SESSION D1
60TH ANNUAL MNCPA
TAX CONFERENCE
November 17-18, 2014
Minneapolis Convention Center
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Good Planning Gone Bad:
Why Your Old Minnesota Estate
and Gift Tax Strategies Need a
Face-Lift
Stuart C. Bear, JD
Chestnut Cambronne, P.A.
Minneapolis, MN
Stuart C. Bear, JD, partner and shareholder at the law firm of Chestnut
Cambronne, P.A., specializes in providing succession planning services
for individuals and businesses. His areas of expertise include wills,
trusts, disability planning, powers of attorney, living wills, asset
protection and Medical Assistance planning. He is also an adjunct
professor at the University of St. Thomas School of Law, where he
teaches will and estate courses. Bear has been distinguished as a fellow
of the American College of Trust and Estate Counsel and listed as a
"Super Lawyer" and "Top 40" estate planning lawyer in Minnesota by
Super Lawyers Magazine.
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60th Annual MNCPA Tax Conference
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Good Planning Gone Bad: Why Your Old Minnesota
Estate and Gift Tax Strategies Need a Face-Life
History1
I.
Minnesota had an inheritance tax as early as 1905. Minnesota also enacted a gift
tax in 1937. In 1979, an estate tax regime replaced the inheritance tax. The gift tax
was repealed altogether. From 1985 to 2001, Minnesota’s estate tax was administered
in the form of a “pick-up tax.” The federal government granted a dollar-for-dollar credit
for state estate taxes and states responded by enacting tax statutes that allowed for
states to receive (i.e. pick up) the maximum amount of funds allowed as a federal
credit. By 2005, the pick-up tax credit was phased out completely and replaced by a
state tax deduction. States responded in the following ways:



31 states eliminated estate and inheritance taxes
14 states retained an estate tax
5 states enacted an inheritance tax
From 2006-2013, Minnesota had a $1 million exclusion for estate tax purposes
and no gift tax. The Minnesota Legislature passed H.F. no. 677 (“2013 Omnibus Tax
Bill”) on May 20, 2013. Governor Dayton signed it into law on May 23, 2013. The 2013
Omnibus Tax Bill brought two major changes. The first change was the creation of a
gift tax. The gift tax granted taxpayers a $1 million exemption for all lifetime gifting.
The gift tax exemption was not unified with the $1 million estate tax exemption, so
taxpayers had to plan properly in order to use both exemptions. The second change
was the addition of an add-back for lifetime gifts made within three years of a
taxpayer’s death. Unlike the federal add-back which includes only certain lifetime gifts
(e.g. transfer of life insurance policies), the Minnesota add-back encompassed all
taxable gifts made within three years of the taxpayer’s death.
On March 21, 2014, Governor Dayton passed Tax Bill Chapter 150 – H.F. No.
1777 (“2014 Tax Bill”). The 2014 Tax Bill repealed the gift tax but retained the three
year add-back for gifts made within three years of death. It also gradually increased the
$1 million exemption to $1.2 million, which will increase by $200,000 each year until
2018 and later when it will be $2 million.
2014
2015
2016
2017
2018 and after
$1.2
$1.4
$1.6
$1.8
$2.0
Million
Million
Million
Million
Million
1
This history section summarizes information presented in Minnesota Estate Tax Study, Minnesota Revenue Tax Research Division, March 5, 2014, http://www.revenue.state.mn.us/research_stats/research_reports/ 2014/estate_tax_report_3_5_14.pdf. For a more thorough history, please refer to this study. 1 60th Annual MNCPA Tax Conference
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The 2014 Tax Bill also cleaned up and simplified the estate taxation scheme. It
eliminated the two-table approach and the “rate bubble.” The rate bubble subjected
those who went slightly over the $1 million exemption amount to a tax rate to a 41%.
II.
Estate Tax Requirements – An Overview
A.
General Federal Requirements
An estate must file a federal estate tax return (Form 706) if the gross
estate exceeds $5.34 million (2014 figure, adjusted annually). The estate tax is
calculated on the taxable estate (gross estate minus any allowable deductions).
