuchremainingassets’inclusioninmyspouse’staxableestateforfederal
and/orstateestatetaxpurposeswouldnotincreasemyspouse’sfederalorstateestateor
generationskippingtransfertaxliability,thegeneralpowerdescribedaboveshallapplyto
allremainingassetsoftheFamilyTrust]
[Ratherthanstartingwithallassetsandthenexcludingcertainassets,asabove,itis
probablypreferableandsimplertodotheopposite–startwithnoassetsandthendefine
thepotentialassetseligibletobeappointiveassets,sincenewtaxcategoriesofassetsmay
becreatedinthefuture,orfrankly,Imayhavejustomittedonethatshouldhavebeen
excluded.Hereisapotentiallybettervariation:
[Alternate #2 definitionof potentially appointive assets] The assets potentially subject to
thisgeneralpowerofappointmentshallonlybethoseassetsoftheFamilyTrustwhosetax
basis would increase in value pursuant to IRC §1014 if included in the powerholder’s
estate.
However,shouldsuchinclusionotherwiseresultinfederalorstateestateorgeneration
skippingtransfertaxliability(evenifanymarital/charitabledeductionwerealsodenied),
theappointiveassetssubjecttothisgeneralpowerofappointmentshallbefurtherlimited,
andapplyornotapplytoeachremainingassetofthetrustnotpreviouslyexcludedasa
potentialappointiveassetaboveinthefollowingorder.
Thepowershallapplytotheassetwiththelargestpercentageofdifferencebetweenfair
marketvalueatthetimeofthepowerholder’sdeathandthecostbasisimmediatelyprior
tothepowerholder’sdeathfirst,cascadinginturntoeachsubsequentassetwiththenext
largestpercentagedifferencebetweenfairmarketvalueandcostbasis(e.g.anassetwith
basisof$10,FMVof$100wouldhavea“percentageofdifference”of90/100,or90%).
[Hereisaclausethatwouldgiveapreferencetodepreciablepropertyandcollectibles,
whichwouldgenerallybemorevaluableforbeneficiaries–Ididnotdifferentiatebetween
5year,27.5year,39yearproperty,etc,someonemoredetailedthanImightcraftaversion
thatdoes:
-2-
[Alternate]Inorderingthesetrustassets,andpurelyforthepurposeoforderingwhich
assetsareappointiveassets,depreciableassetsshallbedeemedtohaveapercentageof
difference50%higherandcollectibleassets30%higher.Toillustrate,ifthetrustownsa
buildingwithabasisof$100,000andFMVDOD$200,000,stockwithabasisof$90,000
andFMV$200,000andartwithabasisof$110,000andFMV$200,000,thepercentageof
differenceforpurposesofthisparagraphshallbe(50%times1.5)75%,55%and(45%
times1.3)58.5%respectively,thusthepowerofappointmentshallapplyfirsttothe
building,thentotheartworkandfinallytothestock.]Forpurposesofthisparagraph,
entitiestaxedasapartnershipthatholddepreciableassetsshallbeconsidereddepreciable
assets,regardlessofwhetheranelectionismadeunderIRC§754.
[Alternatively,andthisgetsevenmorecomplex,youcouldtrysomethingthattriestobe
evenmoretargetedtothetaxeffectbylookingtothetaxeffectuponthetrusteeoreven
thebeneficiaries(moreaccurate,butmuchmorecomplicated).
[Alternate]Thepowershallfirstapplytotheassetwhich,ifthebasiswereincreasedtothe
powerholder’sdateofdeathvalue,wouldreducethehypotheticalfederal[Iwouldomit
stateforeaseofcalculation,butsomemightwanttoincludeit]incometax,includingthe
netinvestmentincomeMedicaresurtax,themostasapercentageofoverallvalueifallof
thepotentiallyappointableassetsofthistrustweresoldimmediatelyaftermyspouse’s
death.Thecalculationofsuchhypotheticalfederalincometaxwhichwouldberecognized
shallbedeterminedunderthehighestbracketwithoutconsiderationofanyotherincome
taxdeductions,credits,exemptions,losscarryforwardsorcarrybacks,whichwould
otherwiseberecognizedonthefilingofafiduciaryincometaxreturn.Forillustration,
assumethetrusthadanIRA,anannuity,cash,stockwithabasisof$100,000,FMV
$90,000,abuildingwithbasis$100,000,FMV$200,000($70,000basisreduceddueto
depreciation),P&Gstockbasis$120,000,FMV$230,000andartworkwithbasis$130,000,
FMV$220,000.Thefirstfourcategoriesofassetswouldbedisregardedasnoteven
potentiallyappointable.Thetrusteewouldcalculatethehypotheticaltaxontheremaining
threeassetsasfollows:building($60,000times28.8%(25%depreciationrecapture+
surtax)plus$40,000times23.8%=$17,280+$9,520=$26,800hypotheticaltax;P&Gstock
$110,000times23.8%(20%LTCGrateplus3.8%surtax=$26,180;artwork($90,000times
31.8%(28%collectiblesrateplussurtax)=$28,620.Thesehypotheticaltaxnumberswould
thenbedividedbytheFMVtodeterminewhichassetwouldhypotheticallybenefitthe
mostfromabasisincrease:$26,800/$200,000=13.4%;$26,180/$230,000=11.38%;
$28,620/$220,000=13.01%.Accordingly,thepowershallapplytothebuildingfirst,then
theartwork,thenthestock.]
[note:myownpreferencewouldbetouseasimpleartificialgrossingupofthedifference
fordepreciableproperty(lesssocollectibles),becauseunlikeotherassets,addedbasisto
depreciablepropertyusuallybenefitstaxpayerswhetherthepropertyissoldornot.]
Onceanasset’s(orgroupofassets’)inclusionasappointiveassetswouldotherwisecause
anincreaseinmyspouse’sfederalorstateestatetaxliability[assumingthemaritalor
charitabledeductionweredeniedtheestate],thepowertoappointthemshallbelimited
tothatfractionorpercentagethatwouldnotcauseanyestatetaxliability.Uponreaching
-3-
thislimit,allotherassetsareexcludedfromthisgeneralpowerofappointment[andshall
besubjecttothelimitedpowerofappointmentdescribedinparagraph2below].
Propertywithdifferentcostbasisfordifferentlotsorpurchasesshallbeconsidered
completelyseparatepropertyforthispurpose(e.g.100sharesofABCstockboughtat
$350/shshallbeconsidereddifferentfrom100sharesboughtat$500/shayearlater),and
maybedividedorfractionalizedaccordingly.
Propertythatisemployersecuritiesreceivedasalumpsumdistributionfromaretirement
planwithnetunrealizedappreciationshallconsidersaidnetunrealizedappreciationfor
thispurpose(e.g.1000sharesofP&Gstockwithataxbasisof$50,000,netunrealized
appreciationof$20,000andfairmarketvalueof$85,000shallconsiderthebasistobe
$70,000forpurposesofapplicationofthisparagraph.Ifthestock’svaluewereequaltoor
lessthan$70,000,itwouldaccordinglynotbeanappointiveassetsubjecttothisGPOA).
ForpurposesofillustratingtheintentofthisParagraph1,if$50,000couldbeaddedtomy
spouse’sestatepriortoapplicationofthisParagraph1withoutcausingstateorfederal
estateorgenerationskippingtransfertax,andtheassetwiththelargestpercentage
differencebetweencostbasisandfairmarketvalueis100sharesofABCstockwithabasis
of$35,000andfairmarketvalueof$100,000,thenthisgeneralpowerofappointment
shallextendtoonly50sharesfromthatlotofstock.
Amaterialpurposeofthisparagraph[sectionXX.X]istograntmyspouseageneralpower
ofappointmentasdefinedunderIRC§2041limitedinsuchawayastomaximizethe
incometaxbasisincreaseunderIRC§1014ofthepropertyheldintheFamilyTrustwithout
increasingmyspouse’sfederalorstateestateorgenerationskippingtransfertax,and
withoutsubjectingsubstantialtrustassetstomyspouse’screditorsshouldmyspouse’s
estatebeinsolvent,soastoprovidethemaximumbenefittoourultimatebeneficiaries.
Thistrustmayaccordinglybeamendedordecantedpursuanttoapplicablestatelaw[or,
referenceatrustprotectororindependenttrusteeamendmentclauseifthereisone
alreadyinthetrusttopermitamendments]tocomplywiththisintendedpurposeshould:
a)IRC§1014,§2041orotherapplicabletaxlawbemateriallychanged;
b)thestate,federalorforeignestateorinheritancetaxapplicabletomyspouse’s
estatebemateriallychanged;
c)myspouseremarryandresideinajurisdictionwithaspousalelectiveshare
definitionthatwouldotherwiseincludeappointiveassetssubjecttoathirdpartycreated
testamentarygeneralpowerofappointment,withouthavingavalidpreorpostnuptial
agreementthatwouldotherwiseexcludethesetrustassets
c)myspouse’sprojectedestateappearlikelytobeinsolventandmyspouseresidesin
astatewhichdoesnotprotectassetssubjecttoatestamentarygeneralpowerof
appointmentfromadecedent’sordecedent’sestate’screditors;
d)animprovedformulayieldsuperiortaxresultsforthebeneficiaries;or
e)anyothersituationarisewhichwouldfrustratetheintentionofthisparagraph.320
320
Lest a practitioner be worried that the IRS could make some crazy argument that a power cannot be changed
from limited to general or vice versa under state law, the Restatement is clear that a power’s status as limited or
general depends on the actual situation at any given time. See Rest. Property, Third, § 17.3, comment d.
-4-
2) Limited Power of Appointment [note, there is no tax need for an LPOA, it is entirely
dependent on whether a settlor wants to grant flexibility of distribution] Ͳ My spouse
mayappointallotherassetsnotsubjecttothegeneralpowerofappointmentinparagraph
1aboveortheexclusioninparagraph3belowtomydescendantsortoanytrustprimarily
therefore, which shall specifically exclude my spouse, my spouse’s estate, my spouse’s
creditors,orcreditorsofmyspouse’sestate.[Thismaybeinsuchamountsorsharesasmy
spouse shall determine, including all to one descendant to the exclusion of all others].
[Alternatively,manyclientsmaywanttomakethismuchmorespecific(e.g.descendants
only unless all predecease, or to descendants and/or trusts therefore equally), or even
require a nonͲadverse party’s consent, for nonͲtax reasons (to prevent disinheriting one
child,forexample)Furthernote–ifIRA/QualifiedPlanassetswerepayabletothetrust,
and there is no conduit provision, then further limitations are recommended – see
separateoutline/checklistonIRAandseeͲthroughtrustissues.
3) Proceedsoflifeinsuranceheldbythetrust insuringthelifeofmyspouse–Myspouse
shallnot,however,haveanypowerofappointment(limitedorgeneral)overanyproceeds
of life insurance owned by the trust and payable to the trust that insures the life of my
spouse[Iamskepticalthatthisisneededatall–atestamentaryPOAoverthetrustassets
maynotbeanincidentofownershippursuanttoIRC§2042ofapolicyownedbythetrust.
And, few bypass trusts would own life insurance on the surviving spouse – avoiding IRC
§2042wouldprecludethesurvivingspouseactingastrusteeaswell.However,Iincluded
thisinanabundanceofcautionpendingresearch.Also,youcouldhaveascenariowhere
2042inclusionwouldbemoot(ienotcauseestatetax),anuancewhichisnotaccounted
forinthisparagraph.Theoretically,someonemaywanttheirspousetobeabletoappoint
lifeinsuranceproceedsaswellifnoadditionaltaxiscaused]
FormandMethodofExerciseofAnyPowerofAppointmentͲ
Myspousehastheexclusiverighttoexercisetheabovelimitedandgeneralpowersof
appointment.[However,anagentformyspouseunderaPowerofAttorneyoracourt
appointedguardianmayalsoexercisethetestamentarypowerofappointmentunderthe
sameconditionsasnotedabove.]Theabovepowersmaybeexercisedbyspecificreference
tothispowerofappointmentinaWill,revocablelivingtrust,orotherwritteninstrumentthat
iswitnessedornotarized.[Manyattorneyslimitthisonlytowills,suchas“maybeexercised
onlybyawillspecificallyreferringtothispowerofappointment”].Shouldmultipleattempts
toexerciseconflict,thelastexecuteddocumentshallcontrol.Thetrusteemayrelyona
powerofappointmentexercisedviaWillnotyetadmittedtoprobate,butthetrusteemayin
itsdiscretioninsistthatanyWillcontainingsuchexercisebeadmittedtoprobateorfiledfor
publicrecord.Indeterminingwhetheratestamentarypowerofappointmenthasorhasnot
beenexercised,thetrusteemayrelyonitsknowledgeofanyexerciseorlackthereofand
proceedaccordinglywithoutliability(exceptforactionstakeninbadfaith),intheabsenceof
-5-
actualknowledgetothecontrarymadeknownwithinthreemonthsafterthepowerholder’s
death.321
Unlessappointiveassetsareotherwisecurtailed,suchappointmentsmaybeincashorinkind
andmaydirectspecificpropertytoanyoneormoreofthepermittedobjectsofthepower,
either in trust, or by creating life estates or other restrictions or conditions for any one or
morepermittedobjectsofthepowerandremainderstootherpermittedobjects.
Conditionalexpansionofpermissibleappointeesifappointmentsmadeinfurthertrust
primarilyforpermittedappointees[note,somethinglikethisparagraphshouldbe
consideredifthereisnotabroadclassofappointees,forinstance,onlytodescendants
underParagraph2oronlytodescendantsorcreditorinParagraph1].Ifmyspousemakes
appointmentintrustforanyofthepermittedappointeesasnotedabove,suchthata
permittedappointeeorappointeesaretheprimarybeneficiaryorbeneficiariesduringtheir
lifetimes,thenapermittedappointeemayinturnbegivenabroadlifetimeortestamentary,
limitedorgeneralpowerofappointment,permittedappointeesofwhichmayinclude
charities,creditorsorotherparties,evenifsuchpartieswerenotintheoriginalclassof
permittedappointees.Inaddition,theremaindermenneednotbeintheinitialclassof
permissibleappointees.Forexample,myspousemayappointtoatrustprimarilyformychild
formychild’slifetime,grantingmychildabroadlifetimelimitedpowerofappointment
and/ortestamentarypowersofappointmentsimilartothissection,andtheremainder
beneficiaryuponmychild’sdeathmaybeacharityorspouseofachild.[stronglyconsider
usingsomethinglikethisunlesssomeonedemandsthatgrandchildren,forexample,befully
vested,notsubjecttodivestmentbyachild’sexerciseofaPOAorotherwise(inthatcase,you
mightmodifythisfurther).ThisclauseallowsfurtherLPOA/GPOAOBITlanguagetoharvest
basisforthenextgeneration,allowsfurtherspraycapabilitiesviaLLPOAforbetterincometax
planning,betterassetprotectioniftheprimarybeneficiaryisfrozenout,etc.TheRestatement
ofProperty,3d,DonativeTransfers,§19.2isclearthatappointmentstononͲpermitted
appointeesmaybevoidedasafrauduponthepower,butwhatiflaterremaindermen,spray
beneficiaries,etcarenotamonginitiallypermittedappointees?Inmoststates,butnotall,a
321
Statesmayalsohaveindemnificationstatutestoenabletrusteestomoveonifthereisnowill
filed/knowledgeofexercise–see,e.g.WashingtonstatuteRCW11.95.060(2),somelanguagefromwhichyou
mayconsiderparrotinginyourdocument:“Unlessthepersonholdingthepropertysubjecttothepowerhas
withinsixmonthsaftertheholder'sdeathreceivedwrittennoticethatthepowerholder'slastwillhasbeen
admittedtoprobateoranadjudicationoftestacyhasbeenenteredwithrespecttothepowerholder'slastwillin
somejurisdiction,thepersonmay,untilthetimethenoticeisreceived,transferthepropertysubjectto
appointmentonthebasisthatthepowerhasnotbeeneffectivelyexercised.Thepersonholdingtheproperty
shallnotincurliabilitytoanyonefortransferssomadeifthepersonhadnoknowledgethatthepowerhadbeen
exercisedandhadmadeareasonableefforttodetermineifthepowerhadbeenexercised.Atestamentary
residuaryclausewhichdoesnotmanifestanintenttoexerciseapowerisnotdeemedtheexerciseofa
testamentarypower.”Youmightaddanexampleofintent–itisnotuncommonforawillclausetoread“I
herebyappointanyandallassetsoverwhichIhaveapowerofappointmentto….”–thisinevitablyleadsto
litigationastowhetherthisisspecificenoughtotriggeraPOA–states/courtsmaydiffer.Ohiohasastatute
requiringaPOAappointmentbywilltobespecific,buthasnoparallelstatuteregardingtrusts/deeds.
-6-
POAthatcandistributeoutrightortoapermissiveappointeeintrustcanalsograntthatsame
appointeeabroadPOAintheappointivetrustunderthetheorythatthebeneficiarycould
havebeengrantedoutrightownership.E.g.WashingtonstatuteRCW11.95.060.However,
unlessyouknowforcertainyourclient’sresidencyandstatelawonthisissue,itsafestto
expresslypermitit.Seee.g.,25Del.Code505,whichismostlypositive,butstillhasflawsre
LPOAsͲhttp://codes.lp.findlaw.com/decode/25/5/505].Hereisacitationthatwillshock
readers,andwhyyoushouldconsidersomethingalongthelinesofabove,oravariation:“An
appointmentbythedonee[powerholder]ofaspecialpowertoonewhoisnotamemberof
theclassisineffective,atleasttothatextent.Thus,apowertoappointamongthetestator’s
childrenortheirheirsuponsuchtermsandconditionsasthedonee[powerholder]maydirect
doesnotauthorizeanappointmenttothechildrenforlife,withtheremaindertotheir
children.”322
Anyassetsnotsoappointedunderparagraph1or2aboveshallpassaccordingtothetakers
indefaultofappointmentclausebelow.AllvaluesdeterminedforpurposesofthisSection
shallbeasfinallydeterminedforfederalestatetaxpurposesasofmyspouse’sdeath.My
trusteemayrelyonvaluesobtainedfrommyspouse’sexecutor(ortrustee,ifnoexecutoris
appointed)usedforanystateorfederalestatetaxfiling.Shouldassetslaterbedetermined
uponauditoramendedreturntobehigherorlowerthaninitiallydetermined,thetrusteeis
absolvedfromliabilityforhavingtransferreditemstoanyimpermissibleappointeevia
GeneralPowerofAppointmentinrelianceontheabovedata.However,anyimpermissible
appointeesshallholdsuchfundsinconstructivetrustforthoseappointeesofanylimited
powerofappointmentortakersindefaultwhowouldhaveotherwisereceivedtheassets.
