2012 Advanced Sales Forum
Sponsored by:
Presented by:
Julius H. Giarmarco, J.D., LL.M.
Giarmarco, Mullins & Horton, P.C.
101 W. Big Beaver Road, 10th Floor
Troy, Michigan 48084
(248) 457-7200
jhg@disinherit-irs.com
www.disinherit-irs.com
1
Estate, Gift, and GST Taxes
Basis Method
GST Tax
Exemption
Top Estate/GST
Tax Rate
Gift Tax
Exemption
Top Gift Tax
Rate
$3,500,000
Step-up in basis
$3,500,000
45%
$1,000,000
45%
-0-
Modified
carryover basis
-0-
0%
$5,000,000
Step-up in basis
$5,000,000
35%
$1,000,000
35%
20112
$5,000,000
Step-up in basis
$5,000,000
35%
$5,000,000
35%
20123
$5,120,000
Step-up in basis
$5,120,000
35%
$5,120,000
35%
2013
$1,000,000
Step-up in basis
$1,000,0004
55%
$1,000,000
55%
Year
2009
20101
Estate Tax
Exemption
1
The Tax Relief Act of 2010:
• For individuals who died in 2010:
 Tax the decedent’s assets at 35%, after estate tax exemption of $5 million and receive a “stepped up” income tax basis equal to fair
market value at death.
 Alternatively, elect out of the estate tax regime, no estate tax is assessed and modified carryover basis rules apply in determining
recipients’ income tax basis in the assets.
2 For 2011 and 2012, portability of the estate tax exemption between married couples (Note: Not applicable to GST tax exemption).
3 Estate, GST, and gift tax exemptions are indexed for inflation in 2012.
4 Indexed for inflation ($1.4M estimate).
2
Wealth Transfer Strategies
Over Lifetime
Annually
Transfer of wealth
excluded from
any gift tax
• $13,000 per individual
($26,000 gift splitting
with spouse) per donee
• Direct payments to
educational institutions
and health care
providers1
Transfer of wealth
through GST, estate,
and gift tax exemptions
Transfer of wealth
utilizing discount
strategies
Transfer of wealth
utilizing freeze strategies
(appreciation-only gifts)
• Gift tax exemption of up
to $5M per individual
• Family limited
partnership (FLP)
• Grantor retained annuity
trust (GRAT)
• GST and estate tax
exemptions of $5M per
individual3
• Family limited liability
company (FLLC)
• Intentionally defective
grantor trust (IDGT)
• Non-voting shares in
family corporation (C or
S corporation)
• Qualified personal
residence trust (QPRT)
• Generation-skipping
transfer trust (GST)
• Irrevocable life insurance
trusts (ILIT)2
Transfer of wealth
through
taxable gifts
• Pay gift tax now rather
than paying estate tax
later
• Converting traditional
IRA to Roth IRA5
• Intra-family loan
• Statutory freeze
partnership (FLP or
FLLC)4
Charitable planning:
CRTs and CLTs.
1
To qualify for exclusion, gifts of tuition and medical expenses must be made directly to the provider.
Often can be structured to use annual exclusion gifting.
3 In 2012, an estate is taxed at a top rate of 35% with a $5.12 million estate tax exemption and a $5.12 million GST tax exemption.
4 Can serve to both utilize discount and transfer wealth utilizing freeze strategies.
5 Paying the income tax in converting a traditional IRA to a Roth IRA is essentially a tax-free gift.
2
3
2012: A Perfect Storm for Gifting
 Low property values.
 Historically low AFRs and Section 7520
rates.
 $5.12M gift/GST tax exemptions are
expiring.
 President Obama’s proposals are looming.
4
President Obama’s 2013 Budget
Proposal
 Reduce the estate and GST exemptions to
$3.5 million and the gift tax exemption to
$1 million and provide a top rate of 45%
for those taxes.
 Portability of a deceased spouse’s unused
estate and gift tax exemption would
continue.
5
President Obama’s 2013 Budget
Proposal
 Eliminate a trust’s GST exemption on the
trust’s 90th anniversary.
 Eliminate valuation discounts on familycontrolled entities.
 Require a minimum 10-year term for
GRATs.
6
President Obama’s 2013 Budget
Proposal
 Modify the treatment of “grantor trusts” so
that:
 Trust assets would be subject to estate tax.