The estate tax rate is progressive, but only those estates subject to the top rate
of 40% actually owe any taxes to the federal government. This is because the
federal government provides a unified credit that allows up to $5.34 million
(2014 figure, adjusted annually) of assets to be exempt from gift tax, estate tax,
or a combination of the two. Estate tax returns are due nine months after the
date of death, but an automatic six month extension can be obtained by filing
Form 4768.
The personal representative may decide to file a federal estate tax return,
even though he or she is not required to do so, if the surviving spouse would
benefit from the portability election. The portability election allows a surviving
spouse to combine any unused unified credit of the deceased spouse with the
surviving spouse’s unified credit amount. The personal representative of the
deceased spouse automatically makes the portability election by timely filing an
estate tax return. The I.R.S. presumes that the estate is making a portability
election unless the tax return affirmatively elects out of portability.
In addition to the estate tax, there is also a generation skipping transfer
(“GST”) tax. The GST tax applies to all gifts and testamentary dispositions where
the recipient is more than one generation below the donor or decedent. There is
a $5.34 million exemption, similar to but separate from the unified credit, which
can be used to shelter GST gifts. However, the GST exemption is not portable.
B.
General State Requirements
The personal representative must file a Minnesota estate tax return (Form
M706) if (1) a federal estate tax return is required to be filed or (2) the sum of
the federal gross estate and federal adjusted taxable gifts made within three
years of the date of the decedent’s death exceeds $1.2 million (in 2014). Minn.
Stat. § 289A.10, Subd. 1. The top estate tax rate is 16%. Minnesota provides a
credit that is equivalent to a $1.2 million exemption (set to increase by $200,000
annually until it caps at $2 million in 2018) and a possible additional $3.8 million
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deduction for qualified business and farm property (discussed later). Estate tax
returns are due fifteen months after the date of death.
The Minnesota estate tax calculation is based on the federal calculation,
so even estates that do not have a federal filing requirement must create a proforma return to submit with their Minnesota estate tax return. Minnesota has not
adopted portability. Minnesota does not have a GST tax. Therefore, tax
practitioners should ensure that both spouses are utilizing their $1.2 million
exemptions and should consider skipping generations to avoid taxation at every
generation.
III.
Face-Lift Strategies
With all of the changes in the past two years, tax practitioners should consult
with their clients and alert them of the changes. They can also provide great benefits to
their clients by ensuring planning gets updated appropriately given the new rules and
the interplay between the differing federal and state estate tax statutes. The following
details some of the “face-lift” strategies to look out for.
A.
Correct Funding Language in Trusts and Wills
Funding formulas in trusts and wills are not to be taken lightly. Careful
consideration needs to be made about what level to fund a trust to and whether
funding should be accomplished using a marital and credit shelter trust
arrangement or using a disclaimer trust arrangement.
Especially if your client’s estate plan was drafted before 2006, it may
contain language funding a credit shelter trust to the federal amount. In addition
to generating state estate tax on the first death, this funding formula may also
waste the surviving spouse’s exemption. The face-lift for this problem is quite
simple. The client needs to update his or her will and trust to fund the credit
shelter trust to the lesser of the federal exemption amount or the state
exemption amount. Depending on the asset level, a disclaimer trust arrangement
may be more beneficial and should be considered as well.
Example-Funding to Federal Exemption: Don Decedent and Susan Spouse
are married and each holds $1.5 million of assets in a revocable trust. Attorney
drafted Decedent and Spouse’s revocable trusts in 2000. The trust language
funded the credit shelter trust to the federal exemption amount. The language
did not provide any downward adjustment to avoid a state estate tax. Decedent
dies in 2014 and Spouse dies in 2018.
Negative Tax Consequences: When Decedent dies in 2014, his credit
shelter trust will be funded with the full $1.5 million that he owns because the
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federal exemption is $5.34 million. This generates $28,000 in Minnesota estate
tax. When Spouse dies in 2018, her credit shelter trust will be funded with the
full $1.5 million that she owns. This generates no estate tax because the
Minnesota exemption has risen to $2 million by 2018. The total passing to
Decedent’s and Spouse’s beneficiaries is $2,972,000.
Corrective Action: Decedent and Spouse go see Attorney. Attorney
amends Decedent’s and Spouse’s revocable trusts to fund to the lesser of the
federal or state exemption amount. Decedent and Spouse execute the trust
amendments.