InPariMateria–Intheeventthatmysurvivingspouseisabeneficiaryofanothertrustwitha
similarformulapowerofappointmentprovision,whetherwithmyselforanotherpartyas
settlor,thissectionshallbereadtogetherwiththelikesectionintheothertrustasifthetwo
trustssubjecttotheformulageneralpowerofappointmentwereonetrustsothatunderno
circumstancecouldsuchformulasignoretheothersoastocausemyspouse’stotal
322
Scott and Ascher on Trusts, 5th Edition, ¶ 3.1.2 Exercise of Power of Appointment, citing In re Dohrman
(Matter of Fiske), 195 Misc. 1017, a case where a widow’s husband had granted her the power to appoint in trust
for children upon her own “terms and conditions”, but she appointed in trust for children with their issue as vested
remainder (ie children had no POA). The children objected, claiming that the power to leave to them in trust was
valid, but that the vesting of the remainder in their descendants was invalid because their issue were not
permissible appointees – the court agreed with the children, and the children took the assets subject to the life
terms, but had free reign over the remainder interest to leave to spouse, charity, whomever at their deaths–
presumably the remainder would thus be in their estates, but it essentially gave them a GPOA. Surprise! I doubt
most practitioners would catch the import of a clause similar to this case. Examine any trust that was funded with
a specific clause like this, perhaps you have an argument for inclusion (which may NOT be desired for larger
estates, with loss assets, etc). Note that this case may be decided slightly differently if under Ca Probate Code
§674 or a state embracing the Restatement 3d Property, Donative Transfers §19.12(c)(a change from 2nd
restatement), which permits appointing to a permissible appointee’s issue in the event the appointee predeceases,
under a quasi anti-lapse theory, even for non-relatives. Restatement (First) of Property §359(2):“The donee of a
special power can effectively exercise it by creating in an object an interest for life and a special power to appoint
among persons all of whom are objects of the original power, unless the donor manifests a contrary intent.”.
-7-
appointiveassetsundermultiplegeneralpowersofappointmenttocreateestateinclusion
resultinginstateorfederalestateorgenerationskippingtransfertax.
CoordinationwithandRelianceuponPowerholder’sExecutor
Thetrusteeshallrelyonawrittenstatement,whichmaybeintheformofadraftfederalor
stateestatetaxreturn,fromthepersonalrepresentative(executor)ofthepowerholder’s
estateastothesizeofthepowerholder’staxableestate(determined,asmentionedabove,
withoutregardtoanymaritalorcharitablededuction),includingavailableapplicableexclusion
amount.Ifnopersonalrepresentativeisappointed,suchastatementorstatementsmaybe
obtainedfromthetrusteeofthepowerholder’slivingtrust,orotherpartyconsidereda
statutoryexecutorunderIRC§2203.
Note#1–GST/DynasticͲthislanguagemaybeadaptedtoapplytononͲspousal
powerholders,ofcourse,andsomeofthismaybeadaptedandincorporatedintothe
exercisinginstrumentwhereveralimitedpowerofappointmentisusedtotriggerthe
DelawareTaxTrap(seelatersampleclauses).Theaboveformulamaybeadaptedtoapplyto
theextentofavailableGSTexclusionratherthansimplytotheextentthatanyappointment
doesnotcauseGSTtax.Seethenextsampleclauseforanalternateversion,withadditional
commentaryandprosandconsofthatvariation.
Note#2–AlternateValuationDateͲAVDisnotaddressedabove.Intheory,anAVDcouldbe
addressedtotweakbasisfurtherinraresituations.AVDisonlyavailablewhentheestatetax
isreduced.Ididnotaddressthistosimplifyadministration(andmydrafting:Ͳ)–toaddress
AVDwouldrequiredelayingdeterminationofthevalueofthepowerofappointmentbysix
monthsandpotentiallycomplicatematters.Imayaddressavariationofthisinfuture
iterationsorpresentations.Example:Jane,asurvivingspouseandbeneficiaryofanOBIT
establishedbyherlatehusband,dieswitha$6millionestateofherown(thus,shehasnoAEA
andthereforenoGPOAovertheOBIT)–butthemarketcrashesand6monthslaterthose
sameassetsare$4.5million.TheOBITmaythereforeexploit$0.75millionofJane’s
remainingapplicableexclusionamount(assumingnoDSUEA,$5.25AEA),butthelanguage
aboveusesDODvaluesonly,whichmaystillhavesomebenefit,butwouldnotbeoptimal.
CanaGPOAsimplybedelayed(probably,seepage28andTreas.Reg§20.2041Ͳ3(b)),andcan
itbeappliedtoassetsbasedonavaluesixmonthslater?ProbablyͲIwelcomeany
commentsorsuggestionshere.
Note#3–Indemnifyingtrusteeforadministrationofassetsbetweenthedateofdeathand
determinationofexerciseofpowerofappointment.Whenthesurvivingspouse/powerholder
dies,itmaybemonthsbeforethetrusteeknowstheexistenceofthePOA’sexercise,much
lesstheexactvalueofthesurvivingspouse’snetestate(andthevalueofany
marital/charitabledeductions).IftheGPOAappliestoapieceofrealestate,andthetrustee
ingoodfaithsellstherealestateafterdeath,thentheGPOAshouldprobablyapplytocash
tracedtothesale.
-8-
Note#4–Thereisnoaccountingfordebts/liens/encumbrancesintheabovelanguage.Most
bypasstrustsarenotleveraged,butyoumayhaveresidencewithamortgage,amargin
account,ormaybeevenintraͲfamilyloanstothebypass.Futureversionsofthislanguagemay
addprovisionstoaccountfor“netvalueafterdebt”forthosesituations,whicharenotan
issuewhensomeonehasaPOAoveranentiretrust.Itshouldnotbeanissueintheabove
languageifalienistiedtoanasset.Forexample,ifthereis$1millionavailableexclusionand
themostappreciatedassetisa$1.5millionbuildingwitha$500,000lien,theentirebuilding
maystillbeappointed,subjecttotheaccompanyingdebt,becausethenetamount
transferredpursuanttotheGPOAwouldbe$1million.Idon’tthinkadditionallanguageis
neededtohandlethat.However,debtsituationscouldbeproblematicwhenthedebtisnot
associatedwithoralienagainstaparticularasset.
Note#5(FAQ)–CommonquestionsatCLEs:DoesexercisingaPOAviaWillrequireprobateof
thewill,orifexercised,subjectittoprobate?A:No.APOAcanbevalidlyexercisedwithouta
Willbeingadmittedtoprobate,unlesstheWillspecificallyrequires,butapurportedWill
rejectedbytheProbateCourtasinvalidwillnotvalidlyexerciseaPOA.323 ExerciseofaPOAby
Willdoesnotsubjectappointiveassetstoprobate.
Noneofthislanguageiswarrantiedormaybereliedoninanyway–norisitlegaladvice
thatcanberelieduponforpenaltyprotection.Useatyourownrisk.Anyconstructive
criticismappreciated.
Copyright2013EdwinP.MorrowIII.NooneatKeyBankreviewedorapprovedanyofthis
outline–anymistakesorsuggestionsaremypersonalwhimsandpredilections.Anylicensed
attorneysandattendeesoftheUltimateEstatePlannerTeleconferenceonTheOptimalBasis
IncreaseTrust,orJune13,2013OhioStateBarAssociationEstatePlanningConferenceon
WealthTransfer,orotherpresentationbythisauthorarefreetocopyandadaptanysample
clausesfortheirpersonallawpractice,withoutneedforattribution.Foranyotheruse,please
[email protected][email protected]
courtesy,ifvariationsareusedorimprovedupon,pleasesendmeanyadaptedlanguageor
ideasforchanges.Ideally,Iwouldliketonoteanysuggestedimprovementsandgivecredit
(oranonymously,ifsomeoneprefers)forsuggestionsorimprovementsinanyfuture
presentations.
ThankstoOhioattorneyBrianLayman(www.laymandatri.com)forprovidedsubstantial
constructivefeedbackonthisclause,andOhioattorneyAndyRichnerforprovidingsubstantial
feedbackonPartIIofthisarticleandCaliforniaattorneyTerenceNunanforsharinghisarticle
andsampleformulaGPOAclauses.
323
Restatement, Property, 2nd §
-9-
SampleLanguageforFormulaGPOAforBypass(Family,CreditShelter)Trust–
AlternateversiontrackingavailableGSTexclusionratherthanavailableAEA(tomaximize
basisincreaseONLYtotheextentofavailableGSTexclusion)
SubjecttotheremainingprovisionsofthisSection,myspousehasthetestamentarypowerto
appointacertainportionofassetsremainingintheFamilyTrustatmyspouse’sdeath.This
powershallapplydifferentlyornotatalltodifferentassets.Thepotentiallyappointiveassets
shallbeconstrainedandlimitedasfollows:
4) General Power of Appointment – My spouse may appoint certain assets of the Family
Trusttomyspouse’screditorsortomydescendantsinsuchamountsandsubjecttosuch
terms,includingtrusts,asmyspousedirects.Theassetspotentiallysubjecttothisgeneral
powerofappointmentshallonlyincludeassetsoftheFamilyTrustwhosetaxbasiswould
increaseinvaluepursuanttoIRC§1014ifincludedinthepowerholder’sestate.
However,shouldsuchinclusionotherwiseresultinfederalorstateestateorgeneration
skippingtransfertaxliability(evenifanymarital/charitabledeductionwerealsodenied),or
exceedmyspouse’savailablegenerationskippingtransfertaxexemptionsuchthatan
appointmentofpotentiallyappointiveassetsasdefinedabovecouldcauseanGSTinclusion
ratioofanappointivetrusttoincrease,theappointiveassetssubjecttothisgeneralpower
ofappointmentshallbefurtherlimited,andapplyornotapplytoeachremainingassetof
thetrustnotpreviouslyexcludedasapotentialappointiveassetaboveinthefollowing
order.WhethermyspouseactuallyappointstoatrustthatwouldbenefitfromGST
exclusioniscompletelyirrelevanttodeterminingwhetherageneralpowerofappointment
appliesunderthisparagraph.
INSERTANORDERINGPARAGRAPHHERE,SEESAMPLESINPRIORSAMPLECLAUSE
Onceanasset’s(orgroupofassets’)inclusionasappointiveassetswouldotherwisecause
anincreaseinmyspouse’sfederalorstateestatetaxliability[assumingthemaritalor
charitabledeductionweredeniedtheestate],orgobeyondmyspouse’savailableGST
exemption,thepowertoappointthemshallbelimitedtothatfractionorpercentagethat
wouldnotcauseanyestatetaxliabilityorgobeyondanyavailableGSTexclusion.Upon
reachingthislimit,allotherassetsareexcludedfromthisgeneralpowerofappointment.
Note–Often,onewouldhavethesameorgreaterGSTexclusionasestate/giftexclusion,but
notalways,especiallywiththenewDSUE/portability–alsoconsidersomeonewhoused
annualexclusionCrummeygiftsandallocatedGSTexclusion.Thus,theaboveformulais
adaptedtoapplytotheextentofavailableGSTexclusionratherthansimplytotheextentthat
anyappointmentdoesnotcauseGSTtax.Ididnotaddressthisinthefirstversionbecause
mostcouplesandtheirchildrenwouldwantthesecondbasisstepupevenifitcaused
portionsofassetstogotoaGSTnonͲexempttrust,butIcouldimaginescenarioswherea
clientmayprefertopreservethemaximumGSTexemptionmorethangarnerasecondstep
upinbasis(e.g.childiswealthythemselves,terminallyill,etc).Forexample,survivingspouse
has$6millionAEA($5.25MillionBEAplus$0.75millionDSUE)and$4.5millionGSTexclusion
- 10 -
($5.25millionGSTminus$0.75millionduetoGSTallocationstoCrummeytrusts)anda$3
millionnetestate–theformulaabovecouldbeadaptedtocaptheGPOAat$1.5millionin
lieuof$3million,whichwouldloseabasisincreaseover$1.5million,butallow$1.5millionin
thebypasstocontinuetobeGSTexempt(ifitisadynastytrust).
Whichispreferred?Ifthechildrenareonlymoderatelywealthy,orwealthyandcharitably
inclined,orspendthrifts,theywouldnotgetanybenefitfromtheadditionaltrustfundsbeing
exemptfromtheirestateviaGSTexemption,orperhapstheycaneasilyuse
Crummey/IGTs/GRATsetctoavoidtaxorsimplyspenddowntheGSTnonͲexempttrustassets
first,asisnormallyencouragedintrustdrafting/administration.Ifthechildorchildrenhave
taxableestatesthemselvesandarenotcharitablyinclined,thecalculationismuchmore
complicated–issaving40%inestatetaxagenerationfromnowbetterthansaving20Ͳ35%
incometax(dependingonstateandbeneficiary’srate)onassetslikelysoldbeforedeath?
Again,thewealthierthechildren,thelesscharitablyinclinedandthemoreunhealthythey
are,thebetteritwouldbetolimittheGPOAtoGSTexclusionavailable.Thelesstheassets
havespecialattributes(collectible,depreciable),thelesslikelytobesoldandthelessinherent
gain,again,thebetteritwouldbetolimittheGPOAtoGSTexclusionavailable.Mypersonal
observationisthatmostclients(andtheirchildren)wouldrathersave$5duringtheirlifethan
$10attheirdeath.
Don’tforgettoconsidersomesortofexpressionofgeneralsettlorintentalongwithatrust
amendmentmechanismtoadapttofuturechangesintaxlaw(thereareparagraphsinthe
firstsampleclause),orwhenattorneysmorecleverthanyouorIcomeupwithbetterwaysto
draftsuchclauses.
Note#2–Becauseapowerholdercanchoosewhethertoappointtoa“skipperson”ornot,
querywhetheryouwanttoamendtheGPOAsothatappointiveassetsarelimitedtoGST
exclusionwhetherassetsareorwouldbeappointedtoaskippersonornot,forthesame
reasonsdiscussedregardingclausestoignoreapowerholder’scharitable/maritaldeduction
(seepages35Ͳ39inmainarticle).Forsmallerestates,nothingwouldbelost,butforlarger
estateswherethespousehasadditionalAEAduetoDSUE,itcouldmatter.
- 11 -
MoreSampleLanguage(Simplifiedversions)
FormulaGeneralPowerofAppointment–SubjecttotheremainingprovisionsofthisSection,
myspousehasthetestamentarypowertoappointacertainportionofassetsremaininginthe
FamilyTrustatmyspouse’sdeath.Myspousemayappointthelargestportionoftheassetsof
thistrustwhichwouldnotincreaseanyfederal[orstate]estatetaxpayablebymyspouse’s
estate[withouttakingintoconsiderationanycharitableormaritalbequestbymyspousethat
wouldbedeductiblebyherestatepursuanttoIRC§2055or§2056]tomyspouse’screditors
ortomydescendantsinsuchamountsandsubjecttosuchterms,includingtrusts,asmy
spousedirects.
[note,thishasnoreferencetoIRD,insurance,lossassets,cash,etc–thebracketedlanguage
regardingstateestatetaxandwhethertogrossupwiththecharitable/maritaldeductionis
discussedearlierinthispaper.However,thisisverysimple,andapparentlytracksthePLRs
thatusedGPOAcappinglanguage–aslightvariationisbelow.
FormulaFractionalGeneralPowerofAppointment.Subjecttotheremainingprovisionsof
thisSection,myspousehasthetestamentarypowertoappointacertainfractionoftheassets
remainingintheFamilyTrustatmyspouse’sdeath.Myspousemayappointthelargest
fractionoftheassetsofthistrustwhichwouldnotincreaseanyfederal[orstate]estatetax
payablebymyspouse’sestate[withouttakingintoconsiderationanycharitableormarital
bequestbymyspousethatwouldbedeductiblebyherestatepursuanttoIRC§2055or
§2056]tomyspouse’screditorsortomydescendantsinsuchamountsandsubjecttosuch
terms,includingtrusts,asmyspousedirects.Theassetssubjecttothegeneralpowerof
appointmentshallbethoseassetswhich,withinthefraction,havethegreatestdifference
betweenthebasisoftheasset,andthefairmarketvalueoftheasset,excludinganyincomein
respectofadecedent.
- 12 -
AdditionalLanguagetoCapatestamentaryGPOAintheeventaPowerHolder’sEstateis
SubstantiallyInsolvent(topreventappointiveassetsfrompotentiallybeingdivertedtoa
powerholder’sestate’screditors)–looselybasedonPLR9110054,discussedinPartIII.m.
“Additionalprerequisiteforandrestrictionsonapowerholder’sGPOA
Intheeventthattheenforceableliabilitiesofthebeneficiarypowerholder'sestateexceed
thevalueoftheassetsagainstwhichtheestate’screditorscouldotherwiseenforceagainst
(baseduponvaluesasfinallydeterminedinthefederalorstateestatetaxproceedingsofthe
beneficiary'sestate,excludingthePower)bymorethan$5,000[orpickanotherdeminimis
amount],notestamentaryGeneralPowerofAppointmentisgrantedhereinunlessthe(i)the
amountoftaxbasisthatwouldbeincreasedbyreasonofthebeneficiary'sdeathcomputedas
ifthepropertythatwouldbeappointablebythispowerifnotforthisparagraphhadbeen
includedinthebeneficiary'sgrossestate,(ii)times20%(thiscouldbelessofcourse,or
perhapsyouuseahighernumberinahightaxstate,orestatewithdepreciable
property/collectibles)exceedstheexcessoftheenforceableliabilitiesofthebeneficiary's
estateoveritsassets,computedasiftherewerenoGeneralPowergranted.
Bywayofexampleinexplainingthisparagraph,iftheamountoftaxbasisthatwould
otherwisebegainedbytheabovementionedtestamentaryformulaGPOAwithouttheabove
paragraphwouldbe$600,000,andthepowerholder’sestateisinsolventwithadeficitof
$100,000,theformulapowerofappointmentwouldstillbegranted,because$600,000times
20%=$120,000,whichexceeds$100,000.”
Note:taxableestateassetspulledinunder2035or2036maynotbesubjecttocreditors
understatelawasGPOAappointiveassetsmight,andlifeinsurancemayalsobeincludedina
taxableestatebuthavesimilarcreditorprotection,hencethereferenceabovetoassetsto
whichacreditormightotherwiseenforceagainst.Fewestatesoffamilieswithenoughwealth
tousetrustsarecompletelyandsubstantiallyinsolventandhaveaggressivecreditorscoming
aftertheirestatewithinthestatuteoflimitations,andaggressiveenoughtogoafternonͲ
probateassetsthatwouldbemoredifficulttoreachinthebestofcircumstances.But,itcan’t
hurttoaddthisinmyopinion.
Notetoself:Alsoresearchwhether,ifsomeonehasanLPOAandaGPOA,cantheyexercise
theLPOA,oristhatdeemedtoexercisetheGPOA?Whatifwemakepotentialappointees
DIFFERENTBENEFICIARIES?ThatmayavoidtheproblemoftheinadvertentlyexercisedGPOA.
