Asset Protection

Nationally renowned estate planning and asset protection attorney, Steven J. Oshins, Esq., AEP (Distinguished), has just released his 4th Annual Domestic Asset Protection Trust State Rankings Chart.

Some of the Highlights:

1. South Dakota closes in on Nevada, but doesn’t quite get there.  These are still the top two states.

2. Ohio comes from nowhere to jump into the first tier.

3. Alaska, Tennessee, Wyoming and Utah all make positive changes.

4. Utah remains ranked low because of its state income tax uncertainty (but is now a great state for Utah residents).

5. For the first time ever, the State Rankings Chart has a column about “Ease of Use” and docks the states that require a new Affidavit for every transfer.  I personally believe that MORE points SHOULD have been taken away from the five states that have the affidavit requirement than the number of points I actually took away.  I will revisit this in next year’s chart.  I just wanted to slowly integrate this new feature into the chart and wanted to err towards underweighting that.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  Connect with us on Facebook, Twitter or LinkedIn.

According to estate planning and asset protection attorney, Jeffrey M. Verdon, there has been a number of court decisions involving failed asset protection planning in the last two years.  In his opinion, the reason for the recent and unusual amount of cases has to do with comprehensive estate planning (with asset and lifestyle protection) and when "bad facts make bad law".  Read the full post...

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact the Jeffrey M. Verdon Law Group, LLP at jeff@jmvlaw.com or 949-263-1133.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minute consultation.  Connect with us on Facebook, Twitter or LinkedIn.

Reproduced with Permission by and Courtesy of Leimberg Information Services, Inc. (LISI).  For information about how to subscribe to LISI, click here.

"A DING trust (standing for Delaware Incomplete Non-Grantor trust) is a strategy designed to eliminate State income taxes on the Grantor’s investment income by having the Grantor transfer his investments to a trust domiciled in a non-tax state which transfer is, on the one hand, an incomplete gift and, on the other hand, not made to a grantor trust.  After a hiatus of some six years, the IRS has now ruled, in PLR 201310002 in favor of a DING  trust. 

The 2013 PLR seems, in large part, to be consistent with the immediately prior PLR in this area, and tells us that the IRS is again willing to issue rulings on DING trusts. Intrepid taxpayers will undoubtedly continue to create DING trusts in states such as Delaware and without the Grantor’s Sole Power. 

There is no reason to believe the IRS would reissue the 2006 PLR, wherein all beneficiary members of the Power of Appointment Committee were replaced upon death.  Cautious taxpayers will model their future trusts on the fact pattern of the 2013 PLR and will be exceedingly sensitive to the number of members of the Distribution Committee, their power to distribute to themselves and whether a member is to be replaced if he or she predeceases the grantor.  A revenue ruling from the IRS dealing with the issue raised by the 2007 News Release would be most welcome and helpful; the 2013 PLR does not give any hint, one way or the other.”

Now, Bill Lipkind provides members with commentary on PLR 201310002, an important development dealing with a powerful planning technique, the Delaware Incomplete Non-Grantor trust.

William D. Lipkind is Chair of the Tax Department of Lampf, Lipkind, Prupis & Petigrow, A Professional Corporation, West Orange, New Jersey, and New York, New York. The Law Firm concentrates its practice in the representation of high net worth individuals and entrepreneurs. It is especially active in domestic and international income and estate tax planning, wealth preservation, business transactional matters and asset protection. Bill has received degrees from Cornell University (B.A. 1964); Harvard University (J.D. 1967); and New York University (LL.M. in Taxation, 1972). He is the author of: “Protecting Assets from Creditors," The CPA Journal, September, 1993: "On The Road Offshore; The Struggle Between Protection of Assets and Fraudulent Conveyances," N.J. Lawyer, July/August, 1992; and "Gallagher Revisited: The Functionally Unrelated Corporate Reorganization," 13 Villanova Law Review 487, 1968.  Bill has been named a Super Lawyer and one of New Jersey’s Top Attorneys for the past five years. He has lectured extensively before professional and lay groups and has both been featured on television and quoted in financial publications. 

Bill wishes to thank Jonathan Blattmachr for his review and comments, but notes that any errors are the author’s responsibility.  

EXECUTIVE SUMMARY:  A “DING” trust (standing for Delaware Incomplete Non-Grantor trust) is a strategy designed to eliminate State income taxes on the Grantor’s investment income by having the Grantor transfer his investments to a trust domiciled in a non-tax state which transfer is, on the one hand, an incomplete gift and, on the other hand, not made to a grantor trust.  After a hiatus of some six years, the IRS has now ruled, in PLR 201310002 (the “2013 PLR”)[1] in favor of a “DING” trust. 

The 2013 PLR seems, in large part, to be consistent with the immediately prior PLR in this area.  However, unlike the prior ruling, the trust in the 2013 PLR contains a reserved power for the grantor to make lifetime distributions to his issue in a non-fiduciary capacity subject to a HEMS ascertainable standard.  The 2013 PLR states that in the fact pattern presented the beneficiary members of the Distribution Committee do not possess, for gift and estate tax purposes, general powers of appointment (at least as long as a member is not replaced in the event he predeceases the grantor) either for distributions back to the Grantor (as did the immediately prior PLR), or for distributions to other beneficiaries (a ruling not in the immediately prior PLR).  Not stated, but of necessity, the trust in the 2013 PLR must be domiciled in a state other than Delaware. 

FACTS:

In the 2013 PLR, the IRS ruled that (i) the Grantor (who with his four sons constitute the Distribution Committee) would not be deemed the owner of any portion of the trust under IRC §§ 673, 674, 675, 676 and 677[2]; (ii) no other members of the Distribution Committee would be deemed an owner of any portion of the trust under IRC §678; (iii) the transfer of property by the Grantor to the trust would not be a completed gift; (iv) a distribution of property by the Distribution Committee to the Grantor would not be a completed gift by any member of the Distribution Committee; and (v) a distribution of property by the Distribution Committee to any beneficiary of the trust other than the Grantor would not be a completed gift by any member of the Distribution Committee other than the Grantor.  In other words, the Grantor made an incomplete gift, the trust is not a grantor trust and no member of the Distribution Committee, excluding the Grantor, has a general power of appointment for gift or estate tax purposes.

The “DING” trust strategy (DING standing for Delaware Incomplete Non-Grantor) contemplates a taxpayer in a high state income tax jurisdiction transferring a portfolio to a trust domiciled in a no state income tax jurisdiction (i.e., Delaware) so that if the trust is not a grantor trust and the transfer of assets thereto does not constitute a completed gift, the taxpayer, with no federal income or gift tax advantages or risks, can escape state income taxes on his portfolio income, at least to the extent the income is not distributed to beneficiaries.

Seven years ago, in PLR 200612002 (hereinafter, the “2006 PLR”), the IRS ruled (and there had been a number of prior rulings) that the trust was not a grantor trust, that the gift by the grantor thereto was an incomplete gift, and that the named members of the Power of Appointment Committee[3] did not possess general powers of appointment in the event distributions were made to the grantor (the ruling being silent on the question of distributions to beneficiaries other than the grantor).  The Power of Appointment Committee consisted of the Grantor’s sibling and another person, both of whom were discretionary beneficiaries of the trust during the Grantor’s lifetime; the Grantor was not a member.  If either member of the Power of Appointment Committee died prior to the Grantor, then that member had to be replaced so that the Committee always had two serving members. 

The Power of Appointment Committee had the sole power to direct distributions of income and principal to the Grantor, her issue, and certain other beneficiaries.  The Power of Appointment Committee acted in a non-fiduciary capacity and could act either unanimously or by the Grantor and one member of the Power of Appointment Committee.  The Grantor possessed a broad special testamentary power of appointment in favor of anyone other than herself, her creditors, her estate or the creditors of her estate.  In default of her exercise of her testamentary power of appointment, the assets passed, upon her death in part to charity and the balance to her spouse and issue.[4]

PLR 200729025 (the “2007 PLR”),  dated April 10, 2007, was similar to the 2006 PLR except that the Power of Appointment Committee consisted of three, not two members.  In the event one Committee member predeceased the Grantor, he would not be replaced.  However, should two members predecease the Grantor, that decedent would be replaced so that the Committee always consisted of at least two members.  The IRS ruled in the 2007 PLR similarly to the 2006 PLR, except that it added the statement “Accordingly, during the period the Power of Appointment Committee consists of B, C, and D, they will not be treated as making a taxable gift if Trust income or corpus is distributed to A [the Grantor] under the terms of the Trust”.  The IRS did not rule with respect to distributions to persons other than the Grantor.