 Distributions to a beneficiary during the
grantor’s lifetime would be subject to a gift tax.
 Trust assets would be subject to gift tax if the
trust ceases to be a grantor trust during the
grantor’s lifetime.
7
President Obama’s 2013 Budget
Proposal
 Caution: Most ILITs are grantor trusts!
 The power to use trust income to benefit the
grantor’s spouse (IRC 677(a)(1));
 The power to use income to pay premiums on
policies insuring the grantor (IRC 677(a)(3)); or
 The grantor’s non-fiduciary power to substitute
trust assets for assets of an equivalent value
(IRC 675(4)(C) and Rev. Rul. 2011-28).
8
Advantages of Lifetime Gifting
 Removes appreciation and income from
the donor’s estate.
 Gifts to an intentionally-defective grantor
trust (“IDGT”) remove the taxes on trust
income from the grantor’s estate.
9
Advantages of Lifetime Gifting
 Shifts income to lower tax brackets of
donees (except where Kiddie Tax applies),
unless IDGT is used.
 Leverages GST exemption. For example,
ILITs.
10
Advantages of Lifetime Gifting
 Removes the gift tax from the donor’s
estate.
 Gift tax is exclusive; estate tax is inclusive.
 IRC Sec. 2035(b) adds back to the estate any
gift taxes paid within three (3) years of death.
 Possible phase out of valuation discounts.
 Possible return to lower gift tax exemption
and higher tax rate in 2013.
11
Disadvantages of Lifetime Gifting
 Loss of control, but this can be mitigated
by:
 Using an FLP or FLLC with the grantor acting
as the general partner or manager.
 Voting and non-voting shares.
 Ability to remove and replace trustees (with
someone not related or subordinate to the
grantor).
12
Disadvantages of Lifetime Gifting
 Loss of stepped-up basis.
 Loss of income.
 Possible Clawback.
13
Is Clawback Really a Problem?
 Arguments Against Clawback
1. Congress did not intend clawback, and this intent
should override any contrary statutory
interpretations.
2. The sunset provisions of EGTRRA treat the $5
million unified credit amount as having never
existed, once 2013 rolls around.
14
Is Clawback Really a Problem?
 Arguments Against Clawback
3. Clawback is inconsistent with the entire unified
gift and estate tax regime – to tax prior gifts at
death that were exempt from tax at the time of
the gift.
4. Code §2001(B)(2) provides that the use of tax
rates in effect at the decedent’s death applies to
the constructive gift tax computation – thus,
unified credit amounts at death should likewise
apply.
15
Is Clawback Really a Problem?
 But even if clawback becomes reality, the
potential to pass appreciation on the
transferred assets tax free is a powerful
impetus for gifting now.
16
Simple Gifts
 Forgive loans.
 Pay off children’s mortgages.
 Equalize custodial gifts and Section 529
plans.
 Pay off split-dollar and premium financing
arrangements.
 Outright gifts of non-voting interests in family
business.
17
Sophisticated Gifts
 ILITs.
 Dynasty Trusts.
 Formula Gifts – Wandry.
 Spousal Lifetime Access Trusts.
 Intentionally-Defective Grantor Trusts.
 Grantor Retained Annuity Trusts
 Beneficiary-Defective Inheritor’s Trusts.
 Qualified Personal Residence Trusts.
 Private Split-Dollar - Loan Regime.
18
GRAT
Irrevocable Life Insurance Trusts
19
ILITs
Crummey Gifts
Grantor/
Insured
Premium Payments
Dynasty/
ILIT
Allocate GST Exemption
Insurance
Company
Death Benefit
Net Proceeds
Children and
More
Remote
Descendants
20
Switching ILITs
 Sale of policy from old ILIT to new ILIT for
cash or promissory note.



If purchase price is at fair market value, then
three-year rule of IRC Sec. 2503 does not apply.
No transfer-for-value if new ILIT is grantor trust.
Rev. Rul. 2007-13.
No gain on sale if old ILIT is a grantor trust (or if
no gain in policy).
21
GRAT
Dynasty Trusts
22
Dynasty Trust –
Overview of Technique
Dynasty Trust
Grantor
No transfer tax paid.