- 13 -
SampleLanguageforExercisingLPOAforBypass(Family)TrustinOrdertoTriggerthe
DelawareTaxTraptoAdjustBasisforAppreciatedAssets
(tobeincludedinWillorLivingTrust,asdirectedbyoriginaldocument)
PursuanttoparagraphXofmyspouse’strustdatedxx/xx/xxxx,Iwasgrantedatestamentary
limitedpowertoappointtheassetsofsaidtrustbyspecificallyreferringtothatpowerinmy
(will,livingtrustorotherdeed).Iherebyexercisethatpowerasfollows:
Iherebyappointthefollowingassetstothe:
1) [newlydraftedTrustforachildorotherintendedbeneficiarythatgrantsthe
beneficiaryaPEGPower–presentlyexercisablegeneralpowerofappointment]or,
2) [theXYZAppointiveTrust],whichshallbeidenticaltothesubtrustunderArticleIII,
ParagraphAoftheXYZTrustdatedXX/XX/XXXX,whichtermsareincorporatedherein,
withtheexceptionthatthistrustshallhavethefollowingadditionalparagraph
applied:“Duringmychild’s[beneficiary’s]lifetime,mychildshallhaveapresently
exercisablegeneralpowertoappointanyorallassetsofthistrusttohisorher
creditors,tohimorherselfortoanyofmydescendantsinsuchamountsorundersuch
termsasmychild[beneficiary]deemsappropriate.”
COPYLANGUAGEFROMFORMULAGPOAABOVEHERE(inclusiveorexclusivedefinition)
2)IherebyappointallremainingassetsoftheXXXXtrustthatwerenotappointedin
Paragraph1tothe[SurvivingSpouse’sTrustthatdoesNOTgrantanyoneaPEGPower,and
thetrustthatwouldprobablybeallocatedanyGSTexemption][orsimplydon’tappointthe
otherassetsatallandletthempassviaresiduary]
- 14 -
SampleLanguageforanLPOAinaBypass(Family)TrustDesignedtobeEligibletobe
RetainedEvenWhenTrustisFundedViaQualifiedDisclaimer–StillAllowingtheSurviving
SpouseDispositiveControlinOrdertoTriggertheDelawareTaxTraptoAdjustBasisfor
AppreciatedAssets
(seediscussioninPartIV–remember,limitedLIFETIMEpowersmighttriggeragifttaxifthe
powerholderhasamandatoryincomeinterestevenifDTTisnottriggered–ifitisdoneinsuch
awayastotriggertheDTT,itDOEStriggerataxablegiftunderIRC§2514,regardlessof
whetheraspousehasmandatoryincomeinterest–butmanyspousescouldn’tcareless–the
incometaxbenefitofsprayingincomemayfaroutweighanygifttaxramifications)
Duringmyspouse’slifetimeanduponmyspouse’sdeath,myspouseshallhavethepowerto
appoint,fromincomeorprincipal,incashorinkind,allassetsofthistrusttoatrustortrusts
foranyorallofmydescendantsthatqualifiesthetransferasataxablegiftorbequestunder
IRC§2514(e)or§2041(a)(3),suchasatrustformydescendantthatgrantsmydescendanta
presentlyexercisablegeneralpowerofappointmentoratrustthatwouldotherwisetrigger
taxablegifts/bequestsunderapplicablestatelaw.Allotherappointeesareexcluded,
specificallymyspouse,myspouse’sestate,myspouse’screditors,andcreditorsofmy
spouse’sestate,inadditiontoanyotherpartynotdescribedabove.
Inaddition,duringmyspouse’slifetime,myspouseshallhavethepowertoappoint,from
incomeorprincipal,incashorinkind,assetsofthistrusttoanyorallofmydescendants,but
limitedtoamountsnecessaryfortheirhealth,educationorsupport.Thisparagraphshould
notbeinterpretedtograntmypermittedappointeesanypropertyinterestasaresultofbeing
apermittedappointee,andmyspouseshallhavenofiduciarydutywhatsoevertothemduring
myspouse’slifetimeunderthisparagraph.Theabovelimitationsshallserveasaceilingto
limitmyspouse’sabilitytodirectthebeneficialenjoymentofpropertypursuanttoTreas.Reg.
§25.2518(e)(2)and(e)(5)Example6.
Theabovepowerofappointmentisintendedtoberetainedwhilestillqualifyinganytransfers
madetothistrustpursuanttomyspouse’sdisclaimer,pursuanttoIRC§2518andthe
exceptionforretainedspousalrightstodirectthebeneficialenjoymentofpropertyunder
Treas.Reg.§25.2518(e)(2).Itshallbeinterpretedaccordingly.
- 15 -
SampleLanguageforaPartialReleaseofaBroadLPOAinaBypass(Family)Trust
wheretheSurvivingSpouseDesirestoFundBypassviaQualifiedDisclaimer–StillAllowing
theSurvivingSpouseDispositiveControlinOrdertoSprayIncomeand/orTriggerthe
DelawareTaxTrapatDeathtoIncreaseBasisforAppreciatedAssets
Example of when to use this: John and Jane have basic AB trusts, with broad LPOAs in the bypass trust. The
trusts are mostly unfunded, then John dies. Jane proposes to disclaim her POD/TOD/JTWROS interests, in which
case the assets will pour into the Bypass, but retention of a broad LPOA would taint the disclaimer (it would result
in a taxable gift, loss of asset protection, full 2036 inclusion, full step down at second death). Jane could disclaim
the entire LPOA, losing the tax flexibility to spray income and get a step up in basis at second death, or, for
potentially better income tax results, she may execute a partial release as envisioned below. When she then
disclaims, the retained LPOA, which can only be exercised in a way to trigger estate/gift tax, should meet the
exception in the qualified disclaimer regs cited below.
PursuanttoparagraphXofmyspouse’strustdatedxx/xx/xxxx,Iwasgrantedalimited
[testamentary]powertoappointtheassetsofsaidtrustbyspecificallyreferringtothatpower
inmy(will,livingtrustorotherdeed).Iwasgrantedthepowertoappointto
____________________[oftenthiswillbeeithertodescendantsortoanyonebutthe
powerholder,powerholder’sestateorcreditorsofeither],whichincludesthepowerto
appointtoatrusttherefore[usuallytrustsincludethispower–ifyoursdoesnot,checkstate
law(commonlawunderRestatementisfavorable),whichprobablyincludesitanyway].
[touseifalifetimepowerisgrantedintheoriginaltrust]Astomylimitedpowertoappoint
duringmylifetime,Iherebypartiallyreleaseanddisclaimtheabovementionedpowerexcept
thatIshallretainonly1)thepowertoappointtoatrustforthepermittedappointeesthatwill
triggerafederalgifttaxunderIRC§2514(e)upontransferand2)thepowertoappointtoany
ofthepermittedappointeesdirectly,butlimitedtoamountsnecessaryfortheirhealth,
educationorsupport.Iherebyreleaseanddisclaimthepowertoappointduringmylifetime
beyondtheappointeesoramountsdescribedabove.
[morecommon–touseifatestamentarypowerisgrantedintheoriginaltrust]Astomy
limitedtestamentarypowertoappointuponmydeath,Iherebypartiallyreleaseanddisclaim
theabovementionedpowerexceptthatIshallretainonlythepowertoappointtoatrustfor
anyorallofthepermittedappointeesthatwilltriggerafederalestatetaxunderIRC
§2041(a)(3)upontransfer.Iherebyreleaseanddisclaimthepowertoappointtoanyother
appointee.
Thisrelease/disclaimerisintendedtoqualifyanyfutureorcontemporaneouslyexecuted
disclaimerthatwouldcauseatransfertothetrustreferencedabove,suchthattherights
retainedafterrelease/disclaimercomplywiththerequirementsofIRC§2518andthe
exceptionforretainedspousalrightstodirectthebeneficialenjoymentofpropertyunder
Treas.Reg.§25.2518(e)(2)and(e)(5)examples6and7.Itshallbeinterpretedaccordinglyand
shallbegiveneffectregardlessofwhetherthisrelease/disclaimerofinterestsisitselfa
qualifieddisclaimerunderIRC§2518.
- 16 -
Note–Thereisnoexampleinthe§2518Regsofwhethersuchadisclaimeris“qualified”(isit
“severable”?),whichiswhyIreferredtotheaboveasa“release”and/or“disclaimer”,nota
“qualifieddisclaimer”.See§25.2518Ͳ3(A)(iii)andexamples9and21inthatRegfor
disclaimingPOAs,whichareconsideredasseparatepropertyinterestsfordisclaimer
purposes.Whethertheabovewouldbe“qualified”isirrelevant,atleastforthelimited
purposeofthisRelease,whichistoprepareanotherdisclaimertobequalified–areleasemay
accomplishthesamethingasaqualifieddisclaimerinsomecaseswithoutilleffect.Fora
greatexampleofacleveruseofapartialreleaseofaGPOAtoqualifyatrustasa“seethrough
trust”,seePLR2012Ͳ03033.IfaGPOAisreleased(notaqualifieddisclaimer),itwouldbea
gifttaxableeventbasedontheunderlyingassets(seeIRC§2514(b))(althoughitmaybe
delayedbybeinganincompletegiftifpowersareretainedascontemplatedbyapartial
release),butareleaseofanLPOA,orportionsofanLPOA,wouldnotbe–seeTreas.Reg.
§25.2514Ͳ3(e)example3“IfinthisexampleLhadapowertocausethecorpustobe
distributedonlytoX,Lwouldhaveapowerofappointmentwhichisnotageneralpowerof
appointment,theexerciseorreleaseofwhichwouldnotconstituteatransferofpropertyfor
purposesofthegifttax.”
- 17 -
SampleLifetimeLimitedPowertoAppointtoEnableSurvivingSpousetoSprayIncome
toChildrenand/orCharities
(includingprovisionslimitingsuchpowersforseeͲthroughtruststatusforretirement
benefitsandqualifiedsubchapterStrusts–obviouslythisisnotformaritaltrusts,
practitionersinstateswithseparatestateestate/inheritancetaxesshouldinvestigatetowhat
extentsuchpowersmightaffecttrustsintendedtoqualifyforthatstate’sseparate
estate/inheritancetaxmaritaldeduction–practitionersinthosestatesmaydividea
bypass/creditsheltertrustbetweena“B1”sharethatisstateestateexemptanda“B2”share
thatiseligibleforseparatestateQTIP–ifnecessary,alifetimelimitedpowerofappointment
mightbelimitedtoonlythe“B1”shareifthatwouldsavestateestatetaxes)
Thetrusteeshalldistributealloranyportionofthetrustestate,fromincomeor
principal,asmyspousemayappointduringmyspouse’slifetime,toanyofmy
descendants,intrustoroutright.[Anyappointmentthatisnotequaltomychildrenor
theirissueperstirpesmayonlybemadewithpermissionof_______,orthe
unanimouspermissionofmychildren,ortheirrepresentativeissueperstirpes.–Some
mayfearasurvivingspousemightbeundulyinfluencedbyonechildtomakeunequal
distributionsthwartinganintendedequalestateplan.Somemaynotcareiftheir
survivingspousedoesthis,andtheremaybeverygoodreasonstomakeunequal
distributions.Inmyexperience,morethanhalfwouldopttoallowtheirspousemore
flexibilityandtrusttheirspouse’sjudgmentandsenseoffairness.Becausealifetime
LPOAisnotintendedtotriggergift/estatetax,wereallydon’tcarefortaxreasons
whetheranonͲadverseoradversepartyconsentisrequired.]
Thislimitedpowerofappointmentshallnotbeexercisable,directlyorindirectly,to
dischargeanylegalobligationofthepowerholder.
Inaddition,thetrusteeshalldistributealloranyportionofthetrustestateasmy
spousemayappointduringmyspouse’slifetime,whethersuchincomeisallocatedto
accountingincomeorprincipal,toanyoneormoreorganizationseachofwhichis,at
thetimecontemplatedforanactualdistributiontosuchorganization,exemptfrom
federalincometaxationunder§501(a)asanorganizationdescribedin§501(c)(3).
Theseappointiveassetsshallbelimitedfurtherasfollows:
5) onlyfromgrosstaxableincomeascontemplatedunderIRC§642(c)[as
discussedherein,thismightalsobefurtherlimitedtohighertaxrateincome,
butmanyclientswouldwantthebroaderabilitytosprayeven“lowerrate”
LTCG/QDincome],and
6) onlyfromgrossincomethatwouldnototherwisebeunrelatedbusiness
incomepursuanttoTreas.Reg.§1.642(c)Ͳ3(d),IRC§681(a)andregulations
thereunder(suchastaxableincomefromanongoingcloselyheldbusiness)
Itismyintentionunderthisprovisionthatanysuchappointmentsqualifyforan
incometaxdeductionpursuanttoIRC§642(c),asamended,andthisprovisionshallbe
construedandmaybeamendedaccordingly.
- 18 -
NOTE:Ifthetrustisintendedtobea“seethroughtrust”holdingqualifiedplan/IRA
benefits,youwillwanttomodifylifetimepowersaccordingly,dependingonwhether
thetrustisaconduitoraccumulationtrust.Asnotedelsewherehereinandinother
articlesandCLEoutlines,itisprobablybetter,especiallywhenusingmoreflexibletax
provisionssuchastheabove,tohavesuchbenefitsinaseparatetrustaltogether
becauseitisunclearwhetheryoucanadequatelytraceorconvincetheIRSthatyou
areadequatelytracingandlimitinganyaccumulationsfromthoseretirementbenefits.
Rememberthatatrustmayqualifyasaconduitforaspouseevenifotheryounger
beneficiariesmightbeentitledtodistributions(bea“seethroughtrust”withthe
spouse’slifeexpectancyasmeasuringlife/”designatedbeneficiary”),butifyounger
beneficiariesmighttakeviaLPOA,thespousewouldnotbe“solebeneficiary”and
thereforewouldlosetheothertwomajorbenefits–apotentiallydelayedrequired
beginningdateandrecalculationoflifeexpectancyeveryyear.However,ifyouhave
anaccumulationtrust,youmightlosethosetwoadvantages,butyoucanretaina
spraypower,aslongasthepotentialappointeesareallyoungerindividuals,which
wouldallowshiftinghighbracketordinaryincome.
[Foraconduittrustintendedtoachieve“solebeneficiary”status–Notwithstanding
theaboveparagraphs,myspouse’slifetimelimitedpowerstoappointshallnotapply
toanydeferrableretirementbenefits[youmightwanttohave/refertoadefinitionfor
this],andsuchassetsshallnotbeconsideredappointiveassetssubjecttothispower,
norshallthislifetimepowertoappointapplytoanybenefitstemporarilyreceivedasa
distributionfromaretirementplanthatmustbethereafterdistributedtomyspouse.
Itismyintentionthatthislifetimelimitedpowerofappointmentbesubordinatetothe
conduittrustprovisioninparagraph____.
[Forconduittrustwhere“solebeneficiary”statusnotsought,oraccumulationtrustͲ
Notwithstandingtheaboveparagraphs,myspouse’slifetimelimitedpowersto
appointshallnotbefurtherlimitedastoanydeferrableretirementbenefits[you
mightwanttohave/refertoadefinitionforthis].Myspousemayonlyappoint
retirementbenefitsduringmyspouse’slifetimetomydescendantsoutright.Thismay
includequalifyingtrustsformydescendantsonlyifacopyofthetrustisgiventothe
IRAcustodian/trusteebyOctober31oftheyearaftermydeathandsaidtrustwould
otherwisequalifyasaseethroughtrust/designatedbeneficiaryitself.]
Notwithstandingtheaboveparagraphs,myspousemaynotexerciseanylifetime
limitedpowerofappointmentoveranySCorporationstockordistributionstherefrom,
overwhichaqualifiedsubchapterScorporation(QSST)electionhasbeenmade,nor
fromanytrustportionoverwhichamaritaldeductionwasorwillbeelectedas
qualifiedterminalinterestpropertyunderfederalestatetaxoritsapplicablestate
estatetaxlawequivalent.
- 19 -
Note–ifthereistestamentaryformulaGPOA,thespousemaybetriggeringataxablegiftby
exercisingalifetimelimitedpowerofappointment.Soalifetimepowerworksoptimallyfor
giftsbeyondtheannualexclusionamountsifthe“optimalbasisincrease”clauseisalifetime
testamentarylimitedpowerofappointmentintendedtotriggertheDelawareTaxTrapunder
§2041(a)(3)toincreasebasis.However,anyformulatestamentaryGPOAwillexcludecertain
assets,suchasretirementplan/IRD.Couldwefashionalifetimepowertoonlycomefrom
thoseexcludedassetstoavoid§2514?Probably,butitisunclearhowthatwouldplayout,
especiallyforassetssuchascashthatmightbeexcludedfromaformulaTGPOAoneday,and
includedthenext.Formanymiddleincometaxpayerswithplentyofestate/gifttaxexclusion,
thiswouldnotbeanissue,andincometaxsavingsgoalswouldtrumpsavinganysuperfluous
estate/gifttaxexclusion.However,wewouldwanttowarnclientsofthepossibilityofits
application–andforsomeclients,itmaymatter.Similarly,ifthespousehada§678(a)power
orisotherwiseentitledtomandatoryincome,usingalifetimelimitedpowerofappointment
couldalsotriggeragifttaxorpossiblyeventriggeranassignmentofincomeevenifthereisno
testamentaryGPOA.SeetheRegesterandSelfcasesdiscussedinfootnote280.
SEENEXTSAMPLECLAUSEONANOTHERWAYTOGETAROUNDTHIS.
- 20 -
SampleTrusteeSprayPowerand/orLifetimeLimitedPowertoAppointtoEnableaParty
OtherthanCurrentBeneficiary(spouse)toSprayIncometoChildrenand/orCharities
AsdiscussedinthenotestotheprevioussamplelifetimeLPOAclause,therearesome
drawbackstothesurvivingspousebeinggrantedalifetimePOA–insomecasesitmaytrigger
ataxablegiftoranassignmentofincome.Ofcourse,givinganindependenttrusteespray
powersisonewaytogetaroundtheserules.However,inmyexperience,settlorsdonot
wanttogiveindependenttrusteessuchbroadspraypowersattheexpenseofthesurviving
spouse,trusteesdon’tnecessarilywantitbecauseoftheincreasedadministration,due
diligenceandliability,andtheremaybeadditionalreporting,accountingandnotice
requirementsaswell–trusteeswouldhavefiduciarydutiestothebeneficiariesundera
traditionalsprayprovision(whichcanalsobeviewedasafiduciarylifetimelimitedpowerof
appointment).Onewaytoalleviatesome,butnotall,ofthoseconcernswouldbetogranta
spouseavetopowerregardinganysuchdistributionsbythetrustee.Theotherway,tome,
preferred,istograntanonͲfiduciarylifetimelimitedpowertoappointtosomeoneotherthan
thesurvivingspouse(thisisknownasacollateralpower)–thispreventsmanymoreofthe
issuesnotedabove.
Thetrusteeshalldistributealloranyportionofthetrustestate,fromincomeorprincipal,as
_____________(someoneotherthanthespouse)mayappointduringmyspouse’slifetime,to
anyofmydescendants,intrustoroutright.Inaddition,thetrusteeshalldistributeany
portionofthetrustestate,butonlyfromgrosstaxableincome,as__________mayappoint
duringmyspouse’slifetime,whethersuchgrosstaxableincomeisallocatedtoaccounting
incomeorprincipal,toanyoneormoreorganizationseachofwhichis,atthetime
contemplatedforanactualdistributiontosuchorganization,exemptfromfederalincome
taxationunder§501(a)asanorganizationdescribedin§501(c)(3).