Almost immediately following the 2007 PLR, in IR-2007-127[5] the IRS announced (the “2007 News Release”) that it was reconsidering “a series of private letter rulings” as to whether beneficiaries who direct distributions of trust income and corpus possessed general powers of appointment.  In the announcement, they suggested that the holdings in the applicable private letter rulings (the 2006 PLR was undoubtedly among the rulings they were contemplating), were inconsistent with two extant Revenue Rulings[6] because the beneficiary members of the Power of Appointment Committee were to be replaced in the event one of them died prior to the Grantor. 

The 2007 News Release invited comments.  Many comments were submitted:  comments agreed and disagreed with the inconsistency suggested by the News Release; agreed and disagreed with the holdings in the various private letter rulings; and offered a variety of recommendations as to potential clarifying revenue rulings and potential drafting solutions.  Regardless, no further DING rulings were issued until the 2013 PLR.

In 2008 the IRS invited public comments on a proposed Revenue Ruling[7] concerning Private Trust Companies.  This generated speculation about whether the issuance of DING rulings would also be subordinated to the actual issuance of this ruling.

Then, in a Chief Counsel Advice Memorandum[8] dated in 2011, the IRS held that a transfer to an irrevocable trust in which the grantor retained a testamentary power of appointment but no lifetime beneficial interest was a completed gift with respect to the life interest, though an incomplete gift with respect to the remainder.  This CCA led to a plethora of expert speculation on whether the IRS was establishing new criteria for the determination of whether a transfer constituted a completed gift or an incomplete gift.  In 2012, the IRS also announced it was considering issuing regulations concerning decanting.[9]  No ruling, including the 2013 PLR, discusses the effect of decanting.

And now the IRS has issued the 2013 PLR.

Facts of PLR 201310002
Interestingly enough, the facts of the 2013 PLR (save one) are essentially similar to the facts of the 2007 PLR.  Thus, in the 2013 PLR the Grantor established an irrevocable trust; during his lifetime all distributions of income and principal may be made by the Trustee to the Grantor and/or the Grantor’s issue, but solely at the direction of the Distribution Committee; the Distribution Committee consists of the Grantor and his four sons and functions in a non-fiduciary capacity; decisions of the Distribution Committee may be effectuated either by the Grantor and a majority of the other members, or unanimously by all members other than the Grantor; and the Grantor possesses a broad special testamentary power of appointment. 

Upon a beneficiary member of the Distribution Committee ceasing to serve, that member is not replaced provided that the Distribution Committee must always have at least two members in addition to the Grantor.  In other words, if three of the four sons predecease the Grantor, then upon the death of the third son, he is replaced.  That, of course, raises the question, not answered in the 2013 PLR, of whether from and after the death of the second son, the surviving two sons have general powers of appointment.

Differing from the 2006 PLR and the 2007 PLR, the Trust in the 2013 PLR also provides that the “Grantor, in a non-fiduciary capacity, may, but shall not be required to, distribute to any one or more of Grantor’s issue, such amounts of the principal (including the whole thereof) as Grantor deems advisable to provide for the health, maintenance, support and education of Grantor’s issue…(the “Grantor’s Sole Power”).”  This provision tracks IRC §674(b)(5).

An analysis of the 2013 PLR leads to a number of conclusions.

First:   It now appears that the IRS will not withhold further issuance of DING rulings merely on account of their pending ruling on Private Trust Companies or their contemplated regulations on the consequences of decanting.

Second:  Non-Grantor Trust Status.  The addition of the Grantor’s Sole Power (a power clearly permitted under IRC §674(b)(5)) does not alter the status of the trust as a non-grantor trust.  Accordingly, reaching a conclusion that the trust is not a grantor trust was just as easy and self-evident in the 2013 PLR as it was in both the 2006 PLR and the 2007 PLR.  The language of the 2013 PLR adds nothing to our collective understanding of the IRS perception of what constitutes a non-grantor trust.  Each beneficiary member of the Distribution Committee is an “adverse party” within the meaning of IRC §672(a).  Accordingly, the Grantor does not possess any of the powers under IRC §§ 674, 676 or 677 which would make the trust a grantor trust nor does the Grantor possess any of the powers described by IRC §675.

Third:   Incomplete Gifts and General Powers of Appointment. Notwithstanding the 2007 News Release, the plethora of comments and suggestions emanating therefrom and the passage of 5 years, the 2013 PLR does not manifest any new or changed views from the IRS on what constitutes an incomplete gift (excluding herefrom the discussion below concerning the Grantor’s Sole Power) and whether beneficiary members of the Distribution Committee possess, at some point, general powers of appointment.  In the 2013 PLR, the IRS must have concluded that, for Federal gift and estate tax purposes, the beneficiary members of the Distribution Committee, at least prior to there being only two members, did not possess general powers of appointment but that the Grantor, in effect, did.

To understand the Ruling, one needs to analyze separately the application of IRC §§ 2514 and 2041 to the Grantor on the one hand and to the beneficiary members of the Distribution Committee on the other.  To make the analysis even more complex, one must be sensitive to the fact that the IRS interprets the phrase “substantial beneficial interest" which would be “adversely affected” differently for income tax purposes (i.e., IRC §672(a)) than for gift and estate tax purposes (i.e., IRC §§ 2514 and 2041).[10]

Pursuant to the terms of the trust in the 2013 PLR, income and principal may be distributed to the Grantor and the other beneficiaries either (x) at the direction of the Grantor and a majority of the beneficiary members of the Distribution Committee (the “Grantor’s DC Power”) or (y) at the unanimous direction of all the beneficiary members of the Distribution Committee.

Grantor, Grantor’s Powers and General Powers of Appointment
Under the authority of IRC  Reg. §25.2511-2(c), IRC Reg. §2514-3(b)(2) and Rev. Rul. 79-63, 1979 C.B. 302, because the beneficiary members of the Distribution Committee are not takers in default of the Grantor’s failure to exercise the Grantor’s DC Power, and because the beneficiary members are mere permissible appointees under the Grantor’s testamentary power of appointment, they are not deemed to have a “substantial interest” which is “adverse” to the Grantor.

Accordingly, because pursuant to the Grantor’s DC Power, the Grantor with the consent of a majority of the other members of the Distribution Committee may distribute income and principal to himself and because those members are not “adverse” for gift and estate tax purposes,[11] pursuant to IRC §2514(c)(3)(B) and IRC §2041(b)(1)(C)(ii) the Grantor does possess (for gift and estate tax purposes, not for income tax purposes) such “dominion and control” which, conceptually, is the equivalent of a lifetime general power of appointment.[12]  The Grantor also possesses a testamentary broad special power of appointment.  Once one concludes that the Grantor has both the equivalent of a lifetime general power of appointment and a testamentary broad special power of appointment, the conclusion that the gift is incomplete is not at all surprising.  Indeed, Estate of Sanford v. Commissioner of Internal Revenue, 308 U.S. 39 (1939) requires the conclusion.  This analysis does not, and the corresponding analysis of the IRS in the 2013 PLR did not, require any consideration of the Grantor’s Sole Power under IRC §674(b)(5). 

Beneficiary Members of Distribution Committee and General Power of Appointment
IRC §2514(c)(3)(A) provides that a power exercisable in conjunction with the grantor is not a general power of appointment.  Accordingly, no beneficiary member of the Distribution Committee has a general power of appointment in the context of the Grantor acting with a majority of the Distribution Committee.

However, the beneficiary members of the Distribution Committee can also act without the consent of the Grantor if they act unanimously.  IRC §2514(c)(3)(B) provides that the power to act is not a general power of appointment if it is exercisable only with a person having a substantial interest in the property subject to the power which is adverse to the exercise by the power holder.

In the 2007 News Release, the IRS questioned whether the results in PLRs such as the 2006 PLR were inconsistent with the holdings of the two Revenue Rulings cited in Note 6.  Those two Revenue Rulings interpret IRC Reg. §25.2514-3(b)(2) to hold that where the power holders are not replaced upon death, the remaining power holders are adverse and the power is not a general power of appointment, but where they are replaced, then the remaining power holders are not adverse and the power is a general power of appointment.[13]

The 2007 News Release speculated that the PLRs may be distinguishable from the Revenue Rulings because the “the grantor’s gift to the trust is incomplete since the grantor retains a testamentary special power of appointment.”  The News Release does not explain how in the case of an incomplete gift, the Grantor’s retention of a testamentary power of appointment would make power holders adverse one to another and thereby avoid having general powers of appointment.

The 2013 PLR does not provide any insight into current IRS views on this issue because, consistent with the Regulations, the Revenue Rulings, and the 2007 PLR, a beneficiary member of the  Distribution Committee is not replaced upon his death prior to the Grantor’s, at least not until the third of them dies.