Positive Tax Consequences: When Decedent dies in 2014, his credit
shelter trust will be funded with $1.2 million of assets. His other $300,000 in
assets will go outright to his spouse or to a marital trust for the benefit of his
spouse. This generates no tax on his death. When Spouse dies in 2018, all $1.8
million of assets that she owns ($1.5 million of her own plus $300,000 of
Decedent’s) will fund her credit shelter trust. This generates no estate tax
because the Minnesota exemption has risen to $2 million by 2018. The total
passing to Decedent’s and Spouse’s beneficiaries is $3 million.
Example-Funding Using a Disclaimer Trust: Assume that Decedent and
Spouse each have $2.5 million of assets and a trust that automatically funds up
to the lesser of the state or federal level. Decedent dies in 2014. Spouse dies in
2018.
Negative Tax Consequences: Interestingly, automatic federal funding is
more beneficial under this factual scenario. Automatic federal exemption funding
results in $178,000 in Minnesota estate tax, leaving $4,822,000 for beneficiaries.
Automatic state exemption funding results in $216,000 in Minnesota estate tax,
leaving $4,784,000 for beneficiaries.
Corrective Action: Decedent and Spouse go see Attorney. Attorney
amends Decedent and Spouse’s revocable trust providing that everything goes to
the surviving spouse but including a disclaimer trust for any assets the surviving
spouse disclaims.
Positive Tax (and Other) Consequences: When Decedent dies in 2014,
Spouse has the ability to decide how much of Decedent’s assets she wishes to
disclaim, up to the full $2.5 million. In addition to the tax benefits, she can
consider other important factors such as life expectancy, anticipated future
needs, and administration benefits of having the assets in trust versus the costs
of trust administration.
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B.
SESSION D1
Non-residents Holding Disregarded Entity Stock
A nonresident used to be able to shield some property sitused (i.e.
located) in Minnesota from estate tax by contributing the property to a passthrough entity. Essentially by putting the property in an entity structure, the
nonresident decedent converted real property or tangible personal property
(both subject to taxation in the state they are located) into intangible personal
property (subject to taxation in the state of the taxpayer’s domicile). However,
the Minnesota Legislature closed this loophole, effective January 1, 2013, by
amending the definition of “situs of property.” Minn. Stat. § 291.005, Subd.
1(9)(iii). Nonresidents with an ownership interest in a “pass-through entity” are
treated as if they owned the underlying real or tangible personal property
outright in proportion to their ownership interest in the pass-through entity. Id.
The definition of “pass-through entity” includes S-corporations, partnerships
(including multiple-member LLCs), single-member LLCs, and trusts. Minn. Stat. §
291.005, Subd. 1(10). Notably, C-corporations and publicly-traded pass-through
entities are not included in the definition. Id.
Example: Debbie Decedent is a Florida resident who owns a lake home in
Minnesota near where she grew up. On the advice of her tax practitioner, she
contributed her lake home to a single member LLC in 2007 to avoid taxes. Her
and her children still use the lake home in the summers. Decedent dies in 2018
with an estate of $5 million. The Minnesota lake home accounts for $1.2 million
of her total estate.
Negative Tax Consequences: Decedent’s personal representative must file
a Minnesota tax return and must prepare a federal pro forma, since Minnesota
uses numbers from the federal return as a starting point. Decedent’s estate must
pay $89,280 in Minnesota estate tax. Note that even though Minnesota property
does not exceed the $2 million 2018 exemption amount, the Minnesota estate
tax is calculated by allocating the total tax on the full $5 million estate to
property sitused inside and outside of Minnesota in proportion to their respective
values.
Corrective Action: Decedent and Attorney meet in 2014. Attorney
recognizes that the LLC no longer meets Decedent’s goal of avoiding Minnesota
estate taxes because the LLC is a “pass-through entity” and any real or tangible
personal property owned by the entity is treated as having a situs in Minnesota.