Anyappointmentmayonlybemadewithpermissionof[myspouse,ormyspouse’sagent,
conservatororguardian][unanimousconsentofmyspouse’schildren].
Anylifetimepowerofappointmentshouldconstrainseethroughtrusts/QSSTsasnotedin
priorsamplelanguage.
Wouldaspousalconsenttosomeoneelse’sappointmentsomehowanegativeramification?
Thisisunlikely,butpossible,dependingontheissue,thusthebracketedexamplesofgranting
aspouseavetopowerversusotherpartieswhowouldindirectlyactonbehalfofaspouse.
Whiletheformerisprobablysufficient,thelatterwouldbesaferinallevents.
- 21 -
DraftProvisiontoEnableandOrderDistributionsofCapitalGainstobeCarriedOutto
Beneficiaries
Trust Accounting for Discretionary Distributions to Beneficiaries
"To the extent that discretionary distributions are made from capital gains allocated to principal, the trustee
shall make them and/or account for them in the books, records and tax returns of the trust in the following
order:
1) from any net short-term capital gains, except those net gains attributable to disposition of property held in a
trade or business not described in IRC §1411(c)(2), or attributable to disposition of an active trade or business
as described in IRC §1411(c)(4);
2)
from any remaining net short term capital gains not described in the above paragraph;
3)
from any long-term capital gains, except those net gains attributable to disposition of property held in a trade
or business not described in IRC 1411(c)(2), or attributable to disposition of an active trade or business as
described in IRC 1411(c)(4);
4) lastly, from any remaining current year long-term capital gains not described in the above paragraph.
This paragraph is intended to ensure compliance with Treas. Reg. §1.643(a)-3(b)(2)”
- 22 -
DraftofProposedOptͲInRuleAgainstPerpetuitiesAmendmentforAdoptioninStatesto
ProvideImprovedTax,EstateandAssetProtectionPlanningOptionsfortheirCitizens
(portionsplagiarizedfrom25Del.Code§§501,504,withanoptinfeatureadded)
OhioRev.Codeproposed§2131.08(H):
Notwithstandinganyotherprovisionofthischapter,inthecaseofanongeneralpowerof
appointmentoverpropertyheldintrust(the"firstpower"),andonlywhereintheinstrument
exercisingthepowereither
a. specificallyreferstothisparagraph,or
specificallyassertsanintentiontotriggerSection2041(a)(3)orSection2514(e)of
theInternalRevenueCodeof1986,or
c. specificallyassertsanintentiontopostponethevestingofanyestateorinterestin
the property which was subject to the first power, or suspend the absolute
ownership or power of alienation of such property, for a period ascertainable
withoutregardtothedateofthecreationofthefirstpower
b.
then, and only to theextent intended and specified in the instrument,any estateor
interest in property, real or personal, created through the exercise, by will, deed or other
instrument, of the first power, irrespective of the manner in which the first power was
created or may be exercised, or whether the first power was created before or after the
passageofthissection [alternatively,“butonlyifthedateofcreationofthatnongeneralpowerof
appointmentisonoraftertheeffectivedateofthissection],shall,forthepurposeofanyruleof
law against perpetuities, remoteness in vesting, restraint upon the power of alienation or
accumulations now in effect or hereafter enacted be deemed to have been created at the
timeoftheexerciseandnotatthetimeofthecreationofsuchpowerofappointment.
[Ohio defines non-general power in another statute, otherwise you might add something like
“and the first power may not be exercised in favor of the donee, the donee's creditors, the
donee's estate or the creditors of the donee's estate”]
Also – You might add “testamentary”, or limit to 2041(a)(3), since there would not be much
use in triggering a taxable gift under 2514(e). However, might you have a case of a GST nonexempt trust where someone wants to appoint and use their gift/GST exemption? Perhaps
someone more creative than I can find a use, but I can’t see much harm in including the gift
possibility as long as the appointment has to affirmatively opt-in.
I don’t think the bracketed language above is necessary, since I don’t think an opt-in statute has
the danger of inadvertently causing some calamity based on application to existing LPOAs, but
I’m still thinking this over a bit. Comments welcome.
- 23 -
DecantingandTrustAgreement
ThisdeclarationofdecantingandtrustagreementisexecutedintheStateof
__________,onthedatehereaftersetforth,by___________________________,asTrustee.
Whereas:
1.
TheSettlor,_______________________________,createdanirrevocabletrust
[revocabletrustmadeirrevocablebythesettlor’sdeathonXX/XX/XXXX],the
__________________________trust(“FirstTrust”),attachedhereto.
2.
____________________________isnowactingassoletrusteeoftheFirst
Trust,whichisnowinexistence.[oramendforcoͲtrusteesaccordingly]
3.
PursuanttoArticleXX,ParagraphYY,theFirstTrustprovidesthattheTrustee
mayinitsdiscretionmakedistributionstoSettlor’sspouse,________________________,for
her“[inserttermsfromtrustthatindicatebroadtrusteediscretiontodistribute].”(ifyou
don’thavebroaddiscretion,butHEMS,thengotoplanB,seesubsequentsample).
a.
OhioR.C.§5808.18(A)providesinpertinentpart,that“Ifatrusteeofatrust,
***hasabsolutepower***tomakedistributionsofprincipaltooneormorecurrent
beneficiaries,thattrusteemayexercisethatpowerbydistributingalloranypartofthe
principalsubjecttothepower,andalloranypartofanyincomethatisnototherwise
currentlyrequiredtobedistributed,tothetrusteeofanothertrust,***thatisforthebenefit
ofoneormorecurrentbeneficiariesofthefirsttrust***Ifpropertyisdistributedpursuantto
theauthoritydescribedindivision(A)ofthissection,thegoverninginstrumentmaydo***the
following:(a)Grantapowerofappointmenttooneormoreofthebeneficiariesforwhose
benefitthepropertywassodistributed,includingapowertoappointtrustpropertytothe
powerholder,thepowerholder'screditors,thepowerholder'sestate,thecreditorsofthe
powerholder'sestate,”[note:moststatedecantinglawsallowgrantinganLPOA/GPOAifthe
trusteehasbroaddiscretion.Consultthislistofdecantingstatuteswithanalysisofeach
state’spowertoaddPOAsathttp://www.sidley.com/stateͲdecantingͲstatutes/andinsert
yourapplicablestatestatuteorcaselawcitationinlieuoftheOhiostatuteabove.Ifyour
statehasnodecantingpower,youmaybeabletochangesitustoonethatdoesusinga
nonjudicialsettlementagreementorothertrustpower.]
b.
[Useifstatelawrequiresnoticetobeneficiary,butfranklyevenifpriornoticeis
notrequiredpursuanttostatuteit’sprobablyagoodideaormayevenberequiredunder
otherfiduciaryduties.]PursuanttoOhioR.C.§5808.18(F),allcurrentbeneficiariesare
entitledtoatleast30dayswrittennoticeofthisdistributionunlessallcurrentbeneficiaries
waivethis.Evidenceofthisnoticeand/orwaiverisattachedherein.
NowTherefore:
- 24 -
TheundersignedTrusteeherebydirectsthatall[or,alternatively,atrusteemightonly
decantthoseassetscapableordesiringofastepupinbasis]oftheTrustassetsoftheFirst
Trustshallbedistributedto___________________________________,asTrusteeofthe
SecondTrust(asdefinedherein),tobeadministeredasapartthereof.
“SecondTrust”meansthetrustcreatedunderthisinstrument.Thetermsofthe
SecondTrustshallbethesameasthetermsoftheFirstTrust,whichtermsareincorporated
hereinbyreference,exceptfortheadditionalprovisionsassetforthbelow:
1.
Trusteeherebygrantsto___________________[settlor’sspouseorother
beneficiary]atestamentarygeneralpowerofappointment[limitedpowerofappointment]as
follows:
INSERTPARAGRAPHSGRANTINGGPOAorLPOATOTRIGGER§2041(a)(3)HERE
Consider–ifthestatedecantingstatutedoesnotallowforremovalofaGPOA/LPOA
(manydecantingstatutesaresilentonthisissueandonlyspecificallypermitADDINGone
ratherthanremovingone),thenyoumightaddanexpirationperiod(aka“Boomerang
clause”),whichletsthetrustlapsebacktoitsoriginalstateandwouldforcethetrusteeto
keepontopoftheissueandperiodicallyrenewthedecanting(orbetter,adefaultmightbeto
lapseonlyupontrustee’saffirmativeaction).Anothersolutionwouldbetoaddaspartofthe
decantingatrustprotector/amendmentprovisionthatwouldallowthesubsequentremoval,
additionoramendmentofthePOA(thiswouldbemypreference).Why?WhatifCongress
amended§1014/§2041somedayorthepowerholderincurssignificantdebt?Alongthose
lines,seethestatementofsettlorintentembeddedinsomeofthesampleclausestopermit
thePOAtobeamendedtoconformwiththatintent.
INWITNESSWHEREOF,________________________[throughitsdulyauthorized
representative],herebysignsthisinstrumentinits(his/her)capacityasbothTrusteeofthe
FirstTrustandastheTrusteeoftheSecondTrust,onthedatehereinaftersetforth.
___________________________,Trustee
By:_______________________________
Date:_____________________________
STATEOFOHIO
)
)
SS.
COUNTYOFWARREN
)
- 25 -
Theforegoinginstrumentwasacknowledgedbeforemeby
________________________[onbehalfof________________________________],Trustee
on___________________,2014.
(SEAL) ____________________________________
NotaryPublic
ThisInstrumentwasPreparedBy:
___________________________
- 26 -
NoticeLettertoCurrentTrustBeneficiaryregardingDecanting
Date
Re: XYZ Trust dated XX/XX/XXXX
Dear _________ ,
As we have previously discussed, this letter is to give you formal notice of our intention to
distribute all [or, as discussed above, only certain assets] of the assets of the above trust to a
new trust. The terms of the new trust will be identical to the terms of the old trust except that
the new trust will grant you a general power to appoint the assets in the trust at your death to
the creditors of your estate [alternately, the decanting might only grant a limited power]. The
proposed amendment and distribution, called a “decanting” is attached to this notice.
You have given us an approximate net worth statement attesting to your solvency and have told
us that you are not co-signed on any loans or know of any outstanding debts or potential claims
against you other then those on the net worth statement. The reason we asked you questions
regarding this was to protect the trust and beneficiaries from any potential future creditors of
your estate. The purpose of adding this clause is to ultimately benefit your children and/or
grandchildren who will be entitled to receive the assets of the trust upon your death.
Under the current trust, the assets of this trust would not included in your taxable estate, and
they would not receive a step up in basis at your death. The approximate amount of this
appreciation as of the last end of quarter was $800,000 [insert approximate value].
This newly added general power of appointment should cause the assets of this trust to be
included in your estate for federal estate tax purposes at your death, but only to the extent it
does not cause an estate tax liability to occur. More importantly, this should cause any
appreciated trust assets held in the trust to receive a step up in basis for income tax purposes.
This may ultimately save the children and/or grandchildren approximately 15-30% income tax
on this appreciation, potentially saving them hundreds of thousands of dollars, depending on
where they reside, the nature of the gain and asset appreciation at the time, when they sell the
assets and other factors.
This amendment will be effective 30 days from this letter. However, you may not want to
delay the amendment this long. Should you prefer to make it effective immediately, you may
waive the 30 day notice requirement by emailing or sending us a short note such as “I hereby
waive the 30 day notice requirement mentioned in your letter and proposed agreement dated
______”.
Sincerely,
Trustee
- 27 -
DecantingandTrustAgreement
(wheretrustpaysallnetincomeorhasHEMStypeascertainablestandards–
§5808.18“paragraphB”decanting)
ThisdeclarationofdecantingandtrustagreementisexecutedintheStateof
__________,onthedatehereaftersetforth,by___________________________,asTrustee.
Whereas:
1.
TheSettlor,_______________________________,createdanirrevocabletrust
[revocabletrustmadeirrevocablebythesettlor’sdeathonXX/XX/XXXX],the
__________________________trust(“FirstTrust”),attachedhereto.
2.
____________________________isnowactingassoletrusteeoftheFirst
Trust,whichisnowinexistence.[oramendforcoͲtrusteesaccordingly]
3.
PursuanttoArticleXX,ParagraphYY,theFirstTrustprovidesthattheTrustee
shallpayallnetincomeatleastannually,plusinitsdiscretionmaypayadditionalsumsof
principal,uptotheentiretrust,toSettlor’sspouse,________________________,forher
“health,education,maintenanceandsupport[inserttermsfromtrust].”
4.
OhioR.C.§5808.18(B)providesinpertinentpart,that“Unless the trust
instrument expressly provides otherwise and subject to the limitations set forth in this section,
a trustee of a first trust who has power, other than absolute power as described in division (A)
of this section, under the terms of the first trust to make distributions of principal to one or
more current beneficiaries may exercise that power by distributing all or any part of the
principal subject to the power, and all or any part of any income that is not otherwise currently
required to be distributed, to the trustee of a second trust.” The trustee hereby states that as
of this decanting, all currently distributable net income has been paid. OhioR.C.§5808.18(B)
furtherprovides “The second trust may be a trust ***** created by the trustee of the first
trust. The power described in this division may be exercised whether or not there is a current
need to distribute trust principal under any standard contained in the first trust. The exercise of
a trustee's power under this division is valid only if the governing instrument for the second
trust does not materially change the interests of the beneficiaries of the first trust.”[note:see
pointsregardingdecantingstatutesingeneralinprevioussample].
5.
Duetothelimitednatureandlimitedchangesbelow,thisdecantingwillnot
affectthebeneficiary’sentitlementtoincomenorthetrustee’sdistributionstandards,nor
materiallychangetheinterestsofthebeneficiariesofthefirsttrust.
6.
[Useifstatelawrequiresnoticetobeneficiary,butfranklyevenifpriornoticeis
notrequiredpursuanttostatuteit’sprobablyagoodideaormayevenberequiredunder
otherfiduciaryduties.]PursuanttoOhioR.C.§5808.18(F),allcurrentbeneficiariesare
entitledtoatleast30dayswrittennoticeofthisdistributionunlessallcurrentbeneficiaries
waivethis.Evidenceofthisnoticeand/orwaiverisattachedherein.
- 28 -
NowTherefore:
TheundersignedTrusteeherebydirectsthatall[or,alternatively,atrusteemightonly
decantthoseassetscapableordesiringofastepupinbasis]oftheTrustassetsoftheFirst
Trustshallbedistributedto___________________________________,asTrusteeofthe
SecondTrust(asdefinedherein),tobeadministeredasapartthereof.
“SecondTrust”meansthetrustcreatedunderthisinstrument.Thetermsofthe
SecondTrustshallbethesameasthetermsoftheFirstTrust,whichtermsareincorporated
hereinbyreference,exceptfortheadditionalprovisionsassetforthbelow:
1.
Trusteeherebygrantsto___________________[settlor’sspouseorother
beneficiary]atestamentarygeneralpowerofappointment[limitedpowerofappointment]as
follows:
INSERTPARAGRAPHSGRANTINGNARROWTESTAMENTARYGPOAorLPOATO
TRIGGER§2041(a)(3)HERE
Somemayarguethataddinganarrowtestamentarypowerofappointmentwould
“materiallychangetheinterestsofthebeneficiariesofthefirsttrust”,principallyofcoursethe
remaindermen.Forcertain,itwouldmaketheirvestedinterestssubjecttodivestment,orat
leastsomeformofdivestment–if,forexample,thetrusteeaddedanLPOAthatonlyallowed
appointmenttotrustsforchildreninequalperstirpesshares,grantingthemaPEGpower,as
opposedtotheresiduaryofthetrustwhichsimplydistributestothechildrenoutright,isthis
reallya“materialchange”forpurposesofOhio’sdecantingstatute?Idoubtanybeneficiary
orOhiocourtwouldseethatasmaterial,butit’sstillenoughtotriggertheDelawareTaxTrap
andmaysavethefamilyhundredsofthousandsofdollarsinincometax.
INWITNESSWHEREOF,________________________[throughitsdulyauthorized
representative],herebysignsthisinstrumentinits(his/her)capacityasbothTrusteeofthe
FirstTrustandastheTrusteeoftheSecondTrust,onthedatehereinaftersetforth.
___________________________,Trustee
By:_______________________________
Date:_____________________________
STATEOFOHIO
)
)
SS.
COUNTYOFWARREN
)
- 29 -
Theforegoinginstrumentwasacknowledgedbeforemeby
________________________[onbehalfof________________________________],Trustee
on___________________,2014.
(SEAL) ____________________________________
NotaryPublic
ThisInstrumentwasPreparedBy:
___________________________
___________________________
IfyouareinOhioorastatelikeOhio,attachnoticeorwaiversofnotice.
- 30 -
ExaminingIrrevocableTrustsforOpportunitiestoStepUpBasisatDeathofBeneficiary
1)
Doesthetrustgrantthebeneficiaryageneralpowerofappointment,allowingthe
beneficiarytoappointtohimself,hisestateorcreditorsoreither?Or,doesthetrustdirect
thetrusteetopaydebts/creditorsofthedecedent/beneficiary?Ifyes,thenstop–theassets
inthetrustwillreceiveadateofdeathbasis.324
2)
Doesthetrustnamethebeneficiaryascontrollingtrustee,orallowthebeneficiaryto
namethemselvesascontrollingtrustee,withoutanyascertainablestandardsastodistribution
tothatbeneficiary?And,isthetrustsitusedinastatethatdoesnothaveasavingsstatuteto
graftascertainablestandardsuponthetrust?Ifyes,thenstop–theassetsinthetrustwill
receiveanewbasisonthebeneficiary’sdeath.Thesewouldbeveryrare,andtrustsorstates
oftenhaveasavingsclausepreventingthisresult.
3)
CouldthetrusthaveotherwiseinitiallyqualifiedforaQTIPelection(allincometo
spouse,nootherbeneficiary,etc)andnoForm706wasfiled?ConsiderfilingForm706witha
lateQTIPelection,sothattrustgetsasecondstepupinbasiswhenthesurvivingspousedies.
4)
Doesthetrusthaveatrustprotector/advisororotherclausepermittingatrust
protector,trusteeorothernonͲadversepartytheabilitytoaddaGPOAorLPOA?Ifthe
powerholderisstillalive,additbutrelease/disclaimanypowertoaddaGPOAovercash,loss
assets,IRD,etc,orassetsexceedingapowerholder’savailableAEA.Ifnot,anditwasnot
added,arguethatsuchapowerinitselfisaGPOAheldbyspousemerelyrequiringthe
consentofanonͲadverseparty,henceaGPOAper§2041(b)(1)(C)(ii)
5)
Doesthetrustgrantthebeneficiaryalimitedtestamentarypowerofappointment?
Theclausedoesnothavetousethosewordsprecisely;itmustmerelyallowthebeneficiaryto
directwhereassetsgoattheirdeath.Ifyes,thendoesthetrustpermitthebeneficiary
powerholdertoappointtoatrustor“forthebenefitof”individualbeneficiaries?Moststate
lawswillallowappointmenttotrustifthetrust/powerissilent.SeeRestatementofProperty,
Third,DonativeTransfers,§19.13and§19.14.Ifyes,thengotostep6.Ifno,gotostep7.