Fourth:  The Grantor’s Power to Distribute Corpus by an Ascertainable Standard.  The remaining item to be considered in the 2013 PLR is whether the inclusion of the Grantor’s Sole Power, (i.e., the IRC §674(b)(5) power) was necessary for the ruling.

In the 2013 PLR, having already concluded that pursuant to the Grantor’s DC Power, the transfer of property by the Grantor to the Trust would be “wholly incomplete” for Federal gift tax purposes, the IRS nonetheless went on in the succeeding paragraph to discuss the Grantor’s Sole Power and to conclude that said power gave the “Grantor the power to change the interests of the beneficiaries” and thus it, too, made transfers to the Trust “wholly incomplete”.  Although the Grantor’s Sole Power relates only to principal, and not at all to income, the IRS nonetheless held the transfer to be “wholly incomplete”.  This holding appears to be in addition to and separate and apart from the holding reaching the same conclusion with respect to the Grantor’s DC Power.[14]

If the Grantor’s Sole Power was, under some undisclosed theory, necessary for the Ruling, then the Ruling presents many problems with a number of state trust statutes.  Because the DING trust included the grantor as a potential beneficiary, the trust is characterized as a self-settled spendthrift trust.

If, for example, the trust were domiciled in New York, then the spendthrift provisions would not be applicable to the grantor and the grantor’s creditors would have full access to the trust.  In such a case, while there might be an incomplete gift, the IRS would characterize the trust as a grantor trust, thereby defeating the strategy.  However, in many of the states which both permit self-settled spendthrift trusts and have no state income tax, the statutes governing self-settled spendthrift trusts do not permit the grantor to retain a lifetime power of appointment[15]. 

Were he to retain such a power in those states, then the trust would not qualify as a self-settled spendthrift trust providing the grantor-beneficiary with creditor protection.  In short, in those states, the trust would be a grantor trust.  For the forgoing reason, although the 2013 PLR does not indicate the state in which the trust is domiciled, it clearly cannot be Delaware or any other state with a similar statute.

Note that the Grantor’s Sole Power only gives the Grantor power over corpus.  If its inclusion was necessary to cause the gift to be incomplete, then the analysis that the Grantor’s DC Power renders a transfer "wholly incomplete" would be questionable (an analytically inconceivable result).

Further, although the text of the ruling seems to say that the Grantor’s Sole Power in and of itself renders the transfer “wholly incomplete”, there are no provisions in the Trust (ignoring for this purpose the Grantor’s DC Power), nor does there appear to be extant authority (with recent commentators apparently taking differing positions), for the transfer to be incomplete as to the lifetime income interest.[16]

Accordingly, one is tempted to conclude that the inclusion of the Grantor’s Sole Power was not necessary for the PLR.  Perhaps the power was included for reasons unique to the Grantor’s personal circumstances; perhaps it was included merely as a gloss to enhance grantor retained rights and powers.

On the other hand, perhaps the inclusion of the ruling on the Grantor’s Sole Power means that, for ruling purposes at least, the IRS is requiring that a grantor retain more rights than were retained in either the 2006 PLR or the 2007 PLR; perhaps the inclusion was a signal that the IRS considers a grantor retained lifetime limited power of appointment over corpus (and not income) to be, in and of itself, sufficient to make a gift wholly incomplete.

Conclusion
The 2013 PLR tells us that the IRS is again willing to issue rulings on DING trusts; intrepid taxpayers will undoubtedly continue to create DING trusts in states such as Delaware and without the Grantor’s Sole Power.  There is no reason to believe the IRS would reissue the 2006 PLR, wherein all beneficiary members of the Power of Appointment Committee were replaced upon death. 

Cautious taxpayers will model their future trusts on the fact pattern of the 2013 PLR and will be exceedingly sensitive to the number of members of the Distribution Committee, their power to distribute to themselves and whether a member is to be replaced if he or she predeceases the grantor.  A revenue ruling from the IRS dealing with the issue raised by the 2007 News Release would be most welcome and helpful; the 2013 PLR does not give any hint, one way or the other.

CITE AS: LISI Estate Planning Newsletter #2076 (March 12, 2013) at http://www.leimbergservices.com. Copyright 2013 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.

CITATIONS:  [1] Concurrently, four other PLRs were issued, one for each of the four sons of the Grantor.  These are PLRs 201310003, 201310004, 201310005, and 201310006.   

[2]  While ruling that the trust did not include provisions that would cause IRC §675 to be applicable with respect to the Grantor, there was an exclusion under that section with respect to the actual operation of the trust, stating that such a determination was a question of fact and could not be made prior to an audit of applicable income tax returns.  This exclusion is customary.

[3] The phrase “Power of Appointment Committee” as used in the 2006 PLR serves the same function as the “Distribution Committee” in the 2013 PLR.

[4] Some commentators speculated that the import of rulings such as the 2006 PLR was that a gift would be incomplete if the grantor were a discretionary beneficiary of income and corpus during his lifetime and possessed a testamentary power of appointment exercisable upon his death.  The potential income interest was sufficient, so the thought went, even though the grantor’s beneficial interest was solely at the discretion of income tax adverse persons.  However, such an analysis did not focus upon the holding in the ruling that with respect to the  Grantor, the members of the Power of Appointment Committee did not have a “substantial adverse interest” for purposes of IRC §2511.

[5] News Release IR-2007-127; 2007 IRB 589 (July 9, 2007)

[6] Rev. Rul. 76-503, 1976-2 C.B. 275 and Rev. Rul. 77-158, 1977-1 C.B. 285.

[7] Notice 2008-63, 2008-2 C.B. 261

[8] LTR 201208026 (September 28, 2011)

[9] In Notice 2011-101, 2011-2 C.B.932, the IRS invited comments from the public with respect to the income, gift, estate tax and GST tax consequences with respect to decanting.

[10] For an excellent recent article discussing the complexities surrounding powers of appointment and observing on the lack of symmetry between the income tax and gift and estate tax provisions, see Diana S.C. Zeydel, When is a Gift to a Trust Complete---Did CCA 201208026 Get It Right?, 117 J. Taxation 142 (September, 2012).

[11] Obviously, the beneficiary members of the Distribution Committee are “adverse” to the Grantor in the sense that acting unanimously, they can distribute 100% of the trust fund to someone other than the Grantor and concurrently impose on the Grantor a substantial gift tax.  Regardless until they exercise such power the Grantor retains sufficient powers such that his transfer to the Trust is incomplete.  What is important here is that the transfer does not become complete until the power is exercised, not that it merely exists.

[12] See Jonathan  G. Blattmachr, Mitchell M. Gans & Diana S. C. Zeydel, World’s Greatest Gift Tax Mystery: Solved, 115 TAX NOTES 243 (2007) for a discussion, under “Meaning of Power of Appointment”, of the IRC’s characterization of a reserved power that would, for local property law purposes, be characterized as a power reserved by the creator of the power for himself.

[13] A discussion of the logic, policy and reasonableness of those two Revenue Rulings is beyond the scope of this commentary.

[14] This appears to be a stand alone conclusion.  If one were to conclude that the Grantor’s Sole Power alone in and of itself rendered a transfer incomplete, then if the grantor were indifferent to being a potential beneficiary, it would appear that he could create a DING without a Distribution Committee, without a retained testamentary power of appointment, and with a single non-adverse trustee.  But see the text of this newsletter accompanying endnote 16.

[15] See, e.g., §3570(11)b.2 and §3571 of the Delaware Qualified Dispositions in Trust Act.

[16] See Joseph Goldstein, Transferee, et al v. Commissioner of Internal Revenue, 37 T.C. 897 (1962).  Compare Diana Zeydel, supra, note 10, with Jeff Pennell on Chief Counsel Advisory 201208026, LISI Estate Planning, Newsletter #1937 (March 7, 2012).

_______________________________________________________

Join us on Wednesday, April 3rd at 9am Pacific (12pm Eastern) for a special 60-minute teleconference on this timely topic with speakers, William ("Bill") D. Lipkind, J.D., LL.M. (Taxation) and Steven J. Oshins, J.D., AEP (Distinguished).  For more information and to register, click here.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  Connect with us on Facebook, Twitter or LinkedIn.

Sources: Leimberg Information Services, William D. Lipkind, J.D., LL.M. (Taxation) and Steven J. Oshins, J.D., AEP (Distinguished)

The House has just approved the Senate bill. President Obama will sign it later this week.  Now what?  [Hint:  You’ll be doing NEARLY EXACTLY what you’ve been doing the past few months, but without the time pressure.]