Attorney proposes the following options for Decedent to avoid Minnesota estate
taxes:

Option 1: Gift all LLC units. If Decedent decides to gift all of her LLC
units in the lake home to her three children, she must report the gift
on a federal gift tax return. She will pay no tax on the gift, assuming
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she has not made gifts exceeding $4.14 million (federal exemption of
$5.34 million less $1.2 million gift of the lake home). Minnesota does
not have a gift tax, so there is nothing to report. When Decedent dies
in 2018, she will not need to file a Minnesota estate tax return or have
a federal pro forma return prepared. She will owe no Minnesota estate
taxes.

Option 2: Gift all but a few units (assume she retains a 1% interest). If
Decedent decides to gift all but a few units in the lake home to her
three children, she will still need to file a gift tax return reporting the
$1,188,000 (99% of $1.2 million) of gifts. Under Option 2, Decedent’s
personal representative will need to file a Minnesota estate tax return
and have a federal pro forma return prepared but she will owe only
$685 in Minnesota estate taxes. In actuality the tax owed may be even
less, because the $685 amount does not discount Decedent’s fractional
ownership in the LLC. Retaining some ownership in the LLC may be
preferable for a client who wants to ensure she has a legal right to
access the lake home, even though it generates a small amount of
estate tax and requires an estate tax return to be filed.

Option 3: Convert the LLC to a C-corporation. If Decedent converts the
LLC to a C-corporation, she will need to file income tax returns for the
corporation each year. The corporation must pay any Minnesota and
federal income taxes due. Presumably there will minimal federal taxes
because Decedent is not generating any income from the property.
There will be some state taxes each year because Minnesota has a
minimum fee for all corporations with combined property, payroll, and
sales exceeding $930,000. In 2013, that amount starts at $190 and
goes up to $9,340 for corporations with assets exceeding $37,360,000.
Decedent’s personal representative would not need to file a Minnesota
estate tax return or have a federal pro forma return prepared because
the Decedent owns no property that is considered to have its situs
located in Minnesota. No Minnesota estate taxes are due.
More Positive Tax Consequences: Regardless of which option Decedent
chooses she will be better off doing one of the three options than taking no
action.
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C.
SESSION D1
Not Meeting a Requirement for the Small Business Deduction of
the Farm Deduction
In addition to the $1.2 million exemption, Minnesota also provides a
deduction of up to $3.8 million for qualified small business or farm property.
Minn. Stat. § 291.03, Subds. 1, 3. Last year, qualified small businesses and farm
property owners enjoyed a maximum deduction of $4 million. The current
statutory calculation has reduced the qualified business and farm deduction to
$3.8 million in 2014. This number will continue to decrease by $200,000
annually, until it reaches $3 million in 2018. Id.
Small Business Property must meet all of the following requirements:
1. The value of the property must be included in the decedent’s federal
adjusted taxable estate, which is after deductions, including debts,
expenses and bequests to a surviving spouse.
2. The property must consist of trade or business property (or shares of
stock or other ownership interests that are not publicly traded).
3. The decedent or decedent’s spouse must have materially participated –
as defined in IRC § 469(h) – in the trade or business during the
taxable year that ended before the decedent’s death.
4. The trade or business must have had gross annual sales of $10 million
or less during the last taxable year that ended before the decedent’s
death.
5. The property must not consist of cash, cash equivalents, publicly
traded securities, or assets not used in the operation of the trade or
business held by the corporation or other entity.
6. The decedent must have continuously owned the property for the
three-year period ending at the decedent’s death.
7. A family member must materially participate in the operation of the
trade or business – as defined in IRC § 469(h) – for the three years
following the decedent’s death.
8. The estate and qualified heirs must agree to pay the recapture tax, if
applicable.
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Qualified Farm Property must meet all of the following requirements:
1. The property’s value must be included in the decedent’s federal
adjusted taxable estate, which is after deductions, including debts,
expenses and bequests to a surviving spouse.
2. The property must consist of agricultural land and must be owned by a
person or entity that is either not subject to or is in compliance with
Minn. Stat. § 500.24.
3. The property must have been classified for property tax purposes in
the taxable year of death as agricultural homestead, agricultural
relative homestead, or special agricultural homestead under Minn.
Stat. § 273.124.
4. The property must have been classified for property tax purposes in
the taxable year of death as class 2a property under Minn. Stat. §
273.13, Subd. 23.
5. The decedent must have continuously owned the property for the
three-year period ending at the decedent’s death.
