Understanding & Drafting Irrevocable Trusts
Presented By:
WealthCounsel, LLC
Bill Conway
www.wealthcounsel.com
Good Morning!

Introductions
Name?
 From?
 Practice experience?
 Hobbies/Interests?
 Why EP 203?

Good Morning!


EP 203 significantly overhauled
Overview
WealthDocx IRT Module
 Insurance-Related IRT Issues
 Sale Transactions with Defective IRTs
 Asset Protection & Self-Settled Trusts
 Split-Interest Trusts

WealthDocx IRT Module
Bill Conway
www.wealthcounsel.com
WealthDocx IRT Module
Irrevocable Trusts Generally



Gifts are completed
Trust assets are removed from estate
Grantor trust?
Maybe
 Maybe not

Selecting the Type of IRT (Page 4)
Selecting the Type of IRT (Page 4)

2503(c) Trust
FBO Minor
 Outright at 21
 Included in estate
 Alternative to UGMA/UTMA


Asset Protection
Self-Settled Trust
 Delaware
 Distribution advisor suggested

Selecting the Type of IRT (Page 5)

Family Bank Trust / BERT Trust


Gifting Trust


Inter Vivos Bypass Trust
Receptacle for lifetime gifts
HEET Trust
Health and Education Exclusion Trust
 Appropriate where no GST exemption left


Intentionally Defective Grantor Trust
Grantor trust set to yes
 Warning re: Crummey

Selecting the Type of IRT (Page 5)

Inheritor’s Trust
Settled by non-beneficiary
 Only one beneficiary allowed


Life Insurance Trust (Single)


Doesn’t ask if insurance is appropriate
investment
Life Insurance (2nd to Die)

Crummey rights automatically included
Other IRTs in WealthDocx

Charitable Trusts


Split-Interest Trusts



CRTs, CLTs, Foundations
GRATs, QPRTs, QTIPs (Later)
Special Needs Trusts (3rd Party)
Retirement Trusts
Grantor as Trustee (Page 6)

Maybe, but why?
Distribution Adviser/Trustee (Page 7)

Personal touch
Other Trust Helpers (Page 7)


Segregating functions
More on Protectors in a moment
UTC Provisions (Page 8)


Be familiar with your state law!
Affects accountings, notice, etc.
Crummey Withdrawal Rights (Page 8)
Crummey Withdrawal Rights (Page 8)

Annual Gift Tax Exclusion
Saves $5 million lifetime credit
 Future Interest Rule
 Crummey Solution

Gifting to Irrevocable Trust

Crummey Solution (Page 9)
No notice required or given
 Tax Court - withdrawal rights were illusory
 9th Circuit reversed – present interest as long
as the withdrawal right is enforceable
 IRS acquiesced in Rev Rul 81-7; Reasonable
notice required

Crummey Issues

Minor Beneficiaries (Page 9)
Guardian may exercise
 Should not be donor/parent

 Inconsistent
positions by IRS
 WD precludes donor/parent from exercising

Non-guardian nominee??
Crummey Issues

Grantor’s Control Over Withdrawal Rights
(Page 10)

WD defaults
 Withdrawal
rights exist
 Pro rata among all benes

Invert defaults?
Crummey Issues

Contingent Beneficiaries (Page 12)

Cristofani (Tax Court)
2
children as current benes
 5 grandchildren as contingent benes
 Tax Ct said no vested interest required
Crummey Issues

Contingent Beneficiaries (Page 12)
Cristofani (Tax Court)
 Kholsaat (Tax Court)

 16
contingent benes
 No withdrawal rights exercised
 IRS argued implicit understanding
 Tax Court said no evidence of an understanding
and none would be inferred
Crummey Issues

Contingent Beneficiaries (Page 13)
Cristofani (Tax Court)
 Kholsaat (Tax Court)
 Holland (Tax Court)

 Family
meeting to discuss not exercising
 IRS argued implicit understanding
 Tax Court said meeting evidenced knowledge of
rights and conscious decision not to exercise
Crummey Issues

Notice of Withdrawal Right (Page 13)

Oral vs. Written
Crummey Issues

Notice of Withdrawal Right (Page 14)
Oral vs. Written
 Frequency

 “Current”
notice
 Schedule of contributions sufficient
 WD requires notice upon each contribution
Crummey Issues

Notice of Withdrawal Right (Page 14)
Oral vs. Written
 Frequency
 Duration

 Reasonable
period of time
 Cristofani was 15 days
 4 days has been approved; 3 days disapproved
 ETIP if spouse has withdrawal right
Crummey Issues

Notice of Withdrawal Right (Page 16)
Oral vs. Written
 Frequency
 Duration
 Accuracy
 Waiver