6)
Hasthepowerholderappointedtoatrustorsubtrustforintendedpermissible
beneficiaries,grantingoneormoreofthemapresentlyexercisablegeneralpowerof
appointment(withdrawalright,suchasaCrummeypower,orpowerofrevocation),evenif
it’sonlyapresentpoweroftheremainderofthetrustcoupledwithanincomeinterest?If
yes,thenanyassetssoappointedwillreceiveanewdateofdeathbasis.Iftheappointive
324
This might occur in a GST non-exempt trust, for example. Certain categories of assets do not receive a new
basis, such as annuities and retirement plans (income in respect of a decedent). Occasionally, the decedent’s
executor or trustee may elect an alternate valuation date which would use a date of subsequent sale within 6
months after death or 6 months after date of death. Because assets declining in value would receive a step down in
basis, consider distributing or selling assets with substantial valuation declines prior to death if possible if a GPOA
cannot be avoided.
- 31 -
trusthasonlyapartialpower,suchasawithdrawalrightlimitedtoa5/5power,thenthisis
likelyproͲratedtoonlycauseinclusionof5%ofthetrust.Ifno,thendoso.
7)
Doesthetrusteehavewidediscretionarypowertodistributecorpustothebeneficiary
andisgovernedbyastatelawthatpermitsdecanting?Ifyes,thenthetrusteemaydecantto
addaGPOA/LPOAtoenableanewbasisatthedeathofthepowerholder.325
8)
IsthetrustgovernedbytheUTCorotherstatelawthatwouldallowatrusteeor
beneficiarytopetitionthecourtforanamendmenttoaddaGPOA/LPOA?Ifyes,thenthe
trusteemaypetitionthecourt(orabeneficiarymight,butseePartVIIofarticlecautioning
againstthepotentialadverseeffectofbeneficiaryactions)toamendthetrusttoadda
narrowlycraftedGPOA/LPOAtoenableanewbasisonthedeathofthepowerholder.
325
See list of decanting statutes with analysis of this power at http://www.sidley.com/state-decanting-statutes/
- 32 -
Forfeitureprovisiontoaddtospendthriftclauseforbetterassetprotection,withan
appropriatecarveoutformaritaldeductiontrusts,QSST,IRA,678(a)
Ifbyreasonofanyactofanysuchbeneficiary,orbyoperationoflaw,orbythehappeningofany
event,orforanyotherreasonexceptanactoftheTrusteeauthorizedhereunder,anyofsuchincome
orprincipalshall,orexceptforthisprovisionwould,ceasetobeenjoyedbysuchbeneficiary,orif,by
reasonofanattemptofanysuchbeneficiarytoalienate,chargeorencumberthesame,orbyreason
ofthebankruptcyorinsolvencyofsuchbeneficiary,orbecauseofanyattachment,garnishmentor
otherproceeding,oranyorder,findingorjudgmentofcourteitherinlaworinequity,thesame,
exceptforthisprovision,wouldvestinorbeenjoyedbysomeotherperson,firmorcorporation
otherwisethanasprovidedherein,thenanymandatorytrustdistributionprovisions(includinga
terminatingdistribution,unlessrequiredbytheapplicableruleagainstperpetuities)orwithdrawal
rightshereinexpressedconcerningsuchincomeand/orprincipalshallceaseandsuchbeneficiarymay
onlyreceivedistributionsatthesoleandabsolutediscretionofthetrustee.Insuchevent,thetrustee
may,initssolediscretion,makedistributionstoanydescendantsofthebeneficiary,andifthereareno
descendantsofthebeneficiary,toanyofmydescendants.
Inadditiontotheaboveeventstriggeringaforfeitureandvoidingofabeneficiary’smandatory
interestsand/orwithdrawalrights,anyfilinginacourtofdomesticrelationsagainstabeneficiaryorby
abeneficiary,otherthanapetitionforadoptionornamechange,suchasforadivorce,dissolutionor
restrainingorder,shallexpresslyhavethesameeffectasabove.
Also–ifyouhavetrustee/beneficiary,“interestedtrustee”clauses,theymightbeintegratedwiththis
sectiontoremoveHEMSstandardsandrequireindependenttrusteetobeappointed.
Thedeathofabeneficiaryshallalsoconstituteacompleteterminationofsuchbeneficiary’sinterestin
thetrustandthetrustestateandanypaymentsaccruedorundistributedbythetrusteeatthetimeof
deathofsuchbeneficiaryshallbedistributedtothesucceedinglivingbeneficiariesorcharities
otherwiseentitledtodistributionsfromthetrustestate.Thisparagraphshallnotoverrideany
exerciseofatestamentarypowerofappointment.
Theaboveprovisionsshallnotapplytoremoveamandatoryincomeinterestfromanytrustshare
previouslyorcurrentlyqualifiedasamaritaldeductiontrustorqualifiedsubchapterStrust,or
otherwiseintendedtoqualifyforthemaritaldeductionorasaqualifiedsubchapterStrust.The
trustee’sfilingofanESBTelectionshallconclusivelybepresumedtoindicateanintentnottoqualifyas
aQSSTandhencetheaboveforfeitureprovisionsshallapplytoanytrustoverwhichanESBTelection
hasbeenmade.Thetrustee/executor’sfailuretofileForm706/709QTIPelectionforatrustthat
mightotherwisequalifybytheextendedduedateofthereturnshallconclusivelybepresumedto
indicateanintentnottoqualifyforthemaritaldeduction.
Inaddition,theaboveprovisionsshallnotapplytoremoveabeneficiary’scurrentsolepowerto
withdrawalincomepursuanttoParagraphXXX,whichgrantsthepowertowithdrawalaccumulated
incomeduringawindowfromDecember15ͲDecember31.Insuchcase,theaboveprovisionsshall
onlyapplyprospectivelytoremoveanyfutureyears’withdrawalrights,or,iftheabovetriggersoccur
Jan1ͲDec15,shallapplyprospectivelytoremovethecurrentyear’swithdrawalright.
Theaboveprovisionsshallexpresslyapplytopowersofrevocation,withdrawaloranypresently
exercisablegeneralpowerofappointment.[note–seetheCastellanocaseastowhythisisincluded)
NOTE:Ihaveseenseveralspendthriftclausesstatethattheentireclausedoesnotapplytoamarital
trustorQSSTorconduittrust.DON’TDOTHAT.TreasRegsspecificallyauthorizeabasicspendthrift
clausepreventingassignment,alienation,etc,justnotonethatgoesfurthertocauseanactual
forfeitureofthemandatoryincomeinterest.
- 33 -
AlternativedispositiontosaveexclusionifDSEU/706filingisbotched
(seePartII,page10,footnote22)
DraftingExample:“Ileavemyentireresiduaryoutrighttomysurvivingspouse,ontheprecondition
thatmypersonalrepresentative(ormytrusteeifnopersonalrepresentativeisappointed,pursuantto
IRC§2203)makesaneffectiveelectiononanestatetaxreturnpursuanttoIRC§2010(c)tograntmy
spousetheuseofmyDeceasedSpousalUnusedExclusionAmount.Shouldforanyreason(intentional
orunintentional),suchanelectionisnoteffectivelymade,orismadeforlessthanmaximumamount
available,Iherebyleavethemaximumamountpossiblewithoutincurringafederalestatetaxtothe
BypassTrustdescribedinParagraph__,andanyremainingresiduaryabovethisamountshallpassto
mysurvivingspouseoutright”.[Iherebyindemnifymyexecutorfromanysuchelectionorfailureto
elect(beitpartial,tothemaximumextentornotmadeatall)madeingoodfaith.][NB:fractional
formulavariationsonthis,orapecuniarymarital,residualbypasswouldbedesirableifIRDsuchas
largedeferredcompensationplansmightbeinvolved].
- 34 -
FormulaGPOAforGSTnonͲexempttrusttooptimizebetweenGSTandEstateTaxEfficiency
ContingentTestamentaryGeneralPowerofAppointment.Ifuponthedeathofabeneficiaryofthis
trustataxableterminationwouldoccur(eitherdirectly,orindirectlybythebeneficiary'sfailureto
exerciseapowerofappointment),thenthebeneficiaryshallhavethetestamentarygeneralpowerto
appointtothecreditorsofthebeneficiary'sestatethesmallestfractionalshareofthetrustproperty
thatwouldreducetoaminimumtheaggregatestateandfederalestate,inheritanceandgeneration
skippingtaxespayableuponthebeneficiary'sdeath.Suchfractionalshareshallbedeterminedasifany
powerofappointmentgrantedtothebeneficiary(underthisprovisionorotherwise)isnotexercised
andsuchtaxableterminationhadoccurred.
Thisparticularclauseisverybasicandhasnoorderingruleandnopreferenceforassetsoverwhicha
GPOAwouldincreasebasis(e.g.excludingcash,IRD,lossassetsetc).Again,liketheverybasicformula
GPOAsoverGSTnonͲexempttrusts,itprobablyworksjustaswellinmanycaseswhereacapisnot
neededanditislikelytobe0%or100%,andinvolvenolossassets.However,whyriskthis?See
followingforamorenuancedapproachincorporatingboththeseideas.
- 35 -
SpousalwaiverforINGstopreventargumentthereisagrantortrustbasedonspousal
interest,topreventKloiber/Dahlargumentsupondivorce,ortohelpensurecompletedgift
forDAPTsorotherirrevocabletrustsnotnamingspousewherecompletedgiftdesired
WAIVEROFCERTAINRIGHTS
I,theundersignedspouseofsettlor,waiveallofmyrights,title,andinterestinanyproperty
transferredtotheattached___________trustdatedXX/XX/XXXX(the“trust”),otherthanasspecified
therein.ThiswaivershallapplybothtocurrentandinchoateintereststhatImayhave,including,but
notlimitedto,rightstoanintestateshare,statutoryelectiveshare,omittedspouse'sshare,orsharein
thenatureofdowerorcurtesy,intheestateoraugmentedestateofsettlor.
Thiswaivershallalsoapplytoanyrightstocontestthetransferasabreachoftrustorfiduciarydutyor
underanyapplicableUniformFraudulentTransfersAct,UniformFraudulentConveyanceActor
UniformVoidableTransactionActincludingcommonlawremediessuchasbutnotlimitedtoequitable
orconstructivetrusts.
Thiswaivershallnotprecludevoluntaryappointmentsorgiftsbyanypowerholderorbeneficiarythat
mightlaterdirectlyorindirectlybenefitmethroughtheirownindependentactions.Norshallthis
waiverprecludemefromlaterdisclaimingorreleasinganysuchrights.
ThiswaivershallconstituteathirdͲpartybeneficiarycontractforthebenefitofallthebeneficiariesof
thetrust,andthesebeneficiariesorthetrusteeofthetrustmayenforcethiswaiverbyappropriate
legalaction.
Dated:January9,2015
[Signaturesandnotaryclause]
[Note:EachstatemayhaveitsownrequirementsforvalidityofpostͲnuptialagreements.Woulda
simplewaiverneedtofulfillalltherequisitesunderstatelawforpostͲnuptialagreements?Perhaps.
ThiswouldnotbethesameasERISA/REAspousalwaiverswhichwouldbepreemptedbyfederallaw.
Isconsiderationrequired?Whetherpropertycontributedisseparateormaritalwouldprobably
matter.Spousesgenerallyowefiduciarydutiestoeachother,beyondthescopeofthisoutline.Any
attorneyrepresentingbothspousesskatesonthiniceethicallytryingtopullshenanigansliketheDahl
andKloibercasesillustrate(perhapseventhoserepresentingonlyonespouseifitismaritalproperty).
Butinmanyinstancesawaiverliketheabovemaybedesiredpurelyfortaxandassetprotection
reasonsͲnotassetprotectionfromthespouse,butagainstthirdpartycreditors.LikeanypostͲnuptial
agreement,therearemanysituationsandeventechniquesandotherplanningthatcanbedoneto
ensuresuchwaiversarenotinanywayabusivetospouses.
- 36 -
Provisioninwill(or,potentially,revocablelivingtrust,butusuallyinwill)toexerciseapowerof
appointment
PropertySubjecttoCertainPowersofAppointment
Iamgrantedapowerofappointment(“FirstPower”)underparagraph_____ofthe
____________TrustdatedXX/XX/XXXX.Iamgrantedapowerofappointment(“SecondPower”)
underparagraph_____ofthe_______________TrustdatedXX/XX/XXXX.
[ifthepowerisageneralpower,orlimitedpowerdesignedtotriggertheDelawareTaxTrap,
andifthepowerisnotcapped,suchthatexerciseorevenmereexistenceofthepowermaycausean
stateorfederalestatetax,querywhetheryouwouldwanttoequitablyapportionsuchtaxes,or
perhapsapportionsuchtaxestotheresiduaryorotherassets]
(1)
IexercisetheFirstPowerbydirectingthat,allofthetrustestatesubjecttothe
FirstPowershallbedistributedtotheTrusteeoftheJamesJonesTrustdatedXX/XX/XXXX;
(2)
IexercisetheSecondPowerbydirectingthat,uponmydeathallofthetrust
estatesubjecttotheSecondPowershallbedistributedtotheTrusteeoftheJamesJonesTrustdated
XX/XX/XXXX,subtrustfbocharitypursuanttoArticleV;and
HereisanexampleofaDelawareTaxTrapsavingsclause,whichmaynotbeneededinsome
states/circumstances,andofcoursemaynotbedesiredinotherswhereyouareactivelytryingto
trigger§2041(a)(3):
[Notwithstandinganythingtothecontrary,ifmyexerciseofanyoftheabovepowersof
appointment(“exercisedpower”)createsanotherpowerofappointment(s)(“newpower(s)”),thenew
power(s)shallnotbeexercisableandmaynotpostponethevestingofanyestateorinterestin,or
suspendtheabsoluteownershiporpowerofalienationof,anypropertyappointedpursuanttothe
exercisedpower(oranysuccessorproceedsofsuchproperty),beyondtheruleagainstperpetuities
applicabletotheexercisedpower.]
- 37 -
WILL YOUR $1 MILLION LLC COST YOUR FAMILY
$167,169 IN ADDITIONAL INCOME TAXES?
Problem:
Over 90% of LLC Agreements have not been amended and adapted
to the tremendous income & estate tax changes since 2013.
For single taxpayers with under $5.43 million estates and married taxpayers with under $10.86 million estates,
the design of LLC provisions should often be quite different from those with larger estates.
TypicallifecycleoffamilyLLCowninga$1millionrentalproperty(sameconceptsapplytobusinessesorotherassets):
LLCwith$1millionproperty
Husbandandwifeown50/50
Basisisnow$400,000each.
Husbanddies,50%goesto
BypassorQTIPTrustforwife
Valuationof50%LLCinterests
discounted15Ͳ70%.Assume30%
10yearspassafterHusband’sdeath,
Trust’s50%LLCinterestis30%
discounted,sothebasisisonly
$350,000FMVatdeath.
**incommunitypropertystate,
Wife’sbasisalsosteppeddown
---------------------------------------------------------------------propertyvaluehasdoubledbyWife’sdeath
10yearspass.Rental
propertynowFMV$2million
Wifedies.50%LLCowned
outrightvaluedatdiscount
Wifeowns50%outrightand
50%isownedbyABTrust
50%LLCintrustgetsnostep
upif bypass,discountinQTIP
50%LLCownedbywifeonly
“steppedup”to$700,000 basis
Basis50%LLCownedbyaQTIP
wouldbethesameͲ$700,000,
ifbypass$350,000Ͳdepreciation
AfterWife’sdeath,childreninherit$2millionLLCproperty,butNOT$2million
---------------------------------------------------------------------basis,causingthemtoincurmoreongoingincometaxthanifoptimalclausesused
Childrensellpropertyfor$2millionw/$1.4
millionbasis(or<$1millionif50%inherited
frombypass).Incur$600,000capitalgain.
Childrenpay$167,169LTCGTaxif50%fromQTIP,
or$278,614LTCGtaxif50%inheritedfrombypass,
(*Ohioresidents,itemizers,noPeaselimit/AMT)
So What?
Keeping the status quo with old-style LLC and Trust Agreements may cost the surviving spouse and/or other
beneficiaries hundreds of thousands of dollars in ordinary income tax (if assets are comprised of depreciable
property), and/or significant capital gains tax when assets are sold, due to IRS mandated valuation “discounts”.
The Solution:
We can maximize these discounts for estates that would otherwise be subject to estate tax, but eliminate this
discount for smaller estates in order to increase basis and lower income tax. LLCs and trusts can be adapted
to exploit the new tax law changes to maximize basis increase for those without taxable estates, and maximize
reduction of estate tax for those with taxable estates, all while keeping important asset protection benefits.
Ask us about upgrading your Trust and LLC with Optimal Basis Increase Clauses.
WILL YOUR OLD TRUST NOW COST YOU
$$$
INCOME TAX
???
Problem:
Over 90% of “A/B” trusts have not been amended and adapted
to the tremendous income & estate tax changes since 2013.
Why is this an important issue -- even for married taxpayers with
under $10.68 million who are no longer concerned about estate taxes?
No2nddeath
stepupin
basis=higher
cap.gainsup
to23.8%
Special
incometax
benefits
lost?
So What?
Old-style trusts can cost your surviving spouse 58% higher income tax burdens, and even higher
burdens to your descendants through higher ongoing tax rates AND loss of basis increase.
The Solution:
Trusts can be adapted to exploit the new tax law changes to achieve better basis increase, take
advantage of income tax loopholes and shift income to beneficiaries in lower tax brackets.
StretchIRA
Tax
Deferral
2ndStep
Up,No
StepDown
inBasis
OBIT
Shift
Incometo
Lower
Brackets
25%
15%
0%
Take
Action!
• Askusabout
upgrading
yourtrustto
anOptimal
BasisIncrease
Trust
$250kHome
Tax
Exclusion
Save23.8%
Copyright2014EdwinMorrowIIIandKeyBank,NA
ReprintedandAdaptedwithPermission
PROBATE
LAW
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QFSNJTTJPOPG5IPNTPO3FVUFST$PQZSJHIUª
'PSNPSFJOGPSNBUJPOBCPVUUIJT
QVCMJDBUJPOQMFBTFWJTJUIUUQ
MFHBMTPMVUJPOTUIPNTPOSFVUFSTDPNMBXQSPEVDUT
JOURNAL OF OHIO
MAY/JUNE 2014 VOLUME 24 ISSUE 5
UNEARNED INCOME MEDICARE
CONTRIBUTION TAX OF SECTION 1411
By Alan S. Acker, Esq.
Carlile Patchen & Murphy
Columbus, Ohio
Based on a presentation by the author at the Cincinnati
Advanced Estate Planning Institute on May 16, 2014.