Estate Planning:

1. We now have a “permanent” $5MM (indexed for inflation) estate, gift and GSTT exemption and a 40% tax rate.  Remember that the word “permanent” really means “until they change it next time”.  This is an opportunity for all of your clients to continue to use their $5MM gift and GSTT exemptions by making gifts into Dynasty Trusts.  All of our wealthy clients should continue to make these gifts.  This is a great opportunity.  We don’t know when Congress will next change the exemption.  Don’t procrastinate.  It might be one year, might be two years, might be three years, etc.  Look at Nevada as the jurisdiction of choice.  See the Dynasty Trust State Rankings Chart.
2. Congress hasn’t touched valuation discounts, GRATs and other techniques.  Again, keep using them.  Great news that our tools are intact.
3. Income taxes were raised for the wealthy.  So CRTs should be more on your mind.  Don’t rush and do them for everyone.  They’re still overused.  But at least consider them more than before.
4. High early cash value life insurance should be used even more than before given the higher income taxes.  Those of you who don’t understand this product should take your favorite life insurance agent out for lunch and get up to speed.

Asset Protection Estate Planning:

1. The congressional bill DID NOT change the fear of law suits and divorces.  You should continue to suggestion Dynasty Trusts for asset protection planning and also Domestic Asset Protection Trusts – especially using the Hybrid Version (see http://www.oshins.com/images/Hybrid_DAPT.pdf).  And I can’t find any reason not to use Nevada as the jurisdiction of choice given that it’s ranked #1 in the DAPT State Rankings Chart (Download Chart)
2. Combine the DAPT with the Double LLC strategy for extra protection.

Steven J. Oshins, Esq., AEP (Distinguished) is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada.  Steve is a nationally known attorney who is listed in The Best Lawyers in America® and has been named one of the Top 100 Attorneys in Worth magazine.  He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011.  He has written some of Nevada's most important estate planning and creditor protection laws, including the law making the charging order the exclusive remedy of a judgment creditor of a Nevada LLC and LP (in 2001, 2003 and 2011), the law changing the Nevada rule against perpetuities to 365 years (in 2005) and the law making Nevada the first and only state to allow a Restricted LLC and a Restricted LP creating larger valuation discounts than any other state allows (in 2009).  He is also the author of the Annual Domestic Asset Protection Rankings which you can download from our Free Resources page.  Steve can be reached at 702-341-6000, x2 or at soshins@oshins.com.  His law firm's web site is http://www.oshins.com.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

Nearly everybody is out of 2012 capacity at this point.  So...

1. Consider setting up a simple one-page gift trust with just the essential terms so you have a valid trust under the state law you are selecting. 
2. Give the settlor’s best friend as Trust Protector the power to completely amend and restate the trust (maybe for a selected period of time like three months) in that Trust Protector’s sole and absolute discretion (and obviously draft around a GPOA).
3. Get it fully executed and funded with the $5MM gift before year-end.
4. Enjoy the New Year’s.  Take a deep breath.
5. Reconvene in 2013 and have the Trust Protector restate the trust with regular provisions.  The settlor can make recommendations, but it clearly must be done in the sole and absolute discretion of the Trust Protector to avoid IRC 2038.
6. Charge the client a premium for doing this so late in the game. You’re entitled to it.

Steven J. Oshins, Esq., AEP (Distinguished) is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada.  Steve is a nationally known attorney who is listed in The Best Lawyers in America® and has been named one of the Top 100 Attorneys in Worth magazine.  He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011.  He has written some of Nevada's most important estate planning and creditor protection laws, including the law making the charging order the exclusive remedy of a judgment creditor of a Nevada LLC and LP (in 2001, 2003 and 2011), the law changing the Nevada rule against perpetuities to 365 years (in 2005) and the law making Nevada the first and only state to allow a Restricted LLC and a Restricted LP creating larger valuation discounts than any other state allows (in 2009).  He is also the author of the Annual Domestic Asset Protection Rankings which you can download from our Free Resources page.  Steve can be reached at 702-341-6000, x2 or at soshins@oshins.com.  His law firm's web site is http://www.oshins.com.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

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With the Hollywood star’s $250-million-plus fortune already locked up, high-profile lawyers stress sensitivity to residency and religion as key differentiators for celebrity clients looking for discreet resolutions.

While Katie Holmes and Tom Cruise raised plenty of eyebrows during their five-year marriage,  their divorce is practically a model for advisors who want to shield their clients’ feelings while protecting their wealth.

It only took 11 days for the lawyers to reach a settlement, saving both stars the expense, trauma and risk of career blowback of an extended or messy public custody fight.

And thanks to the smart decision to file in New York instead of Hollywood, Katie’s people managed to keep the details of how she’ll raise Suri almost entirely out of the public eye.

“Unlike California, divorce filings are not open to the public,” notes Manhattan family attorney Daniel Clement. “I suspect the main reason that Holmes filed in New York rather than California is privacy.”

Getting that privacy evidently mattered to Katie and her advisors made sure she got it.

To get a divorce in New York, she needed to establish at least two years legal residence on the East Coast, so she’s been working toward this — and documenting her visits — since at least 2010.

The minute she ran out the clock, she filed the papers, found another apartment and enrolled Suri in an elite local school.

Location is everything

Other than confidentiality and the right to petition New York courts if something goes wrong with custody of Suri, shifting venues didn’t really buy Katie much.

Despite speculation elsewhere, New York has finally joined the rest of the country as a no-fault state, lawyer Daniel Clement says, so it didn’t really matter who the aggrieved party was.

Both states also divide marital property equitably, which would leave Katie with the same split of the couple’s — mostly Tom’s — wealth either way.

But it’s not hard to imagine scenarios where a change of residency makes a huge difference for a client who may benefit from a different spousal division of the assets.

Smart premarital planning means smoother divorces

For Katie, marital property would be moot even if she didn’t have the luxury of picking an address from which to file the papers.

From all reports, Tom’s people got her to sign a prenuptial agreement that renounced her right to seek half of the roughly $250 million he amassed as the world’s top-paid movie star.

Simply having that deal in place puts them miles ahead of plenty of messy celebrity splits right there.

Furthermore, while the gossip columnists have speculated about the agreement awarding Katie $40 million to $50 million, her people insist that she walked away without taking a dime from Tom.

Why so magnanimous? Granted, Katie was a TV star in the ‘90s and has appeared in some movies, but at a measly-for-Hollywood $30,000 an episode, she’s not exactly a billionaire in her own right.

Unless she made some extremely good investments, estimates of her personal net worth being around $25 million are probably inflated as a matter of pure career earnings.

However, the $15 million Tom’s lawyers reportedly put in a trust for her and Suri before the wedding probably have something to do with it.

Remember, a substantial transfer of assets from the rich partner traditionally makes the contract go down a lot easier — and Katie’s father just happens to be a divorce lawyer, so he knows the drill.

Handing his fiancee $15 million five years ago likely saved Tom $120 million or more, not to mention the airing of whatever secrets he might have in court.

That works out for both parties, says Daniel Clement.

Otherwise, “as part of the divorce and the custody fight, Holmes and Cruise would have to expose not only details about their finances, but intimate details of their lives,” he says.

On the other hand, Tom has reportedly agreed to pay $10 million in annual child support for the next 12 years — a lot more than the normal New York cap of $23,000 a year — so it all comes out in the end.

She’s set up for the rest of her life even if she never works again. And she has no motive to complain.

Religion and other intangibles

With the money questions sewn up in advance, the lawyers got to spend those 11 days ironing out how Suri will be raised and how the stars would characterize the break-up to their fans.

“It’s clear that the spiritual upbringing of the couple’s only child Suri played a central role in the pair’s split,” says New Jersey divorce lawyer Bari Weinberger.

Katie has gone back to Catholicism and has signed Suri up for a church school. That’s controversial for Tom’s friends in the Church of Scientology, to say the least, but the religious terms of the settlement are under wraps.

Weinberger sees a lot of these “intangibles” play a huge role in divorce proceedings, so she’s sure to raise emotional and spiritual concerns with clients.

After all, couples may fight over money but it rarely makes them break up.

She’s even worked with clients to get them back together with their spouses when the emotional problems weren’t really as insurmountable as they thought.

That probably wouldn’t have worked for Tom and Katie, but your clients might have better luck.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

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We are pleased to inform you that we have added 2 more books to our Books & DVD's page.  The list of books on our website are intended to help you and your estate planning practice.  Some books are sold directly through The Ultimate Estate Planner, Inc. and others are available to purchase through other book vendors, such as Amazon or Barnes & Noble. 