Discretionary Distributions
to Children for Life
Advantages
•Creditor protection
•Divorce protection
•Estate tax protection
•Dispositive plan protection
•Spendthrift protection
•Consolidation of capital
Gift should take advantage
of any remaining lifetime gift
exclusion and lifetime GST
exclusion
No transfer tax paid.
Discretionary Distributions
to Grandchildren for Life
No transfer tax paid.
Discretionary Distributions
to Great-Grandchildren
for Life
No transfer tax paid.
Future Generations
23
Dynasty Trust vs.
35% Estate Tax Every 30 Years
$1 Million
After-Tax Growth
Value of Dynasty
Trust After 120
Years
Value of Property if
No Trust
3.00%
$34,710,987
$6,196,128
4.00%
$110,662,561
$19,753,959
5.00%
$348,911,561
$62,282,970
6.00%
$1,088,187,748
$194,248,314
7.00%
$3,357,788,383
$599,386,213
8.00%
$10,252,992,943
$1,830,223,321
9.00%
$30,987,015,749
$5,531,375,980
10.00%
$92,709,068,818
$16,549,148,216
24
GRAT
Formula Gifts
25
Wandry v Comm’r, TC Memo
2012-88
 Say this: I hereby transfer a fixed dollar
amount of my FLP interests worth $5.12
million.
 Not this: I hereby transfer 25% of my FLP
interests.
26
Wandry v Comm’r, TC Memo
2012-88
 The Tax Court in Wandry took note that
other federal courts validated formula
clauses, citing Christiansen (180 T.C. 1,
aff’d 586 F. 3d 1061); Petter (T.C. Memo
2009-280, aff’d 653 F. 3d 1012; and
McCord (461 F. 3d 614).
27
Wandry v Comm’r, TC Memo
2012-88
 In those three cases, and in Hendrix (T.C.
Memo 2011-133), the formula clauses
reallocated any “excess” transfers to
charities (thereby qualifying for a
charitable gift tax deduction) – not back to
the donor.
 The Courts were comforted by the fact
that, presumably, the charities would
assure the values used represented FMV.
28
Wandry v Comm’r, TC Memo
2012-88
 The Tax Court stated that it is
inconsequential that the adjustment clause
reallocated membership units among
petitioners and the donees, rather than to
a charitable organization.
 The Tax Court explicitly stated that the
lack of charitable component in formula
value clauses does not result in a “severe
and immediate” public policy concern.
29
Wandry v Comm’r, TC Memo
2012-88
 Possible drawback with formula clauses:
 How to allocate income and losses during
“open” period?
 If the transferee is a grantor trust, all income
and losses are includible on the grantor’s
income tax return during the open years.
 As such, no amended tax returns will be
necessary.
30
GRAT
Spousal Lifetime Access Trusts
31
SLATs
Grantor
Assets
SLAT
Spouse is trustee; and
spouse and children have
access to income and
principal; spouse is
primary beneficiary
Spouse and
children
At spouse’s death
Remainder to children
and more remote
descendants
32
Reciprocal SLATs
 If Husband and Wife set up trusts for each
other that are similar, then the two trusts
may be “uncrossed” and treated for estate
tax purposes as if each spouse had
created a trust for himself / herself. United
States v Grace, 395 US 316 1969.
 Gift splitting is generally unavailable with
SLATs.
33
Avoiding the Reciprocal Trust
Doctrine
 Use different distribution standards (i.e.,
an ascertainable standard in one SLAT,
and a fully-discretionary trust in the other
SLAT).
 Use different trustees. For example, wife
can be sole trustee and beneficiary of one
trust; and husband can be a co-trustee
(with an independent third party) and
beneficiary of other trust.
34
Avoiding the Reciprocal Trust
Doctrine
 Give one spouse a 5% / $5,000 power, but
not the other.
 Give one spouse a limited power of
appointment, but not the other.
 Give one spouse the broadest possible
limited power of appointment, and the
other spouse a power of appointment
limited to the grantor’s descendants.
35
Avoiding the Reciprocal Trust
Doctrine
 Give one spouse a limited power of
appointment – both during lifetime and at
death; and give the other spouse only a
testamentary limited power of
appointment.
 In an ILIT, include a marital deduction
savings clause in one trust; but not the
other.
36
Avoiding the Reciprocal Trust
Doctrine
 Fund one trust with liquid assets and the
other with illiquid assets (i.e., closely-held
business interests).