Section 1402(a)(1) of the Health Care and Education
Reconciliation Act of 20101 added new § 1411 to the Code,
which section imposes a 3.8% tax on certain individuals,
trusts, and decedents’ estates.2 The IRS issued nal regulations to § 1411 on November 26, 2013,3 which had several provisions that were reserved. Shortly thereafter, on December
16, 2013, the IRS issued proposed regulations addressing
these reserved sections.4 Taxpayers may rely on the proposed
regulations for purposes of compliance with § 1411 until the
issuance of those regulations as nal. Form 8960 is the form
for reporting the net investment income tax by individuals,
estates, and trusts.
Although § 1411 states that it applies to all trusts, other
than wholly charitable trusts, regulations clarify that § 1411
applies only to estates and trusts that are subject to §§ 641 to
685 of the Code.5 However, § 1411 will not apply to the following estates and trusts:6
E A trust or decedent’s estate all of the unexpired interests
in which are devoted to one or more charitable purposes as
described in § 170(c)(2)(B);
E A trust exempt from tax under § 501;
E A charitable remainder trust (but special rules apply for
Mat #41501351
IN THIS ISSUE:
Unearned Income Medicare
Contribution Tax of Section 1411
By Alan S. Acker, Esq.
295
The Art of Avoiding Ohio Income Tax
Using Trusts
By Ed Morrow, J.D., LL.M., CFP
309
The Exclusive Jurisdiction of the
Probate Court and the “Touching
Upon” Standard in the Light
ofRheinhold v. Reichek, et al.
By Adam M. Fried, Esq.
Legal Uncertainty with Respect to
Creditor Claims against Non-Probate
Assets
By Roy A. Krall, Esq
Nikki S. Mesnard, Esq.
Notice of Seminar
Change in Editorial Advisory Board
Is Delayed Probate Necessary?
By Robert M. Brucken, Esq.
Ohio Trust Code, as Discussed in
PLJO
Case Summaries
Legislative Scorecard
319
322
331
331
331
334
335
336
PROBATE LAW JOURNAL OF OHIO
tions of the relevant activities of Company X
and Company Y on a regular, continuous, and
substantial basis.”
37
142 T.C. No. 9 (March 27, 2014).
38
This section provides special rules for
taxpayers in a real property business and such
special rules apply where a certain level of
personal services are performed. Also, the
personal services of an employee do not count
toward determining whether these special
rules apply.
39
Frank Aragona Trust v. Commissioner,
142 T.C. No. 9 (March 27, 2014), footnote 15.
But footnote 14 cites to Carter Trust and notes
that that court did hold that the activities of
non-trustee employees are considered in determining whether the trust materially participated.
40
See Dees, Richard L., “20 Questions (and
20 Answers!) On the New 3.8 Percent Tax,”
(Tax Notes, August 12, 2013).
41
Prop. Regs. § 1.1411-7.
42
Where the transferor acquires its interest
from another passthrough entity in nonrecognition transaction, the transferor will
tack on the period that the previous owner or
owners held the interest. Also, where the
transferor transferred an interest in a subsidiary passthrough entity to a passthrough
entity in a non-recognition transaction, the
transferor must include the period that the
transferor held the interest in the subsidiary
passthrough entity.
43
Regs. § 1.1411-3(c)(1).
44
See Regs. § 1.1411-3(c)(3).
The proposed regulations reected a
capital gain of $5,000 for the non-S portion
and a capital loss of $7,000 for the S portion.
46
Based on the example in the proposed
regulations, presumably net capital losses in
one portion cannot oset net capital gains in
the other portion because each portion is
treated as a separate trust for determining undistributed net investment income.
45
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
the computation and reaches a total of $40,000.
Presumably, this error will be corrected.
49
Regs. § 1.1411-3(d).
50
Regs. § 1.1411-3(d)(2).
51
Regs. § 1.1411-3(d)(2)(iii), Example 1. See
Prop. Regs. § 1.1411-3(d)(2)(ii) for examples for
a CRT having gross income from controlled
foreign corporations or a qualied electing
fund from a foreign investment company.
52
Regs. § 1.1411-3(d)(1)(iii).
53
Prop. Regs. § 1.1411-3(d)(3)(ii).
54
Prop. Regs. § 1.1411-3(d)(3)(iii).
THE ART OF AVOIDING OHIO
INCOME TAX USING TRUSTS
By Ed Morrow, J.D., LL.M., CFP
National Wealth Specialist, Key Private Bank
Dayton, Ohio
Most Americans are patriotic and proud to
pay taxes as a necessary price of living in such
a great country. Ohioans are equally proud to
help our beloved Buckeye state. But, as Arthur Godfrey used to say, we’d feel just as
proud paying half as much. This article will
focus on how Ohio residents can legitimately
avoid Ohio income tax using trusts, including
the new Ohio Legacy Trust, during their
lifetime and that of their surviving spouse.1 As
will become apparent, these techniques (like
many techniques to avoid tax) are really only
useful to those in the highest income tax
bracket.2
If DNI also had consisted of items of
excluded income, then the $9,000 distribution
would have to be allocated among all the items
of income comprising DNI and the undistributed net investment income for the non-S portion would have been higher.
First, we’ll summarize how trusts are taxed
and Ohio’s convoluted trust income tax scheme
as applied to Ohio resident settlors and beneciaries, then we’ll compare three methods used
to avoid Ohio’s trust income tax - the rst two
methods I strongly advocate against, while the
latter method is a legitimate form of estate
planning which just happens to avoid Ohio
income tax. Lastly, we will address situations
involving Ohio-sitused income and businesses,
when even nonresident trusts may be taxed
and when this may or may not be avoided.
The regulation states that the AGI for the
ESBT is $38,000, but then lists the items in
Ohio’s Trust Income Tax Structure.
47
48
K 2014 Thomson Reuters
309
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
Many trusts, including all revocable trusts and
even many irrevocable ones, are “grantor
trusts” for income tax purposes, meaning they
are not considered separate taxpayers and all
gains, income, losses and deductions in the
trust are attributable to the grantor.3 Ohio follows this federal grantor trust rule.4
This article will assume a familiarity with
basic federal duciary income tax principles
and for the remainder of this article “trusts”
will refer to standard non-charitable, irrevocable non-grantor trusts unless specied
otherwise- thereby excluding grantor trusts,
charitable remainder trusts or trustees qualied plans or IRAs.
Trusts and estates have similarities to passthrough entities, but are quite dierent from S
corporations and partnerships - usually, capital gains are trapped and taxed to the trust
and other income is taxed to the beneciaries
to the extent distributed and to the trust to
the extent not distributed. That is a highly
simplied summing up of a complex subject.5
The Ohio Department of Taxation (“ODOT”)
sums up the general rule as to when Ohio will
tax trusts: “The vast majority of trusts will
pay Ohio income tax only if they are resident
trusts, and for most of those trusts, the tax
will apply only to those trusts’ modied nonbusiness income.”6
Some income will be taxed by Ohio regardless of whether a recipient of the income
(including any trust) resides in Ohio - for
example, Ohio lottery winnings or gains from
sale of Ohio real estate.7 However, the rst
important threshold question is whether a
trust is a “resident” of Ohio for purposes of the
tax.
“There are nine independent tests applicable
to determine if a trust is a resident trust. If
any one of those nine tests for a taxable year
applies to the trust, or part of the trust, then
the trust, or that part of the trust, is a resi310
PROBATE LAW JOURNAL OF OHIO
dent trust.”8 This article will only discuss one
of those tests mentioned in the ODOT notice,
and ignore unique situations such as testamentary trusts (which few attorneys ever use
anymore in Ohio), court-ordered trusts, parttime residents, or obvious cases, such as when
someone with no ties to Ohio establishes a
trust.
Let’s assume throughout that our clients are
rmly domiciled in Ohio. Although this article
primarily discusses inter vivos planning, many
of the concepts would also apply to the administration of the trust after the death of the rst
spouse.
R.C. 5747.01(I)(3) sets out Ohio’s residency
denition for trusts, and paragraphs (a)(ii) and
(c) are the main concerns for this article, which
I will quote in full below, along with the
referenced federal statute:
(a) A trust resides in this state for the trust’s
current taxable year to the extent, as described
in division (I)(3)(d) of this section, that the
trust consists directly or indirectly, in whole or
in part, of assets, net of any related liabilities,
that were transferred, or caused to be transferred, directly or indirectly, to the trust by
any of the following:
* * * (i) omitted
(ii) A person who was domiciled in this state
for the purposes of this chapter when the
person directly or indirectly transferred assets
to an irrevocable trust, but only if at least one
of the trust’s qualifying beneciaries is domiciled in this state for the purposes of this
chapter during all or some portion of the trust’s
current taxable year;
* * * (iii) and (b) omitted
(c) With respect to a trust other than a charitable lead trust, “qualifying beneciary” has
the same meaning as “potential current beneciary” as dened in section 1361(e)(2) of the
Internal Revenue Code, and with respect to a
charitable lead trust “qualifying beneciary” is
any current, future, or contingent beneciary,
but with respect to any trust “qualifying beneciary” excludes a person or a governmental
K 2014 Thomson Reuters
PROBATE LAW JOURNAL OF OHIO
entity or instrumentality to any of which a contribution would qualify for the charitable
deduction under section 170 of the Internal Revenue Code.
I.R.C. § 1361(e)(2): Potential current
beneciary. For purposes of this section, the
term “potential current beneciary”
means, with respect to any period, any person
who at any time during such period is entitled
to, or at the discretion of any person may
receive, a distribution from the principal
or income of the trust (determined without regard to any power of appointment
to the extent such power remains unexercised at the end of such period).* * *
Thus, at its most basic, if an Ohio resident
establishes and funds an irrevocable trust with
no Ohio beneciaries, it is not a resident trust,
but if any potential current beneciaries are
Ohio residents, then it is an Ohio resident
trust. This is echoed in the ODOT’s test and
example #2 in their notice.9
The lesson to glean from the statutes and
ODOT tests is, in order to avoid Ohio income
tax on an irrevocable inter vivos non-grantor
trust established by an Ohio resident, is not to
include any Ohio resident as potential current
beneciary, even discretionary, or have Ohio
real estate, tangibles, etc sales of which would
be taxed to even non-resident trusts.
The location of the trustee and administration is irrelevant to Ohio’s scheme of taxation,
so there is no need to use an out of state
trustee for any technique described here, although some may prefer to use Delaware, Nevada, or another state for other reasons (although one must be careful to avoid trustees
residing in some states, such as California,
that might trigger another state’s income
tax).10
Let’s start with a basic example that we will
go back to throughout this article: John Doe
makes over $500,000 annual taxable income
(39.6% bracket, plus 3.8% or 0.9% Medicare
surtax, thus 23.8% capital gains rate, 5.421%
K 2014 Thomson Reuters
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
Ohio tax rate). Let’s assume John is married,
they are both Ohio residents and they have
one child in Florida and two children in Ohio.
He has $10 million in assets he anticipates
selling soon for a capital gain of $9,000,000 this might be a sale of out of state real estate
or C corporation stock, or perhaps even a
forced recognition of gain, like the recent
merger involving Eaton and Cooper
Corporations. In the last section of this article,
we will tackle “source income” from Ohio based
pass through entities, real estate and
businesses. John would like to explore options
that might get around the $488,000 of Ohio
income tax.
All of the methods trapping income in trusts
rather than distributing the income has a high
cost if the taxpayer is not otherwise in the
highest federal tax bracket: the highest income
tax brackets of 39.6% ordinary, 20% capital
gains and the 3.8% net investment income
surtax start at only $12,150 for trusts.11
Let’s explore three methods of avoiding Ohio
residency status for trusts. None of these have
been discussed in this Journal or other CLEs
to this author’s knowledge, but the rst two
have been used and promoted by Ohio practitioners and banks. The rst involves obscuring
the true grantor, the second involves obscuring the current beneciary and the third
involves minor adaptions of standard trust
designs using longstanding common law trust
techniques. I will refer to this latter option as
a Deferred Distribution Power Trust.
OBSCURING THE TRUE GRANTOR
In one technique, the Ohio settlor establishes
an irrevocable trust with Ohio beneciaries,
and grants a family friend, colleague, or other
advisor living in another state such as Florida
a lifetime limited power of appointment. At
this point, it is clearly an Ohio resident trust.
The out of state powerholder then appoints
the trust assets to a new trust for beneciaries
311
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
in Ohio. The settlor of this second trust is
putatively the straw man powerholder, who is
not domiciled in Ohio.
As discussed above, Ohio generally doesn’t
tax trusts just because a beneciary lives in
Ohio, unless various other factors apply. The
Uniform and Ohio Trust Codes clearly permit
a donee (powerholder) of a power of appointment to establish a new trust.12 But, does such
a structure really change the “transferor” for
Ohio income tax purposes as some argue?
Under federal tax law, traditional common law
and ultimately Ohio tax law, such a strategy
does not change the transferor unless the
power was a general power of appointment,
and even then it is probably suspect.
Under federal grantor trust tax rules, decanting (which is essentially a duciary limited
power of appointment) or exercising a limited
power of appointment clearly does not change
the original transferor for income tax purposes
- under such a situation, the grantor would
remain the grantor for federal income tax
purposes.13
The traditional common law of trusts mirrors this as well: the transferor remains the
same after exercise of a limited power of appointment, but changes to the powerholder in
the event of an exercise of a general power of
appointment. Referring to general powers,
Scott and Ascher’s ve volume treatise on
trusts opines “When the donee of such a [general] power makes an appointment in trust,
the donee [powerholder], not the donor [creator
of the GPOA], is the settlor of the new trust.”14
Referring later to limited powers, the same
treatise concludes that “When such an appointment occurs, the donor of the power [creator of
the LPOA], not the donee [powerholder], is the
settlor of the new trust.”
Both federal income tax and common law of
trusts dierentiate between limited powers,
which do not change grantors, and general
312
PROBATE LAW JOURNAL OF OHIO
powers, which do. This is similarly reected in
the fact that exercising limited powers do not
(except under very narrow circumstances)
cause gift or estate tax consequences, whereas
the exercise of a general power generally
does.15 There are also vast dierences between
the two types of powers of appointment
throughout the Ohio Trust Code regarding
virtual representation and creditor protection.
Ohio tax law echoes this same dierentiation by addressing the “transferor” of the property, rather than simply the person who executed the trust document (which is completely
irrelevant for most legal purposes). Indeed,
Ohio law goes to great lengths to emphasize
this, probably even more than necessary. 16
Thus, the success of such planning is mostly
predicated on hiding the truth of the transaction, and could blow up most disastrously, not
only from an Ohio income tax perspective, but
from a federal tax perspective as well, since
the grantor will not have paid taxes on income
which he or she probably should have under
the grantor trust rules.
Of course, with the increased federal lifetime
gift tax exclusion of $5.34 million and indexed
for ination and no Ohio gift tax, many taxpayers have small enough estates to be completely
indierent even if the exercised power were a
general power of appointment (provided the
gift were under $5.34 million and would not
likely later lead to an estate tax). As discussed
above, general powers are treated completely
dierently in tax and trust law, but with the
broad Ohio tax statute implicating residents
who “cause to be transferred, directly or
indirectly,” it is hardly a slam dunk that the
use of a general power would get around the
statute either.
OBSCURING THE TRUE BENEFICIARY
- USING OUT OF STATE ENTITIES
AS SETTLOR/BENEFICIARIES
Some attorneys claim that you may be able
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PROBATE LAW JOURNAL OF OHIO
to reincorporate Ohio businesses in Wyoming
or some other out of state LLC prior to sale or
use such LLCs as a beneciary of an irrevocable trust to get around Ohio income tax. Is this
as easy as it sounds? Any attorney doing basic
corporate work can establish, merge or reorganize a company in another state in a tax-free
reorganization. And, surprising to some, an
LLC can be a settlor or beneciary of a trust.17
Ohio taxation of pass through entities doing
business in Ohio is discussed in the last section of this article. Does merely having an LLC
incorporated out of state as settlor or beneciary change the calculus of whether there is
an Ohio “resident trust,” that is “domiciled in
this state for the purposes of this chapter
[5747]”?
Surprisingly, Ohio law is not as clear on this
point as one might expect. Chapter 5747 of the
Revised Code (Ohio income tax) referred to in
the above quote does not have a denition of
domicile as applied to business entities as it
does for individuals, but the Chapter is replete
with instructions as to how, when and to what
extent companies doing business in Ohio are
taxed. Generally, the state of incorporation is
completely irrelevant for a pass-through entity
for Ohio income tax purposes. What is important is the residency of the investors - if it’s a
non-resident owner, income is apportioned
based on a business’ property, payroll and
sales attributable to Ohio.
In addition to the above concerns, might the
LLC as a beneciary conduit be disregarded
completely by the state of Ohio for lack of a
business purpose? Trusts typically neither
have nor need a business purpose, but realize
that Ohio, like the IRS, can apply sham transaction, step transaction, substance over form
and economic reality doctrines to any complicated transaction.18 If Ohio residents are the
owners of any portion of an LLC that is a current beneciary, no matter where the LLC is
incorporated, it is likely that courts would nd
a trust with such an LLC as a beneciary to
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MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
be a “resident trust” under Ohio income tax
law, and even if it were not, businesses incorporated elsewhere would likely still produce
Ohio “source” income as discussed in the
second part of this article.
BEING COMPLETELY OPEN WITH A
DEFERRED DISTRIBUTION POWER
TRUST
A preferable method to legitimately avoid
Ohio income tax is to use a Deferred Distribution Power Trust. What is this? Let’s go back
to our example. Instead of trying to hide the
transferor or beneciary, John transfers the
$10 million of assets to an irrevocable trust.
Depending on his available gift tax exclusion,
level of assets, he may choose to make this a
completed gift for gift tax purposes, but in
most cases this would likely be structured as
an incomplete gift. Or part to a completed gift
trust, and part to an incomplete gift trust.
Such an incomplete gift trust is colloquially
referred to as a Delaware Incomplete Non
Grantor Trust (“DING”), but the typical DING
trust has no benet for Ohioans, unless it is
modied to adapt to Ohio tax law, as discussed
below.19
In John’s case, if he, his wife or children living in Ohio may receive any income in a given
year, even if they don’t get a dime, even if the
trustee has sole discretion to distribute, and
even if the distribution standards are extraordinarily conservative, the trust is an Ohio resident trust. The child domiciled in Florida
could be a current beneciary without tainting
the trust, but the family wants to be equal to
all of their children and doesn’t want to make
a large gift to her alone.
We are fooled by our existing paradigm into
thinking there is no way around a trust for
John’s family being an Ohio resident trust.
While most trusts permit the trustee to distribute current income and principal in a given
year, they do not have to. Many ILITs, for
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MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
instance, have a clause preventing distributions until the settlor/insured dies, particularly
if the goal of the trust is to provide a set
amount of liquidity at death for a loan covenant, buy-sell, estate equalization or estate
tax. Does John or his family need the funds
this year? Next year? Not for another ve
years, when John and Jane will be retired and
living in Florida? A trust does not need to have
any beneciaries entitled to current distributions of income or principal to be a valid trust,
a beneciary that can be ascertained now or in
the future is adequate.20 Beneciaries might
become current beneciaries at a later date,
sometimes referred to as a “springing executory interest.”21 Trust protectors might be able
to add beneciaries, but practitioners should
be careful since this power in itself may cause
grantor trust status if not carefully curtailed.22
If there are no Ohio resident beneciaries currently eligible for a distribution, the trust is
not an Ohio resident trust.