6. A family member must maintain the 2a classification for the three
years following the decedent’s death.
7. The estate and qualified heirs must agree to pay the recapture tax, if
applicable.
Example: Dan Decedent and Stacy Spouse own farmland in western
Minnesota worth $9 million. Their other assets are minimal. Decedent and
Spouse deeded an undivided ½ interest to each of their revocable trusts in 2010.
The revocable trust formula funds the credit shelter trust to the state exemption
amount. The deeds were properly recorded. All of the property is 2a property
and classified as agricultural homestead property. They have not touched their
estate plans since that time. They file their annual taxes reporting income from
the farm, but have not filed any other documents. Decedent dies in 2014.
Negative Tax Consequences: It is arguable that Decedent does not qualify
for the qualified farm deduction because he does not meet requirement number
2 above. Minn. Stat. § 500.24 generally provides that an entity, including a trust,
is not allowed to own farmland. However, certain exceptions are allowed for
family corporations, partnerships, limited liability companies, and trusts if they
prepare a conservation plan for the agricultural land (if the land is considered
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highly erodible) and file an initial report with the Minnesota Department of
Agriculture called the “Corporate Farm Application.” The Corporate Farm
Application consists of 6 pages of general information about the entity holding
the farmland (e.g. who are the beneficiaries or shareholders) and about the
farmland itself (e.g. total acreage). Each year the Minnesota Department of
Agriculture sends a follow-up letter to ensure the information reported in the
Corporate Farm Application is still correct. If the letter is correct, no further
action is required. If the letter needs to be updated, the responsible party for the
entity must write to the Minnesota Department of Agriculture with the updates.
Since Decedent’s trust has not filed the Corporate Farm Application with
the Minnesota Department of Agriculture, the farmland is owned by a trust that
is not in compliance with Minn. Stat. § 500.24. This error results in a missed
opportunity of avoiding $740,200 of taxes on the second death (assuming 2018
amounts).
Corrective Action: Attorney meets with Decedent and Spouse and
discusses the importance of filing the Corporate Farm Application for each of
their trusts. Decedent, Spouse, and Attorney immediately prepare and file the
Corporate Farm Applications before the Decedent passes away. Attorney also
calls the county assessor to confirm that the property is classified as 2a
homestead property. Attorney calls the county soil and water conservation office
to determine if the land is considered highly erodible and assists the Decedent
and Spouse in creating a conservation plan if it is considered highly erodible.
Decedent now qualifies for the farm property deduction when he passes away
later in 2014. Spouse also qualifies for the farm property deduction when she
later passes away.
Positive Tax Consequences: When Decedent passes away in 2014, he will
be able to shelter all $4.5 million of his assets in the credit shelter trust using the
general exemption amount and the qualified farm property deduction. He will not
owe any Minnesota estate taxes. When Spouse later passes away, she will also
not owe any Minnesota estate taxes because she can deduct $3 million of
qualified farm property in addition to her general $2 million deduction (assuming
2018 amounts).
D.
Missed Disclaimer Opportunities
Disclaiming assets can be a useful tool for tax planning purposes. The two
most likely times when a disclaimer may be used is when the decedent does not
have an estate plan in place or when a decedent has an estate plan but misses
an asset while instituting his or her planning. Another instance when disclaimers
may be helpful is when there are two deaths that occur relatively close in time
and the second estate will be inheriting assets from the first.
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Disclaimed assets pass “as though the disclaimant predeceased the
decedent.” To be a qualified disclaimer the following is required:
1. The disclaimer must be irrevocable. Once a disclaimant disclaims the
assets, he cannot change his mind at a later date.
2. The disclaimer must be unqualified. For example, the disclaimant
cannot disclaim the asset only on the condition that his children will
receive the asset.
3. The disclaimer must be in writing.
4. The disclaimer must be received by the transferor of the interest, his
legal representative, or the holder of the legal title to the property to
which the disclaimer relates not later than 9 months from the date of
death.
5. The disclaimant must not have accepted the asset or any of its
benefits.
6. The disclaimed asset must pass without any direction on the part of
the disclaimant. It is very important to determine who the assets will
pass to before any disclaimers are made. For example, a disclaimant
may not want to disclaim assets to save taxes if doing so will funnel
money to a child with a drug addiction or creditor issues.