Estate Planning for the Blended Family Authors: L. Paul Hood, Jr. & Emily Bouchard
The Ladder of Success: An Asset Protection Primer Authors: Jeffrey R. Matsen, Jeri Larsen, Nicole Mangrum & Tanya Flores

If you have a book or DVD you would like to sell through The Ultimate Estate Planner, Inc., please contact us at 1-866-754-6477. 

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

By Robert L. Moshman, Esq. | The Estate Analyst

Since 1997, 13 states have enacted laws permitting self-settled trusts. Including Colorado, which has had a highly questionable statute on its books since long before the other states, there are a total of 14 states with some form of domestic asset protection trust (DAPT) laws. Each of these DAPT jurisdictions has taken its own approach, and there are critical variations.

To some extent, the 14 states have jockeyed for competitive edge to position themselves as attractive havens for trust funds. Here, we have consulted Nevada attorney Steve Oshins, an authority on the subject, to consider the best DAPT jurisdictions, as well as a new “Hybrid DAPT” approach that enhances the asset protection.

Our Litigious Society

By one poll, three in ten businesses have been sued or threatened with a lawsuit in the last five years. A lawyer can expect to be sued at least once during a career—more depending on the type of practice. Nursing homes experience a steady stream of lawsuits, the majority of which are settled; nursing home clients going forward have to pick up the expense in higher fees.

Anyone with assets can expect to be sued. For physicians, the combination of injured people, risky surgeries, and wealthy physicians results in staggering statistics. Three quarters of physicians in low-risk specialties face malpractice claims, and virtually all physicians in high-risk specialties face claims during their careers. A 2011 study of 40,000 doctors that was published in the New England Journal of Medicine revealed the following.

1. 7.4% of all physicians have a malpractice claim each year.
2. By age 45, 36% of physicians, generally, will have encountered their first claim. For the higher risk specialties, that number shoots up to 88%.
3. By age 65, very few physicians have not been sued. As many as 75% of physicians with low-risk specialties will have been sued by age 65; approximately 99% of physicians with high-risk specialties will have had malpractice suits by that age.

Offshore Asset Protection

A completed gift or a gift in trust can put assets out of harm’s way, so long as the transfer takes place before litigation, is irrevocable, and is undertaken without any fraudulent intent. But this approach divests the grantor of beneficial use and control of assets. However, the completed gift approach is more closely associated with estate planning techniques as opposed to pure asset protection and for many years, asset protection had focused beyond our nation’s borders. 

The offshore option has worked for some people and purposes, but there are certainly shortcomings. There are rules to research and inconveniences for each jurisdiction.  Generally, by the time people go to the trouble of moving assets into a foreign trust, they are often so deep in trouble of some kind that the transfer will be deemed fraudulent. At first blush, a debtor transferring assets to a jurisdiction like St. Vincents in the West Indies might feel reassured that creditors will be forced to prove a transfer was fraudulent by a high burden of proof (beyond a reasonable doubt) and will have a one-year statute of limitations that begins to run from the time of the transfer. 

Making matters worse, a body of law has been developing that may undermine the offshore approach. In Dexia Credit Local v. Rogan, 2009 WL 648634 (N.D. ILL. 2009), for example, an offshore trust from the Bahamas was disregarded when the court determined that a choice of law provision would violate Illinois public policy against self-settled trusts.

The Best DAPT States

In the late 1990s, a number of domestic jurisdictions, such as Alaska, Delaware, and Nevada, began developing laws that made these states domestic financial havens with beneficial tax laws and more favorable asset protection rules. Establishing statutes to permit self-settled trusts has allowed many people to establish their asset protection trusts in these domestic havens.

In a 2010 article written by reporter Ashlea Ebeling, Forbes magazine provided letter grades for the 12 domestic jurisdictions that permitted self-settled trusts at the time the article was written. Leading that list was Nevada, which was the only state to receive an A+. 

Context is critical. A trust set up in a particular state has to contend with that state’s income tax, as well as the other laws of that state. As a starting point, states that have no income tax have an advantage. Virginia, which joins the DAPT list as of July 1, 2012, has an income tax.

The statute of limitations for preexisting and future creditors is also relevant. Nevada and South Dakota have two-year limits, while states such as Alaska and Delaware have four-year standards. There is a tolling period for preexisting creditors. The shorter the period, the sooner the trust assets are protected. 

Most of the DAPT states have carved out exceptions for alimony, child support, and certain torts. Nevada stands alone in not permitting any exceptions.

The Definitive Chart

For the past three years, the definitive DAPT chart comparing jurisdictions has been developed and maintained by Nevada attorney Steve Oshins. 

The chart provides instant comparisons of the statutes of limitation and exceptions applicable to each of the DAPT states. There is also a numerical grading based on a weighting of the various categories.  To download a copy of the Oshins DAPT chart, click here. 

Mr. Oshins also answered questions about the chart, as well as a new “Hybrid” variation he has developed for the DAPT.

Interview with Steve Oshins

Q: So far there are 14 jurisdictions that have adopted some form of DAPT. Is this now a trend that will gather momentum in another 36 states, or have we arrived at a plateau?

A: It’s probably similar to what we have seen over the years with states modifying their perpetuities laws. I expect that we will see a few more of the more progressive states enact DAPT statutes, but I doubt we will see very many more states enact these laws. All of the states that I would expect to enact DAPT laws have already done so.

Q: Some people will always consider domestic trust havens as inferior to offshore trusts. Which option do you think is more protective?

A: At this point, it is still unclear whether a DAPT is more protective than an offshore asset protection trust. Both of these options are a nine out of ten, in my opinion in terms of protection. The offshore option has in nearly every circumstance scared the creditors away, while the DAPT, albeit probably in many less circumstances, has scared the creditors away every time. However, the only type of trust that is nearly a 10 out of 10 in degree of protection is a trust in which the grantor is not a discretionary beneficiary. This is the reason that I came up with the Hybrid DAPT idea.

Q: Among the domestic states, there are upper “A” level states, such as Alaska, Delaware, Nevada, and South Dakota, and second-tier “B” states, such as New Hampshire, Rhode Island, and Tennessee. Is there a big difference?

A: The first-tier states – Alaska, Delaware, Nevada, and South Dakota – get nearly all of the out-of-state business. The second-tier states have excellent DAPT laws, but they fall a little short and thus tend to be good for residents of those states, but there’s just too much competition at the top. Delaware is a wildcard state. Its laws aren’t as protective as the laws of the other so-called first-tier states and are very similar to those of New Hampshire, Rhode Island, and Tennessee. But Delaware tends to get grouped with the first tier because it is so heavily marketed and thus gets a very high percentage of the DAPT business.

Q: You’ve developed a twist on the regular DAPT that you call a Hybrid DAPT, in which the grantor is not initially a discretionary beneficiary but can be added as one later by an independent trustee or trust protector. In what context do you see this as being the most beneficial?

A: This is something that I came up with years ago and have been using for quite some time. I finally gave it the name “Hybrid DAPT” recently and wrote an article on the technique and got an amazing response.

It’s a very simple concept. Basically, the concept is that there is no good reason to include the grantor as a discretionary beneficiary, especially if the grantor won’t need any distributions from the trust anytime soon. This is especially true if the grantor’s spouse is a beneficiary and thus can receive distributions that can be “shared” with the grantor. Therefore, the initial trust document is nothing more than a third-party trust where the grantor is not a beneficiary and thus has a higher probability of protection and should be much more intimidating to a prospective creditor of the grantor.

Only if the grantor actually needs a distribution would the independent trustee or trust protector add the grantor in as a discretionary beneficiary under a provision we build into the trust agreement allowing this. With most DAPTs, because the grantor generally leaves sufficient cash flow out of the DAPT, it would take both a cash flow problem and the grantor to have no spouse to whom a distribution could be given for the grantor to need to be added into the trust as a beneficiary.

Thus, this is a Hybrid DAPT because it starts as a third-party trust and then can be converted into a DAPT at a later date. So the bottom line is that, in my opinion, most DAPTs should be set up as Hybrid DAPTs.

Q: Does the clawback statute in the 2005 Bankruptcy Act have any effect on the Hybrid DAPT?

A: It is extremely unlikely that a DAPT grantor will file for bankruptcy, especially if the grantor has an “old and cold” DAPT that is past the applicable state’s statute of limitations period. In fact, of the hundreds of DAPTs I have created, not one of those clients has gone through bankruptcy.  That being said, it is interesting to note that the Hybrid DAPT most likely does not fit the definition required by §548(e) of the 2005 Bankruptcy Act that would otherwise potentially claw back the assets of a traditional DAPT. One of the requirements of §548(e) is that the debtor must be a beneficiary of the trust. Unless the grantor is added as a discretionary beneficiary of the Hybrid DAPT, this requirement doesn’t exist.

