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Estate Planning Questions and Answers
Excerpts from questions sent to questions@rushforth.org. |
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Estate Planning Questions and Answers
Excerpts from questions sent to questions@rushforth.org. |
Answer: These are trusts and entities that you should avoid, assuming that you want to stay out of trouble with the federal government. A "pure trust" (also called a "constitutional trust") is a gimmick that has been out there for longer than I have been practicing law (21 years). The "business trust" can be a valid business entity similar to a corporation or a limited-liability company, but it is being marketed in the same way as the "pure trust", and it does not work any better. There are a number of variations on these trusts and business organizations with an almost infinite number of names used in marketing. They are almost always marketed with lengthy research memos that include quoted passages from the constitution, the Internal Revenue Code, regulations, rulings, and court cases. Some of the promised benefits include various combinations of the following:
Although I am in favor of replacing all federal taxes with a national sales tax (see the FairTax proposal by the Americans for Fair Taxation), I do not condone illegal tax evasion. I repeat the following warning (which I assume came from the IRS, but I cannot track down the source):
"Taxpayers should be suspicious of arrangements that claim to make personal living expenses deductible, to create charitable contribution deductions for payments benefiting the transferor or family members, or that otherwise result in a taxpayer having to pay no tax with no change in control over his or her income or assets. Promoters of such arrangements advertise their "investment seminars" or "tax seminars" in the local media as well as through the Internet. Taxpayers may also receive unsolicited mail or telephone invitations to participate.
"Often the trusts have names that refer to constitutional issues, fairness, equity, or patriotic themes, among others. In other cases, however, the trusts have names that are similar to common business organizations or nonabusive trusts. Taxpayers should be particularly wary if the promotional materials suggest that the taxpayer not check the arrangement with a tax advisor, such as an attorney or accountant, or with the IRS."
The IRS has classified this type of trust as an "abusive trust arrangement" and has consistently imposed taxes, interest, and penalties on those who use this type of trust to avoid reporting and/or paying taxes. There are a number of variations on these trusts, but some of the IRS's rulings outline what they are and how the IRS will treat them. See, for example, Revenue Rulings 75-257, 75-258, 75-259, 75-260, 75-324, and 80-74. The courts are not sympathetic to those who are deceived by the peddlers of such trusts. See, for example, the Tax Court's ruling in Pennybaker vs. Commissioner, T.C. Memo. 1994-303, Docket 28283-91.
In 1997, the IRS published Notice 97-24 outlining its opposition to this type of technique. The IRS has published Publication 2193 entitled "Should your financial portfolio include To Good to be True Trusts? If you have the Adobe Acrobat reader software installed, you may view the full text of those IRS publications by clicking on these links (which will open a new web-browser window): Notice 97-24 and Publication 2193 (Nov. 1999 version).
BOTTOM LINE: The IRS has consistently ruled that the promised tax benefits don't work. To add insult to injury, the fees charged for these devices are usually very high, and you are gambling with civil and criminal penalties if you get caught.
Answer: An "ABC" trust is a trust for a married couple that divides into three subtrusts (Trust A, Trust B, and Trust C) upon the death of the first spouse. Trust A is often called the "Survivor's Trust", Trust B is sometimes called the "Credit-Shelter Trust" or "Exemption Trust", and Trust C is usually the "Marital Trust". This type of trust is discussed (with an illustrating flow-chart) on the Advanced Estate Planning introductory page, in the section entitled "The A/B Trust and the A/B/C Trust".
Answer: A QTIP trust is a "qualified terminable interest property" trust that is designed to qualify for the marital deduction for federal estate tax purposes. It is one form of the "marital trust", which is "Trust C" of an "ABC Trust", which is discussed (with an illustrating flow-chart) on the Advanced Estate Planning introductory page, in the section entitled "The A/B Trust and the A/B/C Trust".
The QTIP Trust is explained briefly in a memo found at ftp://rushforth.org/pub/memos/ab.pdf. You will need to have the Adobe Acrobat reader software installed on your computer, which can be downloaded for free from Adobe's web pages at http://www.adobe.com/prodindex/acrobat/readstep.html.
Answer: Yes, and many people who have no grandchildren should do so. You may allocate your GST exemption to any trust, and to the extent the contributions of the trust are allocated the exemption, the entire trust can be transfer-tax exempt for yet-to-be-born grandchildren. To allocate the GST exemption with respect to any trust contribution, you must file a gift tax return (IRS Form 709), which is due April 15 of the year following the gift(s). Since you have no living grandchildren, there can be no automatic GST exemption allocation, and the GST exemption will not be considered allocated to the trust unless you file the gift tax return. For maximum flexibility, the trust should probably be designed so that the division into shares for grandchildren (or for any other beneficiaries) does not occur for a number of years, perhaps at the time of your death or within a specific number of years thereafter. The trust should also be designed so that if GST exemption is not allocated to any contribution, it is kept in a separate non-exempt trust.
Answer: I will try to give you a general answer, but this actually is a quite complicated area of tax law. You will need to address specific questions to your CPA, trust and estate attorney, or other qualified tax advisor.