Example 1: Darwin Decedent died in 2018 without an estate plan. He is
survived by his wife (Sally Spouse) and their 5 adult children. His wife is
independently wealthy and has $7 million of her own assets. At his death,
Decedent had the following assets:
Life insurance policy with no beneficiary specified
Bank account
$2 million
$50,000
The life insurance contract provides that if no beneficiary is specified, the
spouse will be the default beneficiary. The laws of intestate in the state of
Minnesota leave everything to a surviving spouse if all children of the decedent
are children of the surviving spouse. Spouse collects the life insurance proceeds
and deposits them into her own savings account. She collects the bank account
with an affidavit of collection and deposits those funds in her own checking
account. Spouse dies in 2020.
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Negative Tax Consequence: There will be no estate tax due on Decedent’s
death because all of his assets qualify for the marital deduction. However,
Spouse has increased her net worth by $2,050,000. Spouse’s estate will pay
$917,800 of Minnesota estate taxes (in addition to federal taxes) when Spouse
passes away.
Corrective Action: The week after Decedent dies, Spouse sees Attorney.
Attorney discusses disclaimer planning and Spouse sees the benefit in that.
Spouse decides that she will disclaim all of Decedent’s assets. Spouse opens a
probate and files the necessary disclaimers with the court. Under Minnesota law,
Decedent’s children share equally in the disclaimed assets. The estate pays
$83,000 of Minnesota estate taxes and no federal taxes when Decedent passes
away. When Spouse passes away she pays $632,000 of Minnesota estate taxes.
She also pays federal taxes. By using disclaimers Decedent and Spouse have
reduced Minnesota estate taxes by $202,800.
E.
Inefficient GST Exemption Allocation
The generation skipping transfer (GST) tax is a tax on transfers made to a
“skip person.” A skip person is any person that is assigned to a generation that is
two or more generations below the generation of the transferor when the
transferor is related to the transferee. For example, a grandchild is a skip person
in relation to a grandparent. When the transferor and transferee are unrelated,
the transferee is considered a skip person if he or she is 37.5 or more years
younger than the transferor.
There are three types of generation skipping transfers: direct skips,
taxable terminations, and taxable distributions. Direct skips are the most
straightforward. They are any transfers made directly to a skip person or to a
trust in which all of the beneficiaries are considered skip persons. For example, a
grandpa giving his grandson a check for $5,000 is a direct skip. Taxable
terminations occur when all non-skip beneficiaries of a trust cease to have an
interest in the trust. For example, a taxable termination occurs at the death of
the last child in a trust if the transferor’s children receive trust income and the
grandchildren receive trust corpus. A taxable distribution is any distribution from
a trust to a skip person other than a taxable termination or a direct skip. I.R.C. §
2612(b). For example, a taxable distribution occurs when a trustee has a
sprinkling power exercisable in favor of children or grandchildren and chooses to
make a distribution to a grandchild.
Each transferor has a GST exemption amount equal to the estate tax
exemption ($5.34 million in 2014). There is also a GST annual exclusion similar
to the gift tax annual exclusion, but the GST annual exclusion has additional
requirements. In order to qualify for the gift tax annual exclusion, the transferred
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interest must be a present interest. The GST annual exemption requires that gifts
made in trust must also meet the following requirements in order to qualify for
the GST annual exemption:
1. The trust must be for the benefit of one skip person or must be to a
trust that creates separate shares for only skip people.
2. The trust must be included in the skip person’s gross estate if it does
not terminate before the skip person dies.
I.R.C. § 2642(c)(2).
The GST tax is complex but some general tips are as follows:
1. Make sure that trusts qualify for the GST annual exclusion if that is the
desired result. (See previous paragraph for requirements.)
2. Do not allocate GST exemption to a trust if it is unlikely that a taxable
distribution or taxable termination will occur. Take steps to elect out of
automatic allocation if it would be more beneficial to utilize the GST
exemption elsewhere. For example, it may make sense to elect out of
automatic allocation of GST exemption to a life insurance trust where
the chance of the trust being subject to GST tax is remote and where
the skip persons will be receiving a guaranteed sum equaling or
exceeding the GST exemption amount at the death of the transferor.
