Estate Planning: Current Developments and Hot Topics

November 11, 2013

Steve R. Akers Senior Fiduciary Counsel, Southwest Region

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This presentation is provided for your general information. The discussion of any estate planning alternatives and other observations herein are not intended as legal or tax advice and do not take into account the particular investment objectives, financial situation or needs of individual clients. This presentation is based upon information obtained from various sources that Bessemer Trust believes to be reliable, but Bessemer makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current opinions only as of the date indicated, and are subject to change without notice. Forecasts may not be realized due to a variety of factors, including changes in economic growth, corporate profitability, geopolitical conditions, and inflation.

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Obama Administration Budget Proposal Fiscal Year 2014

• Restore 2009 estate and gift tax parameters (p.8)

• Consistency of basis (p.9)

• GRAT (p.9)

• GST exemption (p.10)

• Sales to grantor trusts (p.10)

• Extension of estate tax lien for period of §6166 deferral (p.14)

• Health and Education Exclusion (HEET) (p.14)

• Further restrictions on discounts under §2704 omitted (p.15)

• Limits on “stretch IRAs” (for other than spouses) (p. 16)

None of those are likely in 2014 without general tax reform

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IRS Priority Guidance Plan

• New Item: Rev. Prov. 2001-38 (guidance will almost certainly clarify that can use QTIP trusts can be used in connection with portability planning even if first decedent-spouse’s estate is under the exemption amount) (p.17, 46-47)

• Decanting is omitted again this year (p.17)

• Highest priority: (p.18)

– Gift and estate tax imposed on certain expatriates, §2801

– Extensions of time to make GST exemption allocations

– §67(e) final regulations (unbundling requirements apply in tax year beginning after final regulations are issued)

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“New Normal” of Planning After ATRA

Couples Under $5 Million (p. 32-36)

• No federal transfer tax concerns (but state estate tax)

• Income tax; preserving basis step up

• Core dispositive planning

• Many non-tax issues

Couples $5-10 Million (p. 36-38)

• Portability decision

• Income tax

Couples Over $10 Million (p. 38-40)

• Traditional transfer planning

• Gift exemption will increase each year

• Desire for indirect access (Example: SLAT)

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Portability

• Complex factors; communication with clients; if not get a double basis step-up, should client acknowledge that plan in writing? (p. 41)

• Credit shelter trust major factors: (i) Nontax factors; (ii) Future appreciation; (iii) Spouse and children as beneficiaries; (iv) Blended family (p. 42)

• Blended Family: Potential inequities even with QTIP trust (p.42)

– QTIP overpay: If estate tax due at 2nd spouse’s death, QTIP trust bears tax (added estate tax with QTIP included minus estate tax without QTIP trust) even though first spouse’s estate may have been under the exemption amount (p. 43)

– QTIP may underpay: If spouse waives reimbursement right over portion of QTIP that exceeds first spouse’s exemption amount (p. 43-44)

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Portability

• Portability major factors: (p. 44-46) (i) Simplicity of outright ownership; (ii) Double basis step up (but may be able to get basis step-up for credit shelter trust with a formula GPA); (iii) Qualified retirement benefits; (iv) Most assets owned by one spouse and not willing to retitle assets to other spouse; (v) Spousal grantor trust [but takes a very large estate for surviving spouse to be willing to make $5 million gift]; (vi) GST exemption (with use of first spouse’s gift/estate exemption and double basis step up) with QTIP election, but Rev. Proc. 2001-38. (p. 46)

• Flexibility: Disclaimer approach or QTIPable trust approach (p. 48-50)

– Disclaimer approach: But surviving spouse cannot have limited power of appointment

– QTIP approach: Could disclaimed assets pass outright to surviving spouse? (p.49-50)

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Portability—State Estate Tax Coordination

• May want to fund CST at first spouse’s death with state “exemption amount”