Crummey Issues

Maintaining Sufficient Assets (Page 16)
Satisfy from other trust assets
 Distribute fractional portion of policy (if
applicable)
 WD provides for grant of line of credit from
grantor

Crummey Issues

Estate Tax Treatment (Page 16)
Withdrawal Right = GPOA
 GPOA included in power holder’s estate

Gift-Over Problem (Page 17)

Lapse of Withdrawal Right
IRC 2514 (vs. 2503)
 Lapse over 5/5 = Release
 Release = transfer to other beneficiaries (if
any)
 Transfer is of a future interest

Gift-Over Problem

Gift-Over Solutions (Page 18)
Limit withdrawal right to 5/5
 Separate trusts
 Common trust with hanging powers
 Contribute assets so that 5/5 = $12,000
 Loans in lieu of contributions

Gift-Over Problem
Gift-Over Solutions

Common Trust (Page 19)
Limits withdrawal right to 5/5
 No lapse greater than 5/5
 Donee has to aggregate gifts for 5/5

Gift-Over Solutions

Common Trust (Page 19)
Annual Premium:
$5,000
Beneficiaries:
2-Son & Daughter
Dad
$2,500
$5,000
$2,500
Mom
No Giftover
Problem
2514(e) lapse of
$2,500 each
(no gift)
Gift-Over Solutions

Common Trust (Page 19)
Annual Premium:
$52,000
Beneficiaries:
2-Son & Daughter
Dad
$26,000
$26,000
Mom
$52,000
Deemed gift of
$21,000 from
each beneficiary
to the other
2514(e) lapse of
$5,000 each
(no gift)
Gift-Over Solutions

Separate Subtrusts (Page 19)
Allows for full utilization of annual exclusion
 Lapse in excess of 5/5 gifts over to no one
 Beneficiary becomes grantor for GST
purposes over released portion
 Separate accounts must be funded

Gift-Over Solutions

Separate Subtrusts (Page 19)
Annual Premium:
$52,000
Beneficiaries:
2-Son & Daughter
Dad
$26,000
$26,000
Mom
$52,000
Lapse to Separate Lapse to Separate
Trust for Son of Trust for Daughter of
$26,000
$26,000
No Giftover
because no other
beneficiaries to
whom to gift over
Gift-Over Solutions

Hanging Powers (Page 21)
Allows for full utilization of annual exclusion
 Amounts in excess of 5/5 continue to be
withdrawable
 Estate inclusion in event power holder
predeceases
 Best of both worlds

Gift-Over Solutions

Hanging Powers (Page 21)
Annual Premium:
$52,000
Beneficiaries:
2-Son & Daughter
Dad
$26,000
$26,000
Mom
$52,000
Remaining $42,000
continues to “hang,”
therefore no gift
over
2514(e) lapse of
$5,000 each
(no gift)
Gift-Over Solutions

Hanging Powers (Page 21)
Beneficiaries:
2-Son & Daughter
Year 5:
Aggregate
Contributions of
$260,000
Dad
$26,000
$26,000
Mom
$260,000
Balance of
$177,200 “hangs”
Year 5
Year 4
Year 3
Year 2
Year 1
$26,000 lapse
$20,800 lapse
$15,600 lapse
$10,400 lapse
$10,000 lapse
Incomplete Gifts (Page 23)


“dominion and control” retained
But can’t get it back
Grantor Trust Provisions (Page 23)
Grantor Trust Provisions (Page 23)




Overview & History
IRC 671-679
Created to eliminate income tax abuses
involving (then-lower) trusts brackets
Grantor trust as to:
Income
 Principal
 Both

Grantor Trust Opportunities (Page 24)





Tax free sale of appreciated assets
Tax burn as non-taxable contributions
Removal of assets from estate
Tax free distribution to trust beneficiaries
Permissible transferee of life insurance
policy outside of transfer for value rules
Achieving Grantor Trust Status

672 Definitions (Page 24)
Adverse = beneficial interest that is
substantial and whose interest is adversely
affected by exercise or nonexercise
 Nonadverse = Not adverse
 Related or Subordinate = Nonadverse +
parent/issue/sibling/employee/corp
 Spousal Attribution

Achieving Grantor Trust Status

672 Definitions (Page 24)
Adverse = beneficial interest that is
substantial and whose interest is adversely
affected by exercise or nonexercise
 Nonadverse = Not adverse
 Related or Subordinate = Nonadverse +
parent/issue/sibling/employee/corp
 Spousal Attribution

Achieving Grantor Trust Status


Know your defect
One vs. More than One
Certainty
 Ease