Once the trustee has the power to distribute
trust funds to Ohio beneciaries, it becomes a
resident trust. It’s somewhat analogous to
someone putting funds into an IRA to defer
income, you usually have to leave the funds in
there a period of time to get any benet, but if
you move to another state without an income
tax by the time you take the distribution,
you’ve avoided the original state income tax.
Ohio income tax thus can be avoided to the
extent income is trapped in trust and cannot
be distributed by the trustee to Ohio resident
beneciaries in that tax year. Importantly,
Ohio does not have throwback rules similar to
California and New York that might otherwise
try to tax income accumulated in prior tax
years, nor do we have a specic rule regarding
incomplete gift trusts as New York recently
passed.23 Ohio does still have an old throwback
rule on the books, but unlike New York or California, there is no modication to adapt to
federal changes made years ago that make the
rules primarily apply only to foreign trusts.24
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PROBATE LAW JOURNAL OF OHIO
To illustrate the tremendous importance of
the lack of a throwback rule, let’s say John’s
trust sells the $10,000,000 of assets in 2014. It
would incur and pay approximately $2.142 million in federal capital gains tax (23.8%), make
no further distributions in 2014 and avoid the
$488,000 in Ohio tax since there are no current Ohio beneciaries and it is therefore not
an Ohio resident trust.25 In 2015, there is a
“clean slate” as to 2014 income. If in mid-2015,
to take an extreme case, the trust makes
$10,000 in dividends and interest before
distributing the entire amount of the trust to
Ohio beneciaries, the only amount on the K-1
for the beneciaries subject to Ohio tax is the
$10,000 of 2015 income.
Up to this point we’ve simply been discussing ordinary non-grantor trust rules, rather
than DINGs (or “OINGs”). Let’s explore under
what circumstances John or Jane might be the
ultimate recipients of the trust. Recall, per the
statutes quoted above, if John (or his wife, or
resident children) were a potential beneciary
at the sole and absolute discretion of an independent trustee, as a typical Ohio Legacy
Trust/DAPT might provide, then this would
trigger residency trust status, thus Ohio taxation, regardless of whether any funds were
ever distributed to them.
Also, if either were to have a “springing executory interest,” becoming a traditional current beneciary later, this would trigger
grantor trust status even before that event
because income might be accumulated and
distributed to them later (and, therefore, Ohio
taxation directly).26 This may also be true if a
non-adverse party such as a trustee or trust
protector could add them as full beneciaries
later.
How can they possibly benet, even if not
until years later, without triggering grantor
trust status? Historically, DINGs have required distribution committees of adverse parties (typically, children) to permit trustee
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PROBATE LAW JOURNAL OF OHIO
distributions to the settlor and/or spouse - such
adverse party consent negates grantor trust
status. But we should be careful not only to
comply with “DING” rules, but Ohio income
tax rules as well. Mere adverse party consent
does nothing to get around Ohio’s income tax
statute quoted above. This brings us to the
“Power” aspect of the Deferred Distribution
Power Trust. John can grant his children a
non-duciary lifetime limited power of appointment (LLPOA) to appoint funds back to himself
or his wife if they ever need it (of course, they
would have no duciary obligation whatsoever
to do so). They must avoid giving the trustee
any discretionary distribution power to avoid
Ohio’s statute. Because their children are
adverse parties, the existence of this power
would not trigger grantor trust status in itself
under I.R.C. § 677. Moreover, Ohio expressly
EXCLUDES this kind of non-duciary power
from triggering Ohio resident trust status to
the extent it is not exercised, pursuant to the
statutes quoted and bolded at the beginning of
this article.27
At rst glance, this kind of arrangement
reminds one of the warnings inimical to large
lifetime gifts borne out from Shakespeare’s
King Lear. But King Lear never used a Deferred Distribution Power Trust. Had he done
so, he would have avoided a lot of grief. Here,
John keeps just enough control via lifetime
and testamentary powers of appointment to
make the gift incomplete and keep the ultimate
beneciaries in line, but not so much as to
cause grantor trust status.28 Giving each child
(or committee) a LLPOA to appoint to John or
his wife gives just as much if not more access
to the trust as if they were named beneciaries - as long as at least one of the children is
a Cordelia rather than a greedy Goneril or
Regan, John and Jane should not fear the King
Lear eect. In my experience, most people
trust their children more than their attorney
or bank trust department anyway.
If one of the children were to later distribute
K 2014 Thomson Reuters
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
funds to their parent via the LLPOA, this
would then trigger Ohio residency status if
they are still Ohio residents, or possibly even
convert the trust to grantor trust status for
that given year (of course, if John or Jane
moved to Florida by then, Ohio would no longer have nexus to impose its tax, absent Ohio
source income issues discussed below).
Therefore, with a modicum of creativity, we
can use the Ohio Legacy Trust Act to legitimately defer or avoid Ohio taxation of trust
income. A domestic asset protection trust statute is recommended for such “DINGs” to avoid
grantor trust status, since any potential for
creditor access to ordinary self-settled trusts
would lead to a nding of grantor trust status.
Though power trusts do not rely on the “selfsettled” portion of the Ohio Legacy Trust Act
for creditor protection, coming under that Act
does have other benets.29 Many attorneys may
prefer to use the Delaware Qualied Dispositions in Trust Act or some other DAPT statute
to avoid even the appearance of any potential
nexus for Ohio taxation, despite the Ohio
Department of Taxation’s announcements that
trustee residency, choice of trust law and situs
of administration is irrelevant.
UNDERSTANDING OHIO SOURCE
INCOME - WHEN IT CAN AND
CANNOT BE AVOIDED
This brings us to the second part of this
article discussing “source” income. Taxpayers
selling an asset or block of assets for a large
gain are often dealing with real estate and
business entities. These present special issues.
Once we have passed through the gauntlet of
whether a trust is a resident trust or not for
Ohio income tax purposes, we next need to
resolve when and how even non-residents and
non-resident trusts are taxed on Ohio source
income for Ohio income tax purposes. We will
ignore quirky issues such as Ohio lottery
receipts and concentrate on Ohio businesses.
Even an out of state resident will typically
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MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
pay Ohio income tax on pass through income,
whether the out of state resident is a trust or
not. Tax must be withheld at the source, and
entities can le an estimated Ohio return on
behalf of the non-resident owners.30
Back to our example: does this mean John is
out of luck getting around Ohio income tax if
his $10,000,000 asset is a business? Not
necessarily. It depends on the type of business,
the nature of the operations and the structure
of the deal.
C corporations, for example, are not passthrough entities, so the complex pass-through
entity tax rules do not apply to them. A Florida resident isn’t necessarily going to pay Ohio
income tax on P&G stock (a C Corporation)
when it is sold, or pay Ohio income tax on
dividends received, but any Ohio C corporation
has its own taxes to deal with.31 However, most
small to mid-size businesses prefer to avoid
the double tax system of C corps, which can be
much more onerous overall, especially upon
sale, distribution or termination. So, let’s assume for the remainder of this article that we
are dealing with a pass-through entity - an
LLC, partnership or S corporation.
The nature of the operations matter - how
much of the operations are in Ohio? If half the
operations are in Ohio, and half in other
states, there would be apportionment of half
the pass-through income even to non-residents.
The apportionment is slightly more complicated, based on a weighted calculation of sales,
payroll and property, but we don’t need to go
into gritty details for the macro-planning
concepts.
Finally, the structure of the deal matters - is
John selling stock to fellow partners/
shareholders or outsiders, or is the rm selling
in an “asset deal,” whereby the buyers are
purchasing all the assets of the company? Most
buyers prefer to buy the assets of a company
rather than stock, so they can depreciate as316
PROBATE LAW JOURNAL OF OHIO
sets with a new FMV basis, and avoid latent
liabilities of the selling entity. All the reasons
pro and con vary depending on the nature of
the business, contracts, depreciable assets and
whether it’s an S or C corp, etc - many issues
beyond the scope of this article. Some buyers
may be amenable to structuring a buyout as a
stock deal, but some will not even consider it.
The majority are asset deals.
Let’s bypass that debate and summarize the
asset deal for Ohio income tax purposes - if all
gains pass through to the owner of an LLC/
LP/S corp in an asset deal, then we are left
with the conclusions noted above - any Ohio
income apportioned to the business will pass
through and be taxed to a non-resident or a
non-resident trust. For a small business with
operations and employees only in Ohio, that’s
probably 100%. There is no Ohio income tax
avoided by transferring such assets to a nonresident trust.
If it is a stock deal (whether corporate or
LLC), the analysis is similar, but much more
confusing.32
To sum up a very complicated tax scheme,
Ohio will apportion such capital gains from
the sale of a pass through entity very similarly
to that of pass through income, but with more
emphasis on where physical assets of the
company are located just before the sale,
rather than the test noted above that uses
sales, payroll and physical assets to apportion
pass through income.33 Calculation is easy if
all operations of the entity are in Ohio - the
trust will have to pay Ohio tax on all the gain
from the sale. Conversely, it is easy to calculate
if none of the payroll, sales and most importantly, physical assets of the business are in
Ohio - the trust will pay no Ohio tax on the
gain from the sale. Anything in between is
quite complicated, but to summarize, a passthrough entity owner may avoid more Ohio
income tax on an stock sale if more physical
assets of the company are out of state, even if
most of the sales/payroll are in Ohio.
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PROBATE LAW JOURNAL OF OHIO
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
In addition to the messy Ohio tax issues for
businesses, transferring an S corporation to a
non-grantor trust has the added complications
of a forcing an Electing Small Business Trust
(ESBT) election, and possibly adding a 3.8%
surtax, whereas this tax is more easily avoided
in the hands of an “active” investor in the business (or his/her grantor trust). Whether ESBTs
can be “active” business investors and avoid
the 3.8% surtax on business income is a complicated issue, even with a high prole recent
taxpayer victory in Tax Court.34
have signicant annual income above the highest federal tax bracket - well over half a million dollars, or anticipate future income to be
well over that due to anticipated capital gains
or other windfall. Ohioans in this category
typically have a second residence in Florida or
elsewhere, so perhaps such techniques can
entice them from changing their domicile
completely.
CONCLUSION
The Ohio Legacy Trust Act refers to Ohio
Rev. Code 5816.01 et seq., part of the Ohio Asset Management Modernization Act eective
March 2013, and is often generically referred
to as a Domestic Asset Protection Trust.
2
Federal tax rules for trusts are primarily
found in Subchapter J of the Internal Revenue
Code, I.R.C. §§ 641-692. Top federal tax brackets start at $400,000 taxable income for
singles, $450,000 married ling jointly, which
will adjust upwards for ination in 2014.
Ohio’s top income tax bracket, now 5.421%,
starts at $208,500 (brackets adjusting for ination, and absent further legislation will
gradually lower to 5.333% by tax year 2015.
See R.C. 5747.02. http://www.tax.ohio.
gov/ohio—individual/individual.aspx.
3
See I.R.C. §§ 671-679
4
Knust v. Wilkins, 111 Ohio St.3d 331, 856
N.E.2d 243 (2006); Lovell v. Levin, 116 Ohio
St.3d 200, 877 N.E.2d 667 (2007), cert. denied
by 553 U.S. 1033 (2008).
5
If you want the gory detail, attend Alan
Acker’s LL.M. courses at Capital University,
consult his BNA portfolio or attend his Ohio
State Bar Association CLE on Fiduciary Income Tax to be given in November 7, 2014 in
Cleveland and November 14, 2014 in Columbus.
6
Ohio Department of Taxation Information
Release 2003-02, February 2003, found at:
http://www.tax.ohio.gov/ohioindividual/
individual/informationreleases/
trust200302.aspx.
7
R.C. 5747.01(BB)(4)(c)(ii).
8
Ohio Department of Taxation Information
Release 2003-02.
9
Test #2 - Transferor Domiciled in Ohio at
Time of Transfer to Irrevocable Trust
To summarize, establishing a nongrantor,
nonresident trust in the manner contemplated
in the rst part of this article can legitimately
avoid traditional portfolio income, including
capital gains and including sales of closely held
C corps, income from pass through entities
owning out of state property, or proceeds of
sales of such entities, and the portions of business income and sales of pass-through entities
attributable to out of state operations (for sales
of the business stock, not assets, this is primarily weighted to physical assets in or out of
Ohio). However, a non-resident trust, similar
to a non-resident individual, cannot legitimately and eectively avoid the portion of
business income or sales of pass through entities to the extent the assets and operations are
attributable to Ohio.
The Deferred Distribution Power Trust
discussed above has signicant asset protection, family management and even federal
income tax benets for taxpayers with income
above the highest income tax bracket that are
beyond the scope of this article. For anyone
not in the highest federal tax bracket, income
trapped in trust at the highest income tax
bracket starting at only $12,150 of taxable
income is too high a price to pay to make any
trust strategy avoiding Ohio income tax
worthwhile. The clients for whom such a strategy is most useful are those wealthy enough to
K 2014 Thomson Reuters
ENDNOTES:
1
317
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
Two conjunctive requirements:
At the time property was transferred to an
irrevocable trust, the transferor was domiciled
in Ohio for purposes of Ohio’s individual
income tax; and
For all or some portion of the trust’s current
taxable year, at least one of the trust’s qualifying beneciaries (dened below) is domiciled
in Ohio for purposes of Ohio’s individual
income tax.
Notes to Test #2
The transferor of the property need not be
the creator of the trust.
The transferor’s domicile when the trust
became irrevocable does not matter.
Example of Test #2
Individual A created a trust that became irrevocable while A was not domiciled in Ohio
for purposes of Ohio’s individual income tax.
Thereafter, A moved to Ohio and, while domiciled in Ohio for purposes of Ohio’s individual
income tax, transferred property with a fair
market value of $900 to the irrevocable inter
vivos trust. Immediately prior to the transfer,
the trust net assets had a fair market value of
$100. During some portion of the trust’s current taxable year, at least one qualifying beneciary is domiciled in Ohio for purposes of
Ohio’s individual income tax.
The trust is a resident trust for the current
taxable year with respect to 90% of the trust’s
modied nonbusiness income (90% is the
proportion of the trust attributable to the property A transferred to the trust while domiciled
here).
10
See footnote 3 of Ohio Department of Taxation Information Release TRUST 2003-02 Trust Residency—February 2003, http://www.t
ax.ohio.gov/ohioindividual/individual/inform
ationreleases/trust200302.aspx.
11
I.R.C. § 1.
12
UTC § 401(3), R.C. 5804.01 (c).
13
Treas. Reg. § 1.671-2(e)(5): “If a trust
makes a gratuitous transfer of property to another trust, the grantor of the transferor trust
generally will be treated as the grantor of the
transferee trust. However, if a person with a
general power of appointment over the transferor trust exercises that power in favor of another trust, then such person will be treated
as the grantor of the transferee trust, even if
the grantor of the transferor trust is treated
as the owner of the transferor trust under
subpart E of part I, subchapter J, chapter 1 of
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PROBATE LAW JOURNAL OF OHIO
the Internal Revenue Code.”
14
Scott and Ascher on Trusts, 5th Edition,
Volume 1, ¶ 3.1.2 Exercise of Power of Appointment.
15
See I.R.C. § 2041 for estate taxation of
powers of appointment, § 2514 for gift taxation.
16
See R.C. 5747.01(I)(3): “that the trust
consists directly or indirectly, in whole or in
part, of assets, net of any related liabilities,
that were transferred, or caused to be transferred, directly or indirectly, to the trust by
any of the following:. . ..”
17
R.C. 5801.01(c) and (N) and (S).
R.C. 5703.56, though there are no reported cases.
18
For a great discussion of DINGs in the
context of Ohio’s new Legacy Trust Act, see
Baker, DING! Has the Opening Bell Sounded
on Ohio Incomplete Gift Non Grantor Trusts,
Probate Law Journal of Ohio, in two parts,
Sep/Oct 2013 and Nov/Dec 2013 issues. See
PLRs 2013-10002 through 2013-10006, PLR
2006-12002 and PLR 2007-29025, the so called
“DING” trust PLRs, as well as LISI Estate
Planning Newsletter #2076 (March 13, 2013),
PLR 201310002: DING Redux, by Bill Lipkind,
and DINGed, but not Dented, Trusts and
Estates, July 2013, by Michael Gordon and
Scott Goodwin.
20
R.C. 5804.02(B).
19
For a discussion on shifting and springing
executory interests and how they might be
used to ward o IRS tax liens and consideration of trust assets in the event of a divorce
even better than wholly discretionary trusts,
contact author for separate CLE outline.
21
If the trust protector is non-adverse,
I.R.C. § 677 would probably cause such a
power to create a grantor trust if the settlor
and/or spouse could be added as beneciary
later.
22
N.Y. Tax Law § 612(b)(41) new law signed
3/31/14 at: http://www.assembly.state.ny.us/le
g/?defaultd=&bn=S06359checkthissndwrit
e=2013&Summary=Y&Actions=Y&Memo=Y&
Text=Y.
24
R.C. 5747.01(A)(6), referencing I.R.C.
§ 665 accumulation distributions, which are
now dened to primarily apply to foreign
trusts per I.R.C. § 665(c).
25
This is assuming there is not an alterna23
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PROBATE LAW JOURNAL OF OHIO
tive Ohio “source” trigger, such as Ohio real
estate or Ohio business.
26
I.R.C. § 677(a).
27
R.C. 5747.01(I)(3), referencing I.R.C.
§ 1361(e)(2).
28
See discussions in the Lipkind, Gordon
and Baker articles cited previously, essentially,
a lifetime power limited to HEMS (the limitation being necessary to avoid grantor trust
status), and a testamentary LPOA, both expressly permitted under the Ohio Legacy Trust
Act, but many DAPT states do not expressly
permit retained lifetime limited powers of appointment (Nevada and Ohio do, and as of
March 2014, Delaware added that feature to
their law).
29
See R.C. 5805.06(B)(3), discussed in
greater detail in 2013 OSBA Annual Conference on Wealth Transfer Planning CLE material, with comparisons between DAPTs and
Power Trusts. See also, Roy Krall’s material
on this code section in the OSBA’s 2013 First
Annual Ohio Asset Protection and Legacy
Trust Institute CLE.
30
Ohio Adm. Code § 5703-7-03.
31
Ohio’s Commercial Activity Tax is in
Chapter 5751.
For the best analysis of this, see Alan
Acker’s OSBA CLE materials on Fiduciary
Income Tax (pages 175-190), but he can only
do so much to clarify such a messy statute that
makes the Internal Revenue Code look like a
model of clarity.
MAY/JUNE 2014 | VOLUME 24 | ISSUE 5
Cleveland, Ohio
The determination as to whether any particular cause of action belongs in the probate
court or the general division of the common
pleas court typically involves complicated
analysis. Developed precedent needs to be
studied carefully to see if there is really a
bright-line test to determine whether a case
must be led in the probate division as opposed
to the general division of the court of common
pleas. Because there is no overlap in matters
that implicate the probate court’s exclusive jurisdiction, the consequences of simply relying
on the label axed to the cause of action can
be substantial: if a case is led in a court later
determined to be without jurisdiction, then signicant time and expense will have resulted
long before the heart of the dispute is
considered. This article will explore the extent
to which a claim must “touch upon” matters
within the core powers of the probate court
before it implicates the exclusion jurisdiction
in the light of the plenary jurisdiction extended
to matters properly before it.