Q: Your DAPT State Rankings Chart has become a great resource that I frequently consult. How has your chart been received by the asset protection community?

A: It has been extremely well-received. I initially put it together three years ago because I found that there was no one-page comparison of the DAPT jurisdictions in our industry. I decided that our industry needed a chart that shows the material differences among the DAPT jurisdictions in an easy-to-read format. I am glad that you use it as a resource. In this year’s version of the chart, for the first time ever, I decided to not only rank the states, but also to assign numerical scores to each state. The numerical scores help show the degree of differences among the states and help break them into tiers.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  If you are interested in a personal consultation for your office regarding how to make your office more efficient and how to improve the productivity of your attorneys, staff and advisors, contact us today at 1-866-754-6477 to find out how you can receive a free 30 minutes consultation.  Connect with us on Facebook, Twitter or LinkedIn.

Reposted with permission from The Estate Analyst Robert L. Moshman, Esq. & Steven J. Oshins, Esq.

Reposted from TheTrustAdvisor.com

Many states have recently enacted or introduced decanting legislation and several states have recently enacted or introduced directed trust legislation.  As part of continuing efforts for states to stay competitive, domestic asset protection may be the next trend.

Virginia recently enacted asset protection legislation, which will become effective July 1, 2012. Now Ohio becomes the latest state in which asset protection legislation has been introduced.  One of the reasons for the introduction of detailed legislation in Ohio on May 23, 2012 is reportedly to enhance the attractiveness of Ohio as a jurisdiction in which to remain, rather than having residents move to other states to protect their wealth.

Included in the Ohio proposal is the Ohio Legacy Trust Act, which contains detailed asset protection provisions.

Ohio Legacy Trust Act – Domestic Asset Protection Proposal

The proposal allows for the creation of a “legacy trust” by which a ”transferor” is given the ability to make a “qualified disposition” of assets and remain a beneficiary through actions of a “qualified trustee.” The transferor must sign a notarized “qualified affidavit” before or contemporaneously with the qualified disposition and provide that the transferor will not be rendered insolvent, does not intend to defraud creditors, has no pending/threatened court actions and does not contemplate bankruptcy.

Creditors would generally be prohibited from bringing any action against any person who made or received a qualified disposition, against any property held in a legacy trust or against any trustee of a legacy trust.  A creditor can bring an action to avoid a qualified disposition on the grounds that the disposition was made with specific intent to defraud the specific creditor bringing the action.

If the creditor was a creditor before the qualified disposition, the action must be brought by the later of (1) 18 months after the qualified disposition or (2) 6 months after the qualified disposition is or could reasonably have been discovered if the creditor files a suit or makes a written demand for payment within 3 years after the qualified disposition. If the creditor became a creditor after the qualified disposition, the action must be brought within 18 months.  The burden is on the creditor to prove the matter by a preponderance of evidence.  The court must award attorney’s fees and costs to the prevailing party. Protection is provided for trustees and attorneys involved in the creation and administration of a legacy trust.

Any person can serve as an advisor of a legacy trust, except that a transferor can act as an advisor only in connection with investment decisions.  Advisors are considered fiduciaries.

The transferor may retain the right to veto distributions from the trust, remove and appoint advisors or trustees, hold a special testamentary power of appointment and be a discretionary income or principal beneficiary.

The trust must (1) have at least one trustee who resides in Ohio or is an entity authorized to act as trustee in Ohio who materially participates in the administration of the trust, (2) expressly incorporate Ohio law to wholly or partially govern its construction and administration, (3) expressly state it is irrevocable and (4) include a spendthrift provision. The new law would apply to all qualified dispositions made on or after the legislation’s effective date.

In addition to the Legacy Trust Act, other significant changes to Ohio law are proposed, including the following:

Increase in Homestead Exemption

The interest in a residence that is exempt from creditors would increase from $20,200 to $500,000.

529 Plan Exemption

The current exemption for certain payments or rights to assets in accounts, such as IRAs, would be expanded to 529 Plans.

Reimbursement of Income Taxes to Grantors of Intentionally Defective Grantor Trusts

Whether or not the trust contains a spendthrift provision, a trustee’s discretionary authority to pay directly or reimburse the settlor amounts for income taxes payable on trust income will not subject those amounts to the claims of the settlor’s creditors.

As you may recall from previous emails, a similar provision was recently enacted in Virginia (effective as of July 1) and another (modeled on current New York law) is pending in New Jersey, but has not yet passed either house.

Payment of Beneficiary’s Expenses Permitted

Regardless of whether a beneficiary is subject to creditors’ claims, a trustee can pay any expense of a beneficiary permitted by a trust instrument. Even if the payments exhaust the trust funds, the trustee will
not be liable to a beneficiary’s creditors.

Administrative Fiduciaries Have No Other Responsibilities

If a fiduciary is appointed to handle only administrative duties, the fiduciary will have no duties other than administrative duties specifically described and will have no obligation to perform investment reviews or make investment recommendations if there is an investment director.

This post has been brought to you by The Ultimate Estate Planner, Inc., providing practical, tested and proven technical and marketing products to help estate planning professionals throughout the country build their practices.  Connect with us on Facebook, Twitter or LinkedIn.

Source: Sharon L. Klein, Lazard Wealth Management & TheTrustAdvisor.com

Reposted from TrustandEstates.com | By Conrad Teitell, A.B., LL.B., LL.M

 

Many people still believe that Jacqueline Kennedy Onassis created a charitable lead annuity trust in her will. Why? The New York Times and other newspapers obtained a copy of her will from the New York Surrogates Court and reported the terms that spelled out her lead trust. So, how could it be that the CLAT wasn’t created?

 

First, I’ll tell you about the CLAT as it appeared in her will. (You’ll see how beneficial CLATs can be.) Then, I’ll report on recent CLAT Treasury regulations and a recent letter ruling. At the end of this article, I’ll tell you how it came to pass that Mrs. Onassis’s CLAT was never created.

 

MRS. ONASSIS’S NOT-CREATED CLAT

 

Payments to charity. The C & J Foundation would have paid to charities for 24 years "an annuity amount" equal to "eight percent (8%) of the initial net fair market value of the assets of the Foundation as finally determined for federal estate tax purposes."

 

Selecting the charities. The payments would have been to qualified charitable organizations (described in Sections 170(c) and 2055(a) of the Code), selected by her trustees in their absolute discretion:

 

"It is my wish, however, that in selecting the particular qualified charitable beneficiaries which shall be the recipients of benefits from the Foundation the independent Trustees give preferential consideration to such eligible organization or organizations the purposes and endeavors of which the independent Trustees feel are committed to making a significant difference in the cultural or social betterment of mankind or the relief of human suffering."

 

Remainder to family members. At the end of the Foundation's 24-year term, the assets would have been distributed to family members. A number of contingencies were covered, but, basically, the assets would have gone to the descendants of her children.

 

What's in a name? Mrs. Onassis's will called the just-described arrangement a Foundation, but it was really a CLAT. Call it what her will wills, it still smelled sweet for the charities that would have benefitted handsomely for 24 years. And, the estate tax and generation-skipping transfer (GST) tax savings would have been fragrant too.

 

The trustees. Mrs. Onassis's daughter, Caroline B. Kennedy, her son, John F. Kennedy, Jr., Alexander D. Forger and Maurice Tempelsman would have been the trustees.

 

The Foundation administrator. The will provided:

 

"To assist the independent Trustees I authorize, but do not direct, that they retain my close friend and confidante Nancy L. Tuckerman to assist them in the administration of the Foundation. Should the independent Trustees deem it advisable to retain Nancy L. Tuckerman, they shall pay to her from the assets of the Foundation reasonable compensation for the services she shall render. But such compensation shall not be charged against the annuity amount in any full taxable year of the Foundation nor against the appropriate fraction of said amount, determined as herein provided, payable to the qualified charitable beneficiaries in any short taxable year of the Foundation but shall rather be paid from the assets of the Foundation at large."

 

The would-have been estate tax charitable deduction. I don't know the value of Mrs. Onassis's residuary estate that would have funded the CLAT. Based on press reports, let's assume a $100 million residuary estate (a nice round number).

 

Mrs. Onassis died in May of 1994. When computing the estate tax charitable deduction for the value of the charitable lead interest, her estate could have used 120 percent of the Treasury's mid-term federal rate for split-interest gifts for the month of her death or the rate for either of the two preceding months. Using the March Internal Revenue Code Section 7520 rate (the lowest rate and thus the largest estate tax charitable deduction for charitable lead trusts) the estate tax charitable deduction for a $100 million charitable lead trust paying charities $8 million a year for 24 years would have been approximately $96.8 million. So, only $3.2 million of the $100 million trust would have been subject to estate tax. Again, the value of the residuary estate is assumed. Whatever the value, however, the estate tax charitable deduction would have equaled approximately 96.8 percent of the amount funding the charitable lead trust.