Observations from presentation at ACTEC 2014 Fall Meeting by Tom Abendroth (Chicago) and Barbara Sloan (New York)

• If first spouse to die made substantial lifetime gifts, may only be able to fund CST with $100,000 without having to pay state estate tax. (p.52-53)

• If client living in non-tax state owns real estate in “decoupled” state: May owe substantial state estate tax even though assets in the decoupled state are far less than the state exemption amount in that state (State tax is generally the amount of state tax calculated on the entire estate times the proportionate part of assets located in the in decoupled state.) (p.53-54)

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3.8% Tax on Net Investment Income

• 3.8% times lesser of (i) AGI over threshold, or (ii) Net investment income; §1411 (p. 57-58)

• Threshold: $250,000 for married individuals; $11,950 for trusts (in 2013)

• Trusts and Estates: (p. 58-59)

– Low threshold

– “Undistributed” net investment income – Most trust and estate income is NII (p. 59)

– Are capital gains in DNI, so that capital gain is carried out to beneficiary (and tested at the individual threshold to determine if the individual beneficiary is subject to the additional 3.8% tax on capital gains)? (p.60-61)

• Exception for non-passive trade or business income (p. 59)

– How does a trust materially participate? – TAM 201317010 takes a hard-nosed position (p. 64)

– Frank Aragona Trust v. Commissioner, still pending in Tax Court (p.65)

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Building Flexibility to Preserve Basis Step Up

• Grantor (Examples: give someone power to grantor settlor a testamentary limited power of appointment, §2038; implied agreement of retained enjoyment, §2036) (p. 70-71)

• Surviving spouse (Examples: broad distribution power; third party with power to grant GPA to spouse; Delaware tax trap) (p. 51-54)

– Formula GPA (p.72-75)

• Ex.: Up to the amount that would not increase the federal estate tax of the beneficiary

• Determined without considering marital or charitable deduction? But are those acts of independent significance ignored under Kurz v. Commissioner?

• Specify what assets are subject to the GPA—assets with the worst inherent income tax costs with a basis step-up

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“Wandry” Defined Value Clauses

• Transfer by formula to minimize gift tax exposure (p. 99)

• Formula allocation clause: Allocate dollar amount to family trust and excess to charity, spouse, GRAT, or incomplete gift trust. Four cases approve this approach with excess passing to charity (McCord, Christiansen, Petter, Hendrix) (p. 100)

• Formula transfer clause (approved in Wandry): Transfer “that number of units equal to $5 million, as finally determined for federal gift tax purposes” (p. 99)

• Wandry is just a TC Memo case; not appealed; IRS nonacquiesced

– Many Wandry transfers were made in 2012 and have been reported on 2012 gift tax returns

– The IRS is still looking for the “right case” to appeal (Does that mean a “bad facts” case appealable to the 4th Circuit?) (p.114)

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Planning for Same-Sex Married Couples

• 14 states and D.C. (and soon to be Illinois) permit same-sex marriages (representing over one-third of the U.S. population) (p. 126)

• Windsor: Supreme Court held §3 of DOMA unconstitutional (§3 applies to federal laws) (p. 126-127)

• Rev. Rul. 2013-17 (p. 127-129)

– Terms relating to marriage include same-sex couples for federal tax purposes

– “Place of celebration” standard: Married for federal tax purposes if legally married even if now live in a state that does not recognize the marriage

– Domestic partnerships and civil unions not included

– Prospective application but may file refund claims for prior “open” years

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Planning for Same-Sex Married Couples

• Closed Years: Will be litigation but probably constitutional. McKesson Corp. v. Division of Alcoholic Beverages and Tobacco, Dept. of Business, 496 U.S. 18 (1990).

– Gift tax example issue: Paid gift tax in a closed year. Even if no refund, is the unified credit restored if gift qualified for marital deduction?

• More IRS guidance coming regarding retirement plans

– What if benefits paid to persons other than same-sex spouse but spouse did not sign waiver?