Answer: No. A political party is a nonprofit organization in the sense that it does not pay income taxes, but it is not a charitable organization that can accept tax-deductible contributions, either during life for income and gift tax purposes or at death for estate tax purposes. A gift under your will to your favorite political party will not qualify for a charitable deduction for estate tax purposes.
Answer: Your willingness to include a charity is a great help, but, of course, it depends on how much you are willing to leave to charity.
The first step is to make sure that your will or revocable trust is designed to take advantage of both of your "applicable exclusions". As I am sure that you know that as of 1/1/2000, you and your spouse can leave $1,350,000 ($675,000 each) to non-charities without the federal government taking a dime. Under current law, the estate and gift tax "exclusion" amount is scheduled to increase to $2,000,000 ($1,000,000 each). [See the table showing the schedule for the phasing in of an increased "applicable exclusion" at http://www.rushforth.org/planning/advintro.html#applicableexclusion]. If you have a "survivor-gets-everything" estate plan without proper trust planning, one of your exclusions may be wasted.
The next step is to live at least until the applicable exclusion reaches $1 million.
If you leave everything beyond the two exclusion amounts to one or more charitable organizations, there would be no federal estate tax at all. (This can be done by formula so that the amount going to charity adjusts to reflect the current applicable exclusion.) The charitable organization can be existing charities, a community foundation's donor-advised fund, or even a private foundation that can be established by you now or at the time of your death under your will or living trust.
From the perspective of your children or other beneficiaries, they would rather get 45 cents on the dollar (assuming your estate is in the 55% estate tax bracket) than zero, which is what happens when you leave assets to charity.
Part of your estate plan might include a charitable remainder trust that provides lifetime payments to you and the survivor of you, with the trust passing to one or more charitable organizations when both of you are deceased. You can be the trustee of the trust (although I do not generally recommend it), and you can retain the right to change charities (which I heartily recommend).
A charitable remainder trust can also be established as part of your will or revocable trust that provides income or annuity distributions to your children or other beneficiaries during their lifetime or during a period of years (up to twenty). Your estate will be entitled to a charitable deduction equal to the actuarial value of the remainder interest going to charity (as determined under the IRS valuation tables and formulas), so the estate tax will still be imposed, although to a lesser degree.
There are other planning techniques that can help reduce your taxable estate, including the use of limited-liability companies, business sales, charitable lead trusts, and certain retained-interest trusts permitted by law. Be sure to review the advanced estate planning pages. Given the size of your estate, you will not need to be too aggressive to eliminate the federal estate tax if you and your spouse survive at least until 2006. If you have more specific questions, please let me know.
Answer: I never even try to give information (let alone advice) regarding investments. That is outside my bailiwick. There are some TYPES of investments related to closely held business that can help pay estate taxes [such as employee stock ownership plans (ESOPs) and stock eligible for redemptions under Section 303 of the Internal Revenue Code], but for the most part your investments make no difference on estate taxes. How you hold those investments, however, can make a difference.
If your husband and you have an estate with a value that exceeds the amount that can pass free of estate tax, then in most states it makes sense to have a living trust with provisions that maximize the usefulness of each spouse's estate tax exemption. The amount that is excluded for estate tax purposes (which can be called an estate tax "exemption") is currently $675,000, but it is scheduled to increase to $1,000,000 in the absence of modifying legislation.
Depending on the size of your estate, you may also want to consider an irrevocable trust to own you life insurance, and you may wish to consider a family limited partnership or limited-liability company to own investments that you can control while at the same time allowing you to make estate-reducing gifts.
Answer: If your uncle is so inclined, it might be appropriate to start an estate-reducing gift-giving program. For many people with real estate holdings, it makes sense to set up a limited partnership (LP) or limited-liability company (LLC) into which the land is deeded. Your uncle would retain voting control for as long as he wishes, and he could make gifts of nonvoting interests to those he wants to benefit. Because no one would pay as much for a nonvoting interest as they would for a voting interest, the fair market value of the nonvoting interests is lower, which means that it is a lower gift tax value. For example, we set up an LLC for a client and put into it an apartment complex appraised at $1 million. We then gave his children (or, more accurately, an irrevocable trust for his children) nonvoting interests in the LLC. We had a business appraiser evaluate the market value of the gifted interests. The appraiser determined that a 50% nonvoting interest was NOT worth 50% of the apartment complex (or $500,000), but instead it was worth $300,000 because of several factors, primarily the lack of voting control and the lack of marketability. In essence, the fair market value of the non-voting LLC interest was worth 40% less than its pro rata value. We often refer to that 40% diminution in value as a "valuation discount". It simply boils down to the fact that $200,000 of value disappeared for gift tax purposes, which will potentially save this client's children over $80,000 in estate taxes if the property been retained and held until the client's death. (Even more if you take inflation and appreciation into consideration.)
There are other estate reducing techniques, including grantor-retained annuity trusts and charitable remainder trusts. If the property is income-producing, she might also consider a charitable lead trust. The most important thing your uncle should do is to consult an experienced estate planning attorney who is licensed to practice in his state to discuss all of his options.