 Create the trusts at different times.
37
Avoiding the Reciprocal Trust
Doctrine
 If the richer spouse transfers assets to the
poorer spouse so that the poorer spouse
can establish a SLAT, this might trigger the
step-transaction doctrine.
 In Holman, 130 T.C. No. 12 and Gross,
T.C. Memo 2008-21 2008, gifts of
partnership interests 6 days and 11 days,
respectively, after the formation of the
partnership were ruled not to be step
transactions.
38
GRAT
Grantor Retained Annuity Trusts
39
GRATs
$1 million of
Securities
Grantor
(Age 70)
GRAT
$510,517 of
Securities
______________________
End of Year 1
$510,517 of
Securities
______________________
End of Year 2
______________________
GRAT Remainder
$137,915
Actual Asset Transfer
$1,000,000
Annuity Payments (Projected)
$1,021,033
Remainder (Projected)
$137,915
Taxable Gift
$0.08
Assumed 10% growth with a 1.4% §7520*
*January 2011 §7520 Rate
$137,915 of
Securities
Beneficiaries
40
GRAT
Intentionally-Defective Grantor
Trusts
41
IDGT Authorities
 Sale to a grantor trust is disregarded for
income tax purposes. Rev. Rul. 85-13.
 Grantor’s payment of trust’s income taxes is
not a gift. Rev. Rul. 2004-64.
 Power of substitution does not result in
adverse estate tax consequences. IRC Sec.
675(4)(c) and Rev. Rul. 2008-22.
 Power of substitution over life insurance not
an incident of ownership. Rev. Rul. 2011-28.
42
Installment Sale to IDIT
5. Excess Cash
Flow/Premiums
1. Gifts $1M
Grantor/
Insured
2. Loans $9M
IDGT
3. $9M Note to Grantor
Balloon Payment in 9 Years
6. Death Proceeds
(Income and Estate
Tax Free/Leverages
GST Exemption)
Life Insurance
Company
4. $105,300 annual interest
(Interest Rate 1.17%)
Advantages:
 Value of loan proceeds frozen at 1.17% for nine years (assumed mid-term AFR).
 Grantor’s estate further reduced by the income taxes paid on behalf of the trust.
 The trust property escapes estate taxation for as long as permitted under state law.
 Possible valuation discounts for promissory note in Grantor’s estate.
43
Grantor Trust vs.
Non-Grantor Trust
NON-GRANTOR TRUST
GRANTOR TRUST
Year
Beginning
Balance
Taxable
Income
7%
Less:
Taxes at
40%
Ending
Balance
Year
Beginning
Balance
Taxable
Income
7%
Less:
Taxes at
40%
1
$10,000,000
$700,000
$(280,000)
$10,420,000
1
$10,000,000
$700,000
$
2
10,420,000
729,400
(291,760)
10,857,640
2
10,700,000
3
10,857,640
760,035
(304,014)
11,313,661
3
4
11,313,661
791,956
(316,783)
11,788,835
5
11,788,835
825,218
(330,087)
6
12,283,966
859,878
7
12,799,892
8
Ending
Balance
-
$10,700,000
749,000
-
11,449,000
11,449,000
801,430
-
12,250,430
4
12,250,430
857,530
-
13,107,960
12,283,966
5
13,107,960
917,557
-
14,025,517
(343,951)
12,799,892
6
14,025,517
981,786
-
15,007,304
895,992
(358,397)
13,337,488
7
15,007,304
1,050,511
-
16,057,815
13,337,488
933,624
(373,450)
13,897,662
8
16,057,815
1,124,047
-
17,181,862
9
13,897,662
972,836
(389,135)
14,481,364
9
17,181,862
1,202,730
-
18,384,592
10
14,481,364
1,013,695
(405,478)
15,089,581
10
18,384,592
1,286,921
-
19,671,514
44
IDGT vs. GRAT
 With IDGT:




No mortality risk.
Can allocate GST exemption to seed gift.
Mid-term AFR is less than Section 7520 rate.
Back-loading (i.e., interest only with balloon
payment vs. level annuity payment).
 Not a statutory technique.
 Possibility of unintended gift tax, which may be
mitigated by using a “defined value” clause.