 

Which generation has a rendezvous with Treasury? Looking down the road, the GST tax would have been payable at the end of the 24-year term. The amount would have depended on the value of the trust at that time and the then-effective interest assumptions.

 

Assuming: (1) the trust would have been funded with $100 million; (2) it would have used the lowest allowable monthly discount rate — the IRC Section 7520 rate for March 1994 — 6.4 percent; (3) it would have earned 8 percent each year and appreciated 2 percent annually; and (4) it would have made annual end-of-year payments to charity, the value of the assets after 24 years would have been approximately $213.76 million. The GST tax at that time (assuming that the GST is still in existence) would have been approximately $115.13 million, leaving roughly $98.63 million for the family. (Note, with historically low IRC Section 7520 rates, CLATs are now better than ever.)

 

In my sister's house are many lead trusts. Each of Lee B. Radziwill's children would have been remainderpersons of separate 10 percent lead annuity trusts—each to be funded with $500,000. Each trust would have paid $50,000 annually for ten years to charities selected by the trustees.

 

Why was the CLAT called the C & J Foundation? When Abe Lincoln was asked how many legs a sheep would have if its tail were counted as a leg, he responded: "Four. No matter what you call a tail, it's still a tail." But, it's OK to have a lead trust in foundation clothing—especially where the trustees have discretion to select the charities. Actually, you could say that Mrs. Onassis would have created a term-of-years foundation.

 

What is a foundation anyway? A large body of money surrounded by those who want some.

 

“ORDERING” RULES FOR CHARITABLE LEAD TRUST PAYMENTS DISREGARDED . . . FINAL REGULATIONS

 

Bottom line on the top. Treasury regulations (effective April 4, 2012) adopt, with one insignificant change, the June 2008 proposed regulations. A CLT provision (or local law) that specifies the source of income from which amounts are to be paid to the charity has no economic effect independent of income tax consequences and will be disregarded. T.D. 9582, 2012-18 IRB 868 (April 30, 2012).

 

Thus, payments to a charity will consist of the same proportion of each class of the items of income of the trust as the total of each class bears to the total of all classes. The regulations apply to charitable lead trusts and other trusts making payments or permanently setting aside amounts for a charitable purpose.

 

Why is Treasury concerned about an ordering (rather than a pro rata) payment provision? My opinion: The Treasury and the IRS want to maximize taxes. Income ordering provisions in lead trusts are designed to minimize them and to maximize the charity’s benefits. Charitable lead trusts (as differentiated from charitable remainder trusts) aren’t tax exempt and are subject to the complex trust rules (unless drafted as a grantor trust).

 

Charitable deductions for lead trusts. A lead trust itself is allowed a charitable deduction for gross income (the annuity or unitrust amount) paid to the charity. Income above the required payment is taxable to the trust. However, a charitable deduction isn’t available to a lead trust for tax-exempt income because it isn’t includable in the trust’s gross income. And, a lead trust’s IRC Section 642(c) charitable deduction is disallowed for unrelated business taxable income (UBTI) paid to charity. Thus, a CLT has to pay tax on the UBTI. But the trust can qualify for a charitable deduction under IRC Section 512(b)(1) if the UBTI is paid to a public charity during the taxable year. Reg Section 1.642(c)-3(d). However, the deduction is limited to the 50 percent ceiling for individuals. Who says this stuff is complicated?

 

As noted, ordering provisions are designed to minimize taxes to the lead trust and to maximize the charity’s benefits. They do so by providing that income that won’t qualify for a charitable deduction be paid out last.

 

Here’s a seven-tier ordering provision—given as an example in the final regulations—on which Treasury has put the kibosh.

 

Example 1. A CLAT has the calendar year as its taxable year and is to pay an annuity of $10,000 annually to an organization described in Section 1170(c). A provision in the trust governing instrument provides that the $10,000 annuity should be deemed to come first from ordinary income, second from short-term capital gain, third from 50 percent of the unrelated business taxable income, fourth from long-term capital gain, fifth from the balance of unrelated business taxable income, sixth from tax-exempt income and seventh from principal. This provision in the governing instrument does not have economic effect independent of income tax consequences, because the amount to be paid to the charity is not dependent upon the type of income from which it is to be paid. Accordingly, the amount to which Section 642(c) applies is deemed to consist of the same proportion of each class of the items of income of the trust as the total of each class bears to the total of all classes.

 

The Final Regulations’s Preamble Summarizes the Public Comments on the Proposed Regulations and the Treasury’s Response.

 

Commentators said: Treasury’s proposed regulations are contrary to the clear language of IRC Sections 642(c) and 643(a)(5) and the existing regulations.

 

Treasury’s response. The IRS and Treasury have carefully considered these arguments and the analyses suggested by the commentators. We continue to believe that the position clarified in the proposed regulations, requiring that a specific provision of the governing instrument or a provision under local law have economic effect independent of income tax consequences in order to be respected for Federal tax purposes, is the proper interpretation of the relevant Code provisions and is a principle that applies throughout Subchapter J.

 

One commentator said: Income ordering provisions in CLTs have economic effect independent of income tax consequences, because disregarding an income ordering provision could increase a CLT's tax liability, thereby reducing the value of the trust and, in turn, reducing the annual lead unitrust payments to the charitable beneficiaries and increasing the risk that the trust's assets in lead unitrusts and annuity trusts will be depleted before the end of the trust term.

 

Treasury’s response. Although the general pro rata allocation rule may increase a trust's tax liability and, thereby, reduce the value of the trust's corpus, the effect of the payment of the trust's income tax liability is not an economic effect independent of income tax consequences as described in these regulations. Any possible reduction in the unitrust amount subsequently paid to the charitable beneficiary would be the direct result of the payment of income taxes by the unitrust. The use of an income ordering rule in a CLT directing the tax characteristics of the unitrust or annuity payments to the charity is primarily, if not exclusively, an attempt to minimize the tax liabilities of the trust and its remainder beneficiaries. The only effects of the use of an ordering rule are, in fact, dependent solely upon tax consequences: specifically, the reduced amount of tax paid and the trust's retention of the income tax savings.

 

Ordering provisions in CLTs will never have economic effect independent of their tax consequences, because the amount paid to the charity is not dependent upon the type of income it's allocated. An annuity payment is a fixed amount from year to year, and although a unitrust amount may fluctuate annually, the amount is based upon a predetermined percentage of the trust's value.

 

Permitting an ordering rule with no economic effect independent of income tax consequences to supersede the pro rata allocation rule generally applicable under Subchapter J would, in effect, permit taxpayers to deviate at will from the general rule imposed throughout Subchapter J in the case of all kinds of complex trusts.

 

One commentator said. The proposed regulations are contrary to the Federal government's long-standing policy to encourage charitable gifts and to benefit and protect charities.

 

Treasury’s response. The IRS and Treasury have carefully considered the merits and implications of this suggestion. We believe, however, that the proper interpretation of the relevant Code sections does not permit the creation of a special rule for CLTs. A CLT is treated and taxed in the same way as any other complex trust under Subchapter J. Subchapter J does not differentiate between CLTs and other types of complex trust, and there is no provision of Subchapter J that applies exclusively and expressly to CLTs. Thus, any income tax rule applicable to a CLT will apply in the same way to every other complex trust.

 

The Treasury obliges. One commentator requested an example of a provision in a governing instrument that would have economic effect independent of income tax consequences. Thus, the final regulation gives an additional example. Reg. Section 1.642(c)-3(b)(2).

 

Example 2. A trust instrument provides that 100 percent of the trust's ordinary income must be distributed currently to an organization described in Section 170(c) and that all remaining items of income must be distributed currently to B, a noncharitable beneficiary. This income ordering provision has economic effect independent of income tax consequences because the amount to be paid to the charitable organization each year is dependent upon the amount of ordinary income the trust earns within that taxable year. Accordingly, for purposes of Section 642(c), the full amount distributed to charity is deemed to consist of ordinary income.

 

I submitted comments to the Treasury in 2008 on the proposed regulations on behalf of the American Council on Gift Annuities and the National Committee on Planned Giving (now the Partnership for Philanthropic Planning). If you would like a copy of those comments, e-mail me at: cteitell@cl-law.com.

 

Hard to believe. The Treasury didn’t change its position based on my comments.