– What if benefits paid to same-sex spouse without benefit of rollover or special RMD rules that apply to surviving spouses?

• State law recognition—Supreme Court did not rule in Perry (regarding constitutionality of §2 of DOMA providing that states do not have to recognize same-sex marriages from other states), but cases are pending in many states. (p.135-136) Critical for estate planning purposes-Example: Beneficiary's spouse is remainderman or permissible appointee under LPA.

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Planning for Same-Sex Married Couples

• Tax Advantages, Examples (p.132-133)

– Transfer tax- marital deduction, portability, disclaimers, gift-splitting, jointly owned property, GST planning

– Income tax-joint income tax returns (although for many this will be a disadvantage due to the “marriage penalty”), non-recognition of gain for interspousal transfers, community property basis step-up §1014(b)(6)

– Grantor trusts- grantor trust status of previously created irrevocable trusts may have changed as a result of the marriage being recognized

• Tax Disadvantages, Examples (p. 134-135)

– Transfer tax-Chapter 14 limitations

– Income tax-marriage penalty for joint returns if both spouses have significant income, loss deductions, stock attribution rules

– State income tax-will dummy federal separate returns be required?

– Private foundations- disqualified person rules

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Self-Canceling Installment Notes; CCA 201330033; Estate of William Davidson

• Risk premium for cancellation feature (p. 172)

• Estate of William Davidson basic facts (p.180-182)

– Age 85; Life expectancy of 5.8 years under §7520 table

– IRS expert: 2.5 years

– Four medical consultants (two by estate and two by IRS) all said greater than 50% probability of living one year

– Large stock sale in Jan. 2009 for 5-year balloon SCINs with principal premium (80% premium)

– Large stock sale in Jan. 2009 for 5-year balloon SCINs with interest rate premium (13% above §7520 rate)

– Diagnosed with serious illness shortly thereafter

– Died about two months after sales, in March 2009

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Self-Canceling Installment Notes; CCA 201330033; Estate of William Davidson

• IRS Position in CCA 201330033 (p. 174-176)

– Not a bona fide transaction so note should be valued at zero; No reasonable expectation of repayment

– Alternatively, in determining value of SCIN note, §7520 does not apply

• Mortality tables; Reg. §1.7520-3(b)(3)-tables apply if individual is not terminal, defined to mean greater than 50% probability of living at least one year (p. 179)

• IRS says to consider decedent’s “medical history on the date of the gift” (p. 176)

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“Net, Net Gifts”—Steinberg v. Commissioner

• Donor made gifts net gifts to daughters who assumed two (hence the “net, net” description) liabilities:

– Gift tax

– Potential §2035(b) estate tax liability if donor died within 3 years (p.198)

• Donor was age 88; Second offset was for $5.8 million (for younger donors, this offset would be relatively small)

• IRS requested summary judgment that assumed potential estate tax liability is not “consideration in money of money’s worth”—the estate tax would be apportioned to the donees anyway

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“Net, Net Gifts”-Steinberg v. Commissioner

• Reviewed opinion.

– 8-judge majority: Deny SJ, assumption of potential estate tax does not flunk “money or money’s worth” test as a matter of law (p. 199)

– 6-judge concurring: Deny IRS’s motion for SJ but facts may show that the assumed liability adds little to what the donees would pay anyway under apportionment laws and result in little offset (p.200)

– 2-judge concurring: If donor actually dies within two years, the donees’ obligation to pay the §2035(b) added estate tax may be an estate asset

– 1-judge dissent: Allowing a gift tax offset for the potential §2035(b) liability frustrates the purpose of §2035(b) and it should not be permitted to offset the gift value. (p.201) (Judge Halpern wrote the majority opinion in McCord, which similarly refused this gift offset, but that ruling in McCord was reversed by the 5th Circuit.)

• Calculation of offset amount (p.203-205)

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