45
GRAT
Beneficiary-Defective Inheritor’s
Trusts
46
Beneficiary-Defective Inheritor’s
Trust
 A grantor cannot establish a trust for
his/her benefit and protect the trust assets
from creditors or estate taxes (except in
the “self-settled” states).
 But, a third party (i.e., parent) can
establish a trust for a child / grandchild’s
benefit and protect the trust assets from
the beneficiary’s creditors and estate taxes
– provided the beneficiary does not make
gifts to the trust.
47
Parent/Grantor
Funds BDIT
with $5,000
BDIT fbo Child
1.
2.
3.
Beneficiary has a Crummey withdrawal power which makes
the beneficiary the owner of the Trust for income tax purposes.
IRC Sec. 678(a).
Grantor can have no grantor trust powers.
Grantor allocates his/her GST exemption to the gift.
48
Parent/Grantor
Funds BDIT
with $5,000
BDIT fbo Child
4.
5.
6.
Beneficiary is co-trustee with a third party and has the right to
remove and replace trustees with someone who is not related
or subordinate. IRC Section 672(c).
Trustees can use trust income and principal for the
beneficiary’s health, education, maintenance and support.
Beneficiary has a testamentary limited power of appointment
(except over any life insurance on the beneficiary’s life) to “rewrite” the trust.
49
Parent/Grantor
Funds BDIT with $5,000
Installment Sale
IRS
Beneficiary
Pays Income Taxes
7.
8.
9.
BDIT fbo Child
Interest Payments
(at mid-term AFR) /
Balloon (in 9 years)
Beneficiary sells non-voting interests of a start-up business to
BDIT. Beneficiary continues to control the business entity.
Possible valuation discounts.
No gain on the sale. Rev. Rul. 85-13.
Beneficiary’s payment of BDIT’s income taxes is a tax-free gift
to the BDIT. Rev. Rul. 2004-64.
50
Third Party
Guarantee Fee
Partial Guarantee
Parent/Grantor
Funds BDIT with $5,000
IRS
Beneficiary
Pays Income Taxes
Installment Sale
BDIT fbo Child
Interest Payments
(at mid-term AFR) /
Balloon (in 9 years)
10. Since beneficiary cannot make a gift to the Trust, a third party
must guarantee 10% of the loan. Guarantee fee should be
determined by an independent appraiser.
11. The guarantee is the “seed” money so that the sale is not
treated as a disguised gift. IRC Secs. 2036 and 2702.
12. If beneficiary’s spouse is guarantor, fee is not taxable.
51
Third Party
Guarantee Fee
Partial Guarantee
Parent/Grantor
Funds BDIT with $5,000
IRS
Beneficiary
Pays Income Taxes
Installment Sale
Interest Payments
(at mid-term AFR) /
Balloon (in 9 years)
BDIT fbo Child
Pays Premiums
Death Benefit
Life Insurance
Company
13. Trust funds in excess of the interest payment and guarantee
fee can be used to fund the balloon payment.
14. Excess funds may also be used to purchase life insurance so
as to “leverage” the GST exemption.
15. All incidents of ownership must rest with the independent cotrustee.
52
Third Party
Guarantee Fee
Partial Guarantee
Parent/Grantor
Funds BDIT with $5,000
IRS
Beneficiary
Pays Income Taxes
Installment Sale
Interest Payments
(at mid-term AFR) /
Balloon (in 9 years)
BDIT fbo Child
Pays Premiums
Death Benefit
Life Insurance
Company
16. BDITs are relatively untested and based upon PLRs
20084025, 200949012, 201039010 and 129745-11.
17. If the FMV of the assets sold to the Trust is undervalued, a
portion of the asset’s value may be includible in the
beneficiary’s estate.
18. Possible step-transaction challenge by the IRS.
53
GRAT
Portability
54
Portability
 Reasons for portability:
1. Eliminates the need for spouses to retitle
property and create credit shelter trusts.
2. Basis step-up at surviving spouse’s death.
3. Protection against erosion by IRD; preserve
spousal rollover.
55
Portability
 Reasons for portability:
4. Supercharging first decedent’s exemption
amount by having surviving spouse gift that
amount to a grantor trust for the descendants.
5. Protection in decline in value of the credit shelter
trust.
6. Deferral of state death tax on the difference
between federal and state exemption amounts.
56
Portability
 Reasons for Credit Shelter Trusts:
1.
2.