Answer: Paying debts, taxes, and/or other obligations for children constitutes a taxable gift and, if your annual exclusion has been exhausted on another gift, will reduce your available "applicable exclusion" for gift and estate tax purposes (which is $675,000 in 2000). If you are serious about estate reduction, it may be wise to use up your lifetime applicable exclusion with a well-considering gift-giving program. That usually works best if you are giving away something that produces income or is appreciating in value or both (as is discussed under the heading "Making More Effective Gifts" at http://www.rushforth.org/planning/advgifts.html). Giving away nonvoting interests in business interests, such as interests in a family limited partnership or limited-liability company can allow you to give away value without giving up investment control. The gift tax value of a nonvoting business interest with transfer restrictions can be significantly lower than the pro rata value. For example a 10% nonvoting interest in a limited-liability company with $1 million of assets is not truly worth the pro rata share of $100,000 (10% of $1 million) because no one would pay that much for a nonvoting interest that they cannot sell. It may be worth 35-45% less because of the lack of voting control and the existence of transfer restrictions. The diminution in value for lack of voting control is often called a "minority discount", and the diminution in value because of transfer restrictions is referred to as the "marketability discount".
Under current federal income tax law, it is possible to design an irrevocable trust where the income on trust investments is taxed to the settlor and yet the trust assets are excluded from the trustor's taxable estate for federal estate tax purposes. If a trust is classified as a "grantor trust" for federal income tax purposes, it is not considered a taxable gift when the settlor pays the income tax. So, it is possible to structure an irrevocable trust so that the settlor pays the income tax instead of the trust's beneficiaries, and the payment of the tax does not count against either the annual exclusion or the applicable exclusion. It is also possible to design the trust so that the grantor trust status can be cancelled, giving you the flexibility of changing your mind if your situation changes.
I suggest that you discuss your options with a trust and estate attorney in your area.
Answer: The recipient of one or more gifts with a total value of $10,000 or less in a calendar year from any individual donor has no duty to report the gift or to pay any federal income or federal gift tax with respect to the gift(s). If the total of all gifts received from a single donor in a calendar year exceeds $10,000, AND the donor has used up the "applicable exclusion" for gift and estate taxes, the recipient would have "transferee liability" to pay the gift tax if the donor refused to (or was unable to) pay that tax.
Answer: I assume from the question that your estate exceeds the "applicable exclusion" for estate taxes. If that is true, an annual-exclusion gift of $10,000 will save the estate tax on that gift. Since the estate tax rates range from 37% to 60%, the savings can be significant. The three-year rule was modified years ago so that annual-exclusion gifts are not brought back into the estate. (Gifts of life insurance policies are still subject to the three-year rule, however, and any gift tax paid on gifts made within three years of death will be counted as part of the taxable estate.)
In most cases, it makes no sense to make gifts that use up the applicable exclusion or that require the payment of gift tax unless the gift carries with it signficant post-gift appreciation or income that can be excluded or unless the gift qualifies for a valuation discount that would not be available for estate tax purposes at your death. Death-bed gifts are often subjected to strict scrutiny by the IRS, so it is important to do it right, which means that gifts of assets other than cash and marketable securities need to be appraised by a qualified appraiser in order to establish an accurate gift-tax value and that a federal gift tax return must be prepared and filed.
Answer: I assume a Roth IRA is not involved. IRAs are "income in respect of a decedent" (IRD), which means that the estate tax and the income tax both apply. Thus, IRAs are "tax-nasty" assets that you should probably spend while you are living.
Your advisor is correct with respect to the impact of designating the bypass trust or your spouse as beneficiary. Unless there are no other assets that can be allocated to the bypass trust, designating the bypass trust as the primary beneficiary of an IRA account is not usually the best tax planning. Ideally, the assets allocated to a bypass trust will be left untouched by the surviving spouse so that they can appreciate and grow, but that is not possible with an IRA. The mandatory distributions from an IRA will eventually deplete the IRA account, reducing what would otherwise be "bypassed" from estate taxation. As you know, IRAs are eventually subjected to income taxation on the full amount (not just post-death earnings), and the income tax itself will also serve to diminish the effectiveness of the bypass trust.
In most cases, it is best to find other assets to put into the bypass trust and then to name the surviving spouse as the primary beneficiary so that the surviving spouse can roll over the IRA into his or her own IRA. This will avoid the immediate imposition of both the estate tax (because of the marital deduction) and the income tax (because of the favorable rules applicable to spousal rollovers).
Many of my clients do name the revocable trust as a contingent beneficiary unless they want to name "qualified beneficiaries", such as children, and extend the pay-out based on a combined life expectancy of them and those beneficiaries. Naming the trust can avoid probate if a beneficiary dies first and can avoid guardianship proceedings if minor beneficiaries are involved. The income tax can be deferred up to five years but no longer if the living trust is the beneficiary (unless the trust itself is set up as a "qualified beneficiary").
Perhaps I am confirming what your other advisor has already told you, but I recommend against putting an IRA in a bypass trust except to the extent necessary to avoid wasting the "applicable exclusion" for estate taxes. Your advisor is in a better situation than I to give you specific advice for your situation.
Email address:
layne@rushforth.org
Your comments and suggestions will be greatly appreciated.