Current Trends in Estate Planning: "Freezing" a Client's $5.12 Million Gift/Estate Tax Exemption Presenter: Gal N. Kaufman, Esq. Offit Kurman, PA 4800 Montgomery Lane 9 th Floor Bethesda, MD 20814 gkaufman@offitkurman.com 240.507.1709 www.offitkurman.com September 26, 2012
Current Law Current Federal Gift/Estate Tax Exemption Amount is $5.12 Million 2
New Law As of January 1, 2013, the Federal Gift/Estate Tax Exemption Amount will be $1 million 3
The Question… How to “Freeze” a Client’s Exemption at $5.12 million? 4
How to Freeze Client’s Exemption at $5.12 Million? Solution #1: Client gifts assets up to $5.12 million to descendants (or trust for their benefit) Issue: The client does not get to enjoy the gifted assets 5
How to Freeze Client’s Exemption at $5.12 Million? Solution #2: Create and fund trust for benefit of spouse Issue: Spouse has access to trust but client does not 6
How to Freeze Client’s Exemption at $5.12 Million? Solution #3: Self-Settled Trust The following States have a Self-Settled Trust Statute: • Delaware • Missouri • Alaska • New Hampshire • Nevada • Oklahoma • Rhode Island • Tennessee • Utah • Wyoming • South Dakota • Colorado • Hawaii 7
How to Freeze Client’s Exemption at $5.12 Million? Self-Settled Trust What is a Self-Settled Trust? A trust, typically irrevocable, which permits distributions, in the discretion of the Trustee, to the Settlor of the Trust 8
How to Freeze Client’s Exemption at $5.12 Million? • PLR 200944002: – taxpayer created irrevocable trust (believed to be in Delaware) – trust designated corporate (Del.) trustee – trust permitted (but did not require) distributions to taxpayer, spouse and descendants, per trustee’s discretion – trust contained spendthrift provision – no part of the trust could be used to pay or satisfy taxpayer’s legal obligations – Trust did not give taxpayer a limited (or general) power of appointment over the trust assets – IRS ruled that the gift taxpayer made was a completed gift AND that the value of the trust assets at taxpayer’s death would not be includible in his taxable estate for estate tax purposes • IRS analyzed IRC Section 2036(a)(1), which provides, generally, that a taxpayer’s estate includes assets that he has transferred during his lifetime but over which he has retained certain “strings”, such as the right to receive the income from the transferred assets. • Regulations Sec. 20.2036-1(b)(2) provides that IRC Section 2036(a)(1) is triggered if taxpayer transfers assets to a trust but the assets of the trust can be used to satisfy the taxpayer’s legal obligations. 9
How to Freeze Client’s Exemption at $5.12 Million? • Delaware’s Qualified Dispositions in Trust Act (12 Del. C. §§ 3570–3576 ) – client must establish an irrevocable trust that contains a spendthrift clause – the trust must designate Delaware law as governing law of the trust – the trust must appoints at least one Delaware trustee (i.e ., an individual who lives in Delaware (except the client) or a Delaware trust company that performs certain duties; the trust may have non-Delaware co-trustees and Delaware or non- Delaware advisers. 10
How to Freeze Client’s Exemption at $5.12 Million? • The Delaware Act specifically permits a client to have the power to: – consent to or direct investment changes – veto distributions; and/or – replace trustees or advisers. • The Delaware Act also expressly authorizes a client to have one or more of the following: – ability to receive income or principal pursuant to broad discretion or a standard; – right to receive current income distributions (not advisable in context of “freezing” client’s exemption); – an interest in a CRT or a QPRT; 11
How to Freeze Client’s Exemption at $5.12 Million? • (con’t.) – up to a 5% interest in a total-return unitrust or a GRAT; – power, which the client may exercise by Will or another document, to appoint the principal in the trust at death to or for anyone except the client, the client’s estate, the client’s creditors, or the creditors of the client’s estate (not advisable in the context of “freezing” client’s exemption); – ability to be reimbursed for income taxes attributable to the trust on a mandatory or discretionary basis; or – power to provide for the payment of taxes, debts, and expenses payable at the client’s death. 12
How to Freeze Client’s Exemption at $5.12 Million? • Delaware Trust should not: – appoint the client trustee or co-trustee; – provide that the client will get trust assets back at a certain age or after a certain amount of time; – contain any express or implied understanding that the trustee must or is required to make distributions to the client; – contain a limited (or general) power of appointment in the client over the trust assets (as may be the case with a Delaware Trust designed solely for asset protection purposes); – authorize the trustee, adviser, protector, or committee to terminate the trust; or – authorize the trustee to reimburse the client for gift taxes. 13
How to Freeze Client’s Exemption at $5.12 Million?… “Non-Reciprocal” Trusts Husband creates a trust for the benefit of Wife and Wife creates a trust for the benefit of Husband 14
How to Freeze Client’s Exemption at $5.12 Million? “Non- Reciprocal Trusts” US v Grace Est., 395 US 316 (1969) • Are the trusts “inter-related?” • Does the “arrangement, to the extent of mutual value, leave[ ] the settlors in approximately the same economic position as they would have been had they created trusts naming themselves as life beneficiaries.” 15
How to Freeze Client’s Exemption at $5.12 Million? “ Non-Reciprocal” Trusts Factors to consider in creating Non-Reciprocal Trusts: • Timing of creation (and funding trusts) • Beneficiaries • Trustee selection • Asset selection • Power(s) of appointment • Richer spouse/poorer spouse 16
How to Freeze Client’s Exemption at $5.12 Million? “Non-Reciprocal” Trusts State estate tax benefits: many local jurisdictions (MD, DC, DE, NY) impose state estate tax, but not a gift tax 17
How to Freeze Client’s Exemption at $5.12 Million? “Non-Reciprocal” Trusts Example: Husband & Wife have estate of $10 million and live in Maryland No Non-Reciprocal Trust Planning in 2012: If death of both occurs in 2013 ($1 million federal gift/estate tax exemption), combined (Federal and Maryland) estate tax would be approximately $4 million 18
How to Freeze Client’s Exemption at $5.12 Million? “Non-Reciprocal” Trusts Example: Husband & Wife have estate of $10 million and live in Maryland Yes Non-Reciprocal Trust Planning in 2012: If deaths of both wife and husband occur in 2013 ($1 million Federal gift/estate tax exemption) combined (Federal and Maryland) estate tax would be Ø Even if Federal exemption remains at $5.12 million per person, Maryland estate tax saved would be approximately $1 million 19
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