3.
4.
5.
6.
Property management.
Spendthrift protection.
Creditor protection for surviving spouse.
Remarriage and blended families.
Transfer of post-death appreciation.
Protection against decreases in the inherited
exemption amount.
57
Portability
 Reasons for Credit Shelter Trusts:
7. Possible loss of exemption if surviving spouse
remarries and survives a second spouse.
8. Use of state death tax exemption by deceased
spouse.
9. Allocation of first decedent’s GST exemption.
10. Surviving spouse can lend money to the Credit
Shelter Trust at the AFR to obtain a greater rate
of return.
11. Portability set to expire in 2013.
58
Optional Credit Shelter Trust –
Disclaimer Trust
Living Trust
First Spouse’s Death
Surviving
Spouse
Within 9 months time may disclaim
Everything is left to surviving
spouse outright, except what
he/she disclaims.
Surviving spouse can receive
income and principal for health,
education, maintenance and
support; plus a 5% annual
withdrawal right.
Surviving Spouse’s Death
After second death, all trust
assets pass to the couple’s
heirs.
Credit Shelter
Trust
Heirs
59
Potential Problems with Disclaimer
Trusts
 No protection for children from a prior
marriage.
 Surviving spouse may not disclaim, remarry,
and then leave assets to a new spouse.
 Surviving spouse might not be in the right
state of mind to protect the qualified
disclaimer.
60
GRAT
Qualified Personal Residence
Trusts
61
QPRTs
Residence
Grantor
QPRT
Rent-Free Right of Use of Residence for 15 Years
ASSUMPTIONS:
Grantor’s Age
FMV of Residence
FMV in 15 years
at 5% growth
Term of QPRT
After Expiration
of Selected
Term of Years
70
$1,000,000
$2,079,000
15 Years
RESULTS:
Initial Gift
$374,130
FET Savings (35%)
$569,679
§7520 Rate (January 2012) 1.4%
Pays
Grantor
Rent
Children
or ILIT
62
QPRT vs. IDGT Sale-Leaseback
 Section 7520 rate and AFR:


QPRTs are less tax efficient when Section 7520
rates are low, resulting in higher gift tax values.
Conversely, IDGTs are more tax efficient in times
of lower interest rates.
 Grantor’s age and health:


There’s a mortality risk with QPRTs.
In contrast, with an IDGT only the unpaid
balance of the note is included in the grantor’s
estate.
63
QPRT vs. IDGT Sale-Leaseback
 Valuation issues:


With a QPRT, an upward adjustment of value
(upon a gift tax audit) increases the value of the
gift.
However, with an IDGT, it may be possible to
avoid an unintended gift tax by using a formula
clause. Wandry v Comm’r, T.C. Memo 2012-88.
64
QPRT vs. IDGT Sale-Leaseback
 Basic issues:


With a QPRT, the remainder beneficiaries take
the grantor’s basis in the residence. And the
grantor cannot reacquire the residence (to obtain
a stepped-up basis).
In contrast, with an IDGT, the grantor can
reacquire the residence by substituting other
high-basis property of equivalent value. The
power of substitution (IRC Section 675(4)) is the
most commonly-used grantor trust trigger.
65
QPRT vs. IDGT Sale-Leaseback
 GST planning:


Because of the so-called “ETIP” rules, GST
exemption cannot be allocated upon QPRT
funding.
In contrast, with an IDGT, GST exemption can
be allocated to the seed gift.
66
QPRT vs. IDGT Sale-Leaseback
 Other issues:



QPRTs are statutory techniques; whereas,
IDGTs are based on case law and rulings.
A single taxpayer may have two QPRTs; and a
married couple may have three QPRTs. But, with
IDGTs, there is no limit on the number of sales
and leasebacks.
An IDGT sale and leaseback could result in
higher property taxes at the onset; whereas, with
a QPRT, such increased taxes will not occur until
the end of the term.
67
GRAT
Private Split-Dollar – Loan Regime
68
Private Split-Dollar - Loan
Regime
Premium
Insured(s)
Interest Payment
Collateral Interest in Policy
Equal to Premiums Paid
Gift Equal to Interest Payment
ILIT Owns
Policy
Net Death
Benefit
ILIT for the
Benefit of
Beneficiaries
69
THE END
THANK YOU