32
R.C. 5747.212.
Frank Aragona Trust v. Commissioner,
US Tax Court Docket No. 15392-11 (March 27,
2014), and 20 Questions (and 20 Answers) on
the New 3.8% Surtax, Tax Notes, by Richard
Dees.
33
34
THE EXCLUSIVE JURISDICTION
OF THE PROBATE COURT AND
THE “TOUCHING UPON”
STANDARD IN THE LIGHT
OFRHEINHOLD V. REICHEK, ET
AL.
By Adam M. Fried, Esq.
Reminger Co., LPA
K 2014 Thomson Reuters
In January of 2014, the Eighth District
Court of Appeals agreed that the general division of the common pleas court lacked jurisdiction to consider a case alleging various torts
including conversion, fraud, negligence and
legal malpractice because the alleged conduct
related to a guardianship.1 In that case, Rheinhold, while a minor, received a settlement
stemming from an automobile accident. Her
mother, Pickering, was appointed guardian
and ordered to place the settlement proceeds
into a restricted account. After Rheinhold
turned 18, Pickering led an application to
terminate the guardianship with the purported
consent of Rheinhold. The probate court than
issued an order to Dollar Bank to release the
funds to Rheinhold. Thereafter, the Probate
Court approved Pickering’s nal account,
which ling purported to contain Rheinhold’s
consent. Rheinhold later claimed that she was
unaware of the orders aecting the termina319
no
n/a
2 No "Step down" in basis on 2nd death
3 Avoid potential lesser basis step up when fractional
interests (LLC, TIC, etc) fund trust, at 2nd death
no
5 No "Step down" in basis on child's death
(if dynastic style, protective trust)
n/a
no
no
no
no
yes
6 Capital Gains Able to Escape Tax Rate Trap of
43.4% or 23.8% over $12,150 if bene is in lower bracket
7 Ability to spray income (non-fiduciary) to lower tax
bracket beneficiaries or possibly even charity
8 Ability to spray capital gains as well
9 Ability for "above the line" charitable deduction
10 Ability for spouse to make lifetime tax-free"gifts"
11 Ability for better tax treatment for special assets
(personal residence, small business stock, etc)
Ongoing Income Tax Treatment and Flexibility
yes
4 "Step up" in basis on child's death
(if dynastic style, protective trust, to extent GST exempt)
Basis Treatment at Death of Beneficiary (Child)
yes
Outright
Will or Trust
(w/portability)
1 "Step up" in basis at 2nd death
(QTIP has potential for Rev. Proc. 2001-38 step up denial)
Basis Treatment at Death of Surviving Spouse
Key Features
no
no
no
no
no
no
yes
no
no
yes
no
Traditional
Bypass
no
no
no
no
no
no
no
no
no
no
probably
Traditional
QTIP
no
no
no
no
no
no
no
no
yes
no
yes
Traditional
GPOA marital
yes*
(if §678(a) used)
yes*
yes
yes
yes
yes
yes
yes
yes*
(up to AEA)
yes
yes*
(up to AEA)
Optimal Basis
and Income Tax
Efficiency Trust
Companion chart to article, "The Optimal Basis Increase and Income Tax Efficiency Trust" - please consult for explanation of variations
(For simplicity, this chart does not compare intervivos SLATs, QTIPs, or other lifetime gifting options, though SLATs may also be adapted)
(Some "traditional" bypass or marital trusts may have more features than indicated, this chart compares the "ordinary" common trust for spouse)
(Some benefits may be limited/constrained by available applicable exclusion amounts. Assumes beneficiaries are not in top income tax bracket)
Comparison of Various Basic Trust Design Options for Married Couples
no
no
no
no
13 Income from inherited assets protected from creditors
14 Protection from divorce, remarriage, squandering
spousal elective share, ERISA/REA, etc
15 Better incapacity/management capability
16 Potential Medicaid/govt benefits advantage
no
no
no
no
n/a
18 Allows dynastic GST use at first death (reverse QTIP)
19 No need for timely filed 706/portability to exploit
1st decedent spouse's $5.34m+ estate/GST exclusion
20 Can save millions in add'l estate tax in event of
simultaneous death if one spouse's estate > $5.34m+
21 Surviving spouse can remarry w/o jeopardizing
first spouse's use of exclusion (i.e losing DSUE amt)
22 Enables disclaimer funding while still keeping a POA
no
no
24 Ability to spray income to beneficiary
in lower tax bracket or lower tax state
25 Ability to shelter trust income from state income tax
for trust income (incl CG) not K-1'd to beneficiary
See separate article on avoiding Ohio Trust Tax
maybe
if added
yes
no
yes
yes
yes
yes
yes
yes
yes
yes
if discretionary
yes
maybe
no
no
yes
no
yes
no
yes
no
some
yes
yes
no
yes
maybe
no
no
yes
no
yes
no
no
no
no
yes
yes
no
yes
maybe
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
yes
© 2013-2014 Ed Morrow III. Permission to reprint liberally granted, criticism welcome
Email: [email protected] or [email protected]
no
23 Inherited assets escape state estate tax at 2nd death
(to extent of exclusion, if not separate state QTIPed)
State Estate & Income Tax Features
no
17 Inherited assets escape estate tax at 2nd death
Federal Estate/Gift/GST Tax Features
no
12 Inherited principal protected from creditors
Asset Protection Considerations
yes
n/a
2 Powerholder can give back arbitrarily, w/ No fiduciary duty
(need not consider other beneficiaries, can be arbitrary)
3 Possible grounds for suit from benes if all funds revert to settlor
yes
5 Taxable gift if funds come back to donor
(if trust is designed as a completed gift)
n/a
n/a
7 Easy to Structure as a Non-Grantor Trust
8 Non-Grantor Trust, could spray income post-transfer
no
yes
9 Easy to Structure as an incomplete gift
10 Easy to Structure and ensure a completed gift
(for married donor - is it complete if spouse as creditor can access?
Gift Tax Treatment and Flexibility
n/a
6 Easy to Structure as a Grantor Trust
Ongoing Income Tax Treatment and Flexibility
yes
4 Taxable gift if funds come back to donor
(if trust is designed as an incomplete gift)
Gift Taxation of Any Donor Access Post-Transfer
no
1 There is a Fiduciary Duty owed to Donor as a beneficiary
(must typically consider all beneficiaries and evaluate
distribution requests based on standards in document)
no, but possible,
see PLRs
yes
yes, if qualified
no, but see
ING PLRs
yes
no
no
yes
no
yes
yes
Perhaps partial gift
if LLPOA PH has a
interest (Regester)
no
no
yes
no
yes
yes
yes
yes
yes
yes
yes, if LLPOA PH is yes, if LLPOA PH is
adverse (a benef)
adverse (a bene)
yes
Perhaps partial gift
if LLPOA PH has a
interest (Regester)
no
no
yes
no
Companion chart to OSBA Wealth Transfer Planning CLE June 13, 2013. Please consult that text for more detailed explanation of variations
Abbreviations: DAPT = Domestic Asset Protection Trust. GPOA = general power of appointment. LPOA = limited power of appointment
LLPOA = lifetime limited power of appointment. For this chart, assumes settlor/donor is not the powerholder, but a mere potential appointee.
OLT = Ohio Legacy Trust, Ohio's DAPT statute at 5816.01 et seq. PH = powerholder. All trusts in chart assumed irrevocable.
SOL = Statute of Limitations, FT=fraudulent transfer, UFTA = Uniform Fraudulent Transfers Act
ING = Incomplete, Non-Grantor Trust
Non SelfOutright
Self Settled
Non selfSettled Power
Key Features
gift to a donee
DAPT (OH
Settled "Power"
Trust w/LLPOA
(beneficiary)
OLT or other)
Trust w/LLPOA
that is also OLT
Settlor is not bene Settlor is not bene
How Donor Could Access Funds Post-Transfer
other than donor
Settlor is bene
Comparison of DAPT v. Lifetime Limited Power of Appointment (LLPOA) Trust Design Options
n/a
no
no
no
yes
n/a
n/a
n/a
yes
16 Court potentially "freezing out" settlor/beneficiary (Grant case)
17 Exception creditors of settlor can reach assets even if
there is no fraudulent transfer, by spendthrift exception
18 Shorter SOL, tougher fraudulent transfer standards apply
to help donor and deter later creditors (nonbankruptcy)
19 Requires Affidavit of Solvency for all Transfers
20 Potential Medicaid/govt benefits advantage > 5 yrs
21 Greater chance of other state law applying in conflict
22 Strong chance of continued creditor protection even if
out of state (non-DAPT) law held to apply
23 Chance of Federal Tax Lien attaching to Settlor as beneficiary
24 Property is subject to beneficiary's creditors
(absent 5% power, mandatory interest or termination date, etc)
25 May escape Ohio income taxation if no CURRENT bene in state
(assumes settlor is Ohio resident, trust is non-grantor)
(see separate Probate Law Journal of Ohio article)
no
no
yes
no
yes
no
yes
yes
yes
yes
yes
yes
yes
unclear, and
PLRs will not address
no
yes
yes
no
no
yes
no
unknown
no
no
no
no
no
no
n/a
yes
no
no
yes
no
unknown
no
yes
no
no
no
no
n/a
yes, if LLPOA is
yes, if LLPOA is
inactive < SS's death inactive < SS's death
yes
© 2013 Edwin P. Morrow III. Permission to reprint liberally granted, criticism welcome
Email: [email protected] or [email protected]
no
n/a
15 Clear that 11 USC §548(e) 10 year FT SOL could apply
(Mortensen, Huber cases)
State (Ohio) Income Tax Features
n/a
n/a
n/a
yes
14 In discovery/bankruptcy filing - must disclose being beneficiary
Asset Protection Considerations
13 Can help protect special self-settled trusts (CRT, QPRT, GRAT)
by protecting grantor's retained income/unitrust
11 Completed Gifts Remain Outside of Estate, no §2036 issue
(though there is always "prearrangement"/"understanding" risk)
12 Could double as inter-vivos QTIP to exploit "poorer spouse"
funding and use $5.43 million GST via reverse QTIP
Estate/GST Tax Treatment and Flexibility
yes
yes
3 Is irrevocable (for CP transfer, spouses together can)
4 One year "curing period" required to achieve increase
no
9 Increased creditor protection if lifetime creditors arise
yes
yes
10 Increased creditor exposure of first to die's estate
(if the estate is insolvent, e.g. wrongful death accident)
11 Wrongful death lawsuit or major debt against one estate
could wipe out transferred assets, up to both estates
Outside Creditor Protection Issues at First Death
yes
yes
8 Increased creditor exposure if lifetime creditors arise
(including destruction of tenancy by the entireties)
Outside Creditor Protection Issues During Life
yes (1/2)
yes (1/2)
no
yes (1/2)
no
?
yes (1/2)
no
yes
yes
yes
yes
No "floating spouse" clauses
yes
6 Disinheritance Issue if first to die has "2nd thoughts"
7 Potential substantial loss if spouses divorce after transfer
(for CP Trust, to extent transferred property unequal)
yes
5 Spouse can take some of transferred assets while living
Keeping Fidelity to the Estate Plan of Transferor
n/a
2 Settlor and/or spouse can be only trustees
1 Need independent/corporate trustee in TN/Alaska
Administrative Issues
Factors to Consider
no
(if curbed)
no
no
?
no
yes
no
no
no
yes
no
no
if GPOA is formula, capped
yes
no
yes
?
no
yes
yes
no
no
yes
no
Testamentary
GPOA (JEST)
Trust
(Gassman)
yes
yes
Kind of
yes
yes
yes
yes
no
yes
yes
no
no
Inter-vivos
Estate Trust
(Handler)
Technique to Get Full Step Up at 1st death
Transfer Gain Alaska/Tenn. Lifetime GPOA
Property
CP Trust
(aka JEST)
to ill spouse
for Gain
Trust
> year prior
Property
(Gassman,
(Blattmachr)
Blase)
no
yes
no
"CP"="community property". "JEST"="Joint Exemption Step Up Trust"
Companion Chart to Part VII of The Optimal Basis Increase Trust white paper Dec. 2014 version
no
no
yes
no
n/a
no
no
no
depends
on design
yes
yes
no
Upstream
Optimal Basis
Increase Trust
(Morrow)
Comparison of Basic Strategies for Step Up at First Death for Married (or Unmarrried) Couples
no
n/a
18 Potential double use of gift tax exclusion if §2523 n/a
19 Argument there is no GPOA b/c donor can revoke
yes
21 Spouse/trustee may change investments (to cash, etc)
no
23 Can achieve step up upon older parent/relatives' death
(without using lifetime gift exclusion of donor upon death)
no
yes
yes
yes
unlikely
n/a
no
no
weak
no
yes
yes
no
no
yes
no
yes
yes
yes
yes
no
possible
no
no
no
yes
Alaska/Tenn. Lifetime GPOA
CP Trust
(aka JEST)
Trust
no
yes
no
yes
yes
no
yes
no
possible
no
no
no
yes
Testamentary
GPOA (JEST)
Trust
no
yes
yes
yes
no
no
no
no
no
maybe
no
no
no
Inter-vivos
Estate Trust
yes
no
no
no
yes
no
no
yes
no
maybe
no
no
no
Upstream
Optimal Basis
Increase Trust
For articles on the above techniques other than the attached white paper, see I.R.C. §1014(e) and Gifted Property Reconveyed in Trust , 36 Akron Tax
Journal 33, by Mark Seigal, Tax Planning with Community Property Trust, by J. Blattmachr and H. Zaritsky and M. Ascher, JEST Offers Serious Estate
Planning Plus for Spouses (Parts 1 and 2) , Estate Planning, Oct/Nov. 2013, by Alan Gassman, Christopher Denicolo and Kacie Hollendale. Also
yes
22 Must be married (not registered partner, living together)
Other Miscellaneous Issues
yes
no
20 If asset value/market declines, "double" step down occurs
- can be drafted around
Potential Market Issues to Thwart Tax Result
no
no
15 Reciprocal gift issue if both spouses create
17 Requires using annual, lifetime or other non-marital gift
no
14 Issue if in state not permitting post-nuptial agreements
weak
no
13 U.S. Supreme Court case nearly on point against
16 Step transaction issues due to simultaneous transfers?
yes
Transfer
to ill spouse
> year prior
12 Existing PLRs argue to deny step up under 1014(e)
(however, unclear to what extent and how if in trust)
Potential Tax/Legal Issues to Thwart Tax Result
Factors to Consider (page 2)
Comparision of Basic Strategies for Step Up In Basis at First Death for Married (or Unmarried) Couples - Page 2
Comparison of Various Trust Income Tax Shifting Options to Avoid Trapping Income in Trust
no
3 Can utilize 1 year election to make late distributions
(allowing any 2014 qualifying distribution to count as 2013)
no
yes
yes
5 Can be used in conjunction with LLPOA/spray power
6 Ability to shift capital gains as well as other income
7 Ability to spray ongoing business income (S/LLC)
yes
no
no
8 Subjects applicable income to creditors of beneficiary
& more likely to be "available" if beneficiary divorces
9 Trustee discretion protects from abuse/undue influence
10 Trust might require veto/consent of various parties to
curtail extraordinary unwarranted distributions
Asset Protection Considerations
probably
4 Can change year to year with trust protector/decanting
or valid amendment to change governing instrument
Ongoing Income Tax Treatment and Flexibility
no
no
2 Can utilize 65 day election to make late distributions
(e.g. allowing early 2014 distributions to count as 2013 distr)
Timing of Distributions
1 Actual Distributions must be made to shift income
(caveat, for "simple" trusts requiring acct income to be paid
some income may be shifted even if distribution not made)
yes
yes
no
yes
yes
yes
probably
no
yes
yes
yes
yes
no
yes
yes
yes
probably not
no
yes
yes
yes
yes
no
yes
yes
yes
probably
no
yes
yes
yes
yes
no
no
yes
yes
probably
yes
no
yes
Companion chart to article, "The Optimal Basis Increase and Income Tax Efficiency Trust" - see p76-102 for further explanation of variations below
Assumes beneficiaries are not in top income tax bracket. 678a power assumes all income, rather than up to 5% (which might eliminate a few issues)
LLPOA=lifetime limited power of appointment. This does not discuss various trustee powers to adjust or convert to unitrust, which might shift burden.
678(a)
1.643(a)-3(b)(1) 1.643(a)-3(b)(2) 1.643(a)-3(b)(3)
642(c)
Key Features
Mallinckdrodt
Treat CG as
CG distributed actually distrib.
Charitable
BeneficiaryAccounting
"books records or trustee uses
Deduction
Requirement of Distributions
withdrawal
Income/DNI
tax returns"
determine amt
yes
yes
no
no
yes
yes
yes
no
n/a
yes
Discretionary in
kind distribution
of unrealized
gain asset (643e)
no
no
yes
no
some
no
n/a
no
no
no
(phantom inc.)
Using
S corp with
a QSST
election
yes
yes
12 Gift tax possible if income released/assigned/appointed
13 Unwithdrawn Income subject to 2036 inclusion (>5%)
probably
no
yes
yes
15 Section 121 excl. for sale of residence if bene get CG
16 Section 179(d) expensing problem for business assets
17 Can shift S Corp income to lower rates (assume > estate)
18 Can except muni/tax exempt income to keep in trust
no
(unless power
removed)
20 Easily change to trap income to escape state income tax
(e.g. if beneficiary later changes to high federal bracket)
yes
yes
22 Easy for trustee to determine/administer
23 Requires very competent trustee and/or accountant
yes
no
no
yes, for CG
or more if no
distributions
no
no
not ESBT
yes
no
no
no
no
no
yes
yes
no
no, CG must
pass unless no
distributions
no
no
not ESBT
yes
no
no
no
no
no
yes
no
no
yes, for CG
or more if no
distributions
no
no
not ESBT
yes
no
no
no
no
no
probably
(tracing?)
yes
no
n/a
yes
yes
no
yes
n/a
yes
no
no
no
© 2013 Edwin P. Morrow III. Permission to reprint liberally granted, criticism welcome
Email: [email protected] or [email protected]
yes
21 Failure to withdraw/distribute income complicates filing
(is remaining trust a partial grantor trust under 678a?)
Trustee Issues, Tax Accounting, Administration
no
19 Allows effective"above the line" deductions many states
State Estate & Income Tax Features
no
14 "See Through" IRA Trust (401(a)(9)) and QSST (S corp)
Requires carve out from POAs to prevent distributions
Special Asset Tax Features
yes
11 Estate inclusion of income/ withdraw right via IRC 2041
Federal Estate/Gift/GST Tax Features
yes
yes
no
yes
(sell in trust)
no
n/a
n/a
n/a
no
no
no
no
no
yes
(once elected)
yes
no
no
(ESBT req.)
no
no
yes
no
no
yes
yes
(stub QSST)
yes
no