3. Make sure that the client’s estate planning documents specifically allow
for a reverse QTIP election to be made. A reverse QTIP election allows
the first decedent to be treated as the transferor of certain property
for GST tax purposes at the second decedent’s death. A federal estate
tax return needs to be filed at the first death to make the special QTIP
election on Schedule R.
4. Ensure that all trusts have a GST inclusion ratio of zero or one. If this
is not the case, take steps to effectuate a qualified severance if
possible. See Treas. Reg. § 26.2642-6.
5. Consider skipping multiple generations. GST tax is calculated the same
regardless of whether the transferee is a grandchild or a great
grandchild. Furthermore, in Minnesota any skip (even just to the
grandchild) provides a benefit because Minnesota does not impose a
GST tax.
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F.
SESSION D1
Failure to Consider Required Minimum Distribution Rules for
Retirement Plans
The Internal Revenue Code has very specific guidelines about how
retirement plan benefits must be paid out after a plan participant dies. The
required minimum distributions are calculated based on the following factors: (1)
the named beneficiary and (2) whether the participant died before or after his
required beginning date. The required beginning date is the date that the
participant must start taking distributions from the plan. For IRAs, this is usually
the April 1st of the calendar year following the year in which the participant
reaches age 70.5. The most common issue that occurs related to required
minimum distributions is when a participant dies before the required beginning
date and leaves assets to a trust that is not considered a see-through trust. The
see-through trust requirements are as follows:
1. The trust must be valid under state law. This is a very low threshold
and will not usually result in estate plan issues.
2. The trust must be irrevocable or must become irrevocable upon the
death of the plan participant. Again this is a very low threshold, as
most revocable trusts used for estate planning purposes are set up to
become irrevocable on the death of the plan participant. But watch out
for joint trust arrangements which may allow a surviving spouse to
continue to revoke or amend the trust after a decedent/participant’s
death.
3. The beneficiaries must be identifiable from the trust instrument. This
means that the trust cannot reference another document. However,
class gifts (e.g. children) are considered gifts to identifiable
beneficiaries so long as it is possible to identify the member of the
class who has the shortest life expectancy.
4. Certain documentation must be provided to the plan administrator.
Check your client’s plan documents to determine what this
documentation is. Sometimes it is a copy of the trust while other plan
providers require a certified list of trust beneficiaries so that they do
not have to make the determination of beneficiaries themselves.
5. All of the beneficiaries of the trust must be “designated beneficiaries”
under the Internal Revenue Code. Only individuals or see-through
trusts are considered “designated beneficiaries. Remote beneficiaries
are considered.
13 60th Annual MNCPA Tax Conference
SESSION D1
Example: Doug Decedent lists his revocable trust as the beneficiary of his
traditional IRA. The IRA has $1.5 million of assets in it at Decedent’s date of
death. Decedent’s trust provides that the trustee can make discretionary
distributions of income and principal to any of Decedent’s three children. When
the youngest child reaches age 35, all trust property will be distributed outright
to Decedent’s children. If no children survive Decedent, Charity will receive all
trust assets. Decedent dies at age 60, before his required beginning date.
Negative Tax Consequences: Decedent’s trust is not considered a seethrough trust because it lists Charity as a contingent remainderman. Since the
trust is not a see-through trust and since Decedent died before his required
beginning date, the trustee of Decedent’s trust must withdraw the full $1.5
million from the IRA no later than 5 years after the Decedent’s date of death.
This will create considerable tax liability for Decedent’s trust or Decedent’s
children.
Corrective Action 1: Attorney talks with Decedent about his goals for his
estate plan. Decedent says that he “doesn’t want his kids to receive everything
at once.” Attorney explains how a conduit provision works in a revocable trust. A
conduit provision provides that any required minimum distribution taken from a
retirement plan be immediately distributed to the income beneficiary of the trust.
However, the Charity is then disregarded as a beneficiary and the required
minimum distribution from the IRA is calculated based on the oldest child’s life
expectancy. Decedent thinks that a conduit provision sounds like a great way to
space out distributions to his children. Attorney drafts the first amendment to
Decedent’s revocable trust and Decedent executes it. When Decedent passes
away, the trustee of his trust will be able to stretch out distributions from the
retirement plan over the oldest beneficiary’s life expectancy. This will save a
substantial amount of taxes.