 

If one were to do battle with the IRS in court over this issue (and I’m not suggesting doing so), perhaps my comments would be helpful in writing the brief for the taxpayer. Again, I’m not suggesting that a taxpayer go to court on this issue, but if the decision is made to do so, consideration should be given to litigating in a federal district court rather than in the U.S. Tax Court.

 

Every client is entitled to his decade in court—keeping in mind that it’s a long way to certiorari.

 

CLAT’S ASCENDING ANNUITY PAYMENTS—OK (Letter Ruling 201216045)

 

Quick background. Treasury regulations (above) specify how payments from charitable lead annuity and lead trusts are taxable. CLT income payments consist of a pro-rata share of each item of trust income. Any trust provisions (or state law) directing payments under an ordering provision will be disregarded. Treas. Regs. Sec tion 1.642(c)-3(b)(2).

 

Time now for a different CLT issue. Most charitable lead trusts are lead annuity trusts, few are lead unitrusts.

 

Now that we know how the payments are deemed taxable (pro-rata rule, not ordering rule), how is the payment itself set? Generally, it's specifically set in the trust instrument.

 

Example. Charitable lead annuity trust is funded with $1 million and the annual payment is set at $30,000 for the ten-year term. Then the trust assets go to the family members.

 

Example. Charitable lead unitrust is funded with $1 million and the annual payment is to be 3 percent multiplied by the net fair market value of the trust’s assets, as revalued each year, for the ten-year term. Then the trust assets go to family members.

 

Unlike charitable remainder trusts, lead trusts have no 5 percent minimum and no 50 percent maximum payment requirements. And there is no 10 percent minimum remainder interest requirement. In fact, CLTs are often drafted with as small a remainder as possible in order to avoid making gifts to the family remainder takers. This is especially so when the IRC Section 7520 rate is low—the current case.

 

The mechanism to try to achieve as small a remainder interest as possible is using a formula for setting the annual payout. Read on, and you’ll learn about that in the following letter ruling.

 

Facts. A CLAT created at the donor’s death is to make payments to a private foundation (or its successor in interest) for 10 years. Then the trust corpus will be distributed per stirpes to trusts for the benefit of the donor’s descendants. If there are no remaining descendants, the trust corpus will be distributed to the Foundation or a similar qualified organization.

 

The trust states that it is the donor’s intent that the CLAT “qualify as a charitable lead [trust] so that the value of the interest passing to charity is deductible as a charitable lead interest under Sections 2055 (e)(2)(B) and 2522(e)(2)(B) of the Code, and so that the payments of the amount to charity will be deductible from the gross income of the trust to the extent provided by Section 642(c).”

 

The trust uses this formula to determine the annual annuity amount:

 

Accounting from the beginning date, the annual annuity amount shall be an amount that will produce a present value under §7520 of the Code for the non-charitable remainder interest equal to zero or as close to zero as possible without exceeding zero.

 

The trustee is prohibited from exercising any power or discretion granted by state law that would be inconsistent with the CLAT’s qualification as a charitable lead trust under IRC Section 2055(e)(2).

 

The donor’s United States Estate (and Generation-Skipping Transfer) Tax Return, Form 706, was timely filed. On Schedule O of Form 706, the estate claimed a charitable deduction under IRC Section 2055(a) for the present value of the property passing to the CLAT. The estate received a closing letter from the IRS accepting the estate tax return as filed.

 

The CLAT trustees, with the consent of the Foundation and the remainder beneficiaries, and with notice to the state attorney general’s office, filed a complaint with the state probate court requesting that the court construe the formula for determining the annuity amount to permit variable ascending annuity payments, commencing on the donor’s date of death and continuing for the 10-year annuity term, with the annuity payments made to ascend each year by 120 percent of the prior year’s payment over the annuity term, rather than a straight-line annuity payment over the 10-year term.

 

The complaint explained that construing the formula as a straight-line annuity would make it unlikely that the trustees could make the annuity payments over the entire term. Therefore, the trustees would be unable to satisfy the donor’s intentions regarding the gift of the lead annuity interest to the charitable beneficiary. According to the letter ruling, the court was given schedules showing a comparison to the straight-line method that demonstrated that a variable ascending annuity payment method would result in a higher total payout to the Foundation.

 

The state probate court found the material allegations to be true and the relief requested to be in the best interests of the beneficiaries. Further, the variable ascending method conforms to the terms of the trust and meets the donor’s intent and tax objective. The court issued an order construing that both straight line and variable ascending annuity payment formulas are actuarial equivalents (based on the IRC Section 7520 rate applicable at the donor’s death) and either form of payment is permitted under the CLAT agreement.

 

The probate court ruled that its order is subject to the condition that the trustees request and receive a favorable private letter ruling from the IRS.

 

Key to all the favorable IRS rulings that follow: “We [the IRS] conclude that the construction of Trust’s formula for determining the Annuity Amount to permit variable ascending annuity payments resolves a genuine ambiguity in Trust and therefore the court order issued [Date] will be treated as the settlement of a bona fide contest. Payments of gross income made under that construction will be considered pursuant to the terms of the governing instrument within the meaning of [IRC] §642(c)(1).”

 

The IRS rules (Letter Ruling 201216045):

1. The CLAT’s terms, as construed by the state court’s order to permit variable ascending annuity payments, commencing on the decedent’s death and continuing for the 10-year annuity term, will satisfy the requirements of IRC Section 2055(e)(2) for a guaranteed annuity interest (for example, an arrangement under which a determinable amount is paid periodically, but not less often than annually, for a specified term of years) and, therefore, property of the taxable estate of the decedent passing to the charitable lead trust will qualify for a charitable deduction under IRC Section 2055(a).

 

2. The CLAT will be allowed a deduction under IRC Section 642(c) for each taxable year in an amount equal to the annuity amount paid from the charitable lead trust’s gross income during the taxable year in accordance with the CLAT’s terms, as construed by the state court’s order to permit variable ascending annuity payments, commencing on the donor’s death and continuing for the 10-year annuity term, except that no charitable deduction will be allowed for any amounts allocable to the trust’s unrelated business income for the taxable year.

 

3. The construction of the terms of the CLAT by the state court’s order, allowing ascending annuity payments over the 10-year annuity term, will not constitute a termination under IRC Section 507 of the CLAT’s private foundation status.

 

4. The construction of the terms of the CLAT by the state court’s order, allowing ascending annuity payments over the 10-year annuity term, will not be self-dealing under IRC Section 4941.

 

5. The construction of the terms of the CLAT by the state court’s order, allowing ascending annuity payments over a 10-year annuity term, will not subject the charitable lead trust to tax on the undistributed income of a private foundation under IRC Section 4942.

 

6. The construction of the terms of the CLAT by the state court’s order, allowing ascending annuity payments over a 10-year annuity term will not subject the charitable lead trust to tax on excess business holdings under IRC Section 4943.

 

7. The construction of the terms of the CLAT by the state court’s order, allowing ascending annuity payments over the 10-year annuity term, will not be an investment, which jeopardizes charitable purposes subject to tax under IRC Section 4944.

 

8. The construction of the terms of the CLAT by the state court’s order, allowing ascending annuity payments over a 10-year annuity term, will not be a taxable expenditure under IRC Section 4945.

 

9. To the extent that the construction of the terms of the CLAT by the state court’s order, allowing ascending annuity payments over the 10-year annuity term, is a transaction with respect to the CLAT’s interest or expectancy in property held by the estate, the living trust or the non-exempt marital trust such transaction will not be self-dealing under IRC Section 4941.

 

FINALLY, WATSON HERE’S THE SOLUTION TO THE CASE OF JACKIE O’S LEAD TRUST THAT NEVER WAS

 

Mrs. Onassis’s inter vivos revocable living trust gave almost her entire estate outright to her two children, Caroline and John. It provided that to the extent that her children disclaimed their inheritance, the disclaimed amounts would pour over to the C & J [CLAT] Foundation created by her will. Well, the kids didn’t disclaim.

 

This was savvy estate planning. She wanted her children to make the final decision whether a CLAT should be created.

 

Inter vivos trusts generally provide privacy—not available with wills. In this case, however, a New York Times investigative reporter working on a follow-up article on Mrs. Onassis’s CLAT, checked with the New York State Attorney General’s Charity Bureau. He learned that the C & J Foundation was not funded. This was reported in a Saturday edition of The New York Times and in hardly any other publications.

 

And that dear readers, is the news from Lake Taxbegone.

 

© Conrad Teitell 2012. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.  For information about Conrad Teitell’s publications and lectures visit: taxwisegiving.com. For information about Cummings & Lockwood visit: cl-law.com.

 

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