Corrective Action 2: Attorney talks with Decedent about his goals for his
estate plan. Decedent says that when he originally set up the estate plan, he
thought his children were too young and irresponsible to handle that kind of
money. Now, 10 years later, he believes that they would all be capable of
making responsible decisions with the IRA. He also says that the charity was
there “in the off chance that everyone dies at the same time.” Attorney assists
Decedent in setting up his beneficiary designations to leave 1/3 to each of his
children with provisions to leave it to any surviving child or children if one or
both of his children predecease Decedent. Attorney lists the revocable trust as
14 60th Annual MNCPA Tax Conference
SESSION D1
the contingent beneficiary to receive the IRA only in the event that all of
Decedent’s children are dead. By leaving the benefits outright to his children,
each child is allowed to stretch the required minimum distributions over his or
her life expectancy. This is especially helpful if there is a large age gap between
the oldest and youngest child. Charity will still get the IRA funds if a catastrophic
event occurs and all of Decedent’s children predecease him, but leaving it
outside of trust reduces the tax burden in the more likely event that at least one
of Decedent’s children survives him.
Corrective Action 3: Attorney and Decedent discuss Decedent’s goals
related to his overall estate plan. When they speak, Decedent expresses a desire
to have about ½ of his estate go to his children and ½ of his estate go to
charity. His children are grown and are successful in their own right (i.e. the
children are not going to be depending on this inheritance for their daily living).
Decedent also has a stock portfolio totaling $1.5 million. Attorney explains to
Decedent how it is beneficial to fund a charitable bequest with an IRA. A charity
will not need to pay income taxes on distributions from the IRA so it doesn’t
matter to the charity whether it has a 5 year payout or a stretched payout. The
children would be better off receiving the stock portfolio because the tax on the
capital gains in the stock portfolio will likely be less than the tax on the ordinary
income from the IRA distributions. Decedent likes the idea of funneling certain
assets to particular beneficiaries based on the beneficiaries’ different tax
objectives. Decedent changes his beneficiary designation on his IRA to the
charity. He leaves the stock portfolio titled in the name of his trust which lists his
children as the primary beneficiaries.
G.
Updated Planning for Same-Sex Couples
Governor Dayton signed H.F. 1054 into law on May 14, 2013. H.F. 1054
legalized marriage between two persons, regardless of their sex. The law took
effect on August 1, 2013. Prior to the enactment of H.F. 1054, many same-sex
couples had estate and disability plans in place that provided for the other
partner since they were aware that the partner would have no statutory
protections.
Same-sex couples who have gotten married should consider updating
their estate and disability plans to ensure they are receiving all of the benefits
that come with being married, including the unlimited marital deduction for
estate tax purposes.
15 60th Annual MNCPA Tax Conference
H.
SESSION D1
Revisiting Gifting Strategies
Gifting was hampered by the institution of a gift tax under the 2013
Omnibus Tax which imposed a flat 10% tax for any gift over the $1 million gift
tax lifetime exemption amount. Since the 2014 Tax Bill repealed the gift tax, tax
practitioners may want to revisit gifting strategies for their clients. One caveat is
that the 2014 Tax Bill did not repeal the look-back for gifts made within three
years of death, so deathbed gifting that was commonly used prior to 2013 is still
not a desirable option. Gift (early) and live!
VII.
Conclusion
The general consensus among tax practitioners is that the 2014 Tax Bill brought
numerous positive changes, including increasing the exemption amount, simplifying the
estate tax statutes, repealing the gift tax, and eliminated the “rate bubble.” The new
legislation provides tax practitioners with the opportunity to reach out to clients to
discuss these changes and assist them in making any required updates to the clients’
planning documents. Hopefully these face lift strategies provide you with a starting
point in evaluating areas where updating or utilizing new planning opportunities may be
appropriate.
16 60TH ANNUAL MNCPA
TAX CONFERENCE
November 17-18, 2014  Minneapolis Convention Center, Minneapolis, MN
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D1. Good Planning Gone Bad: Why Your Old Minnesota Estate and Gift Tax Strategies Need a
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Minnesota Society of Certified Public Accountants
www.mncpa.org  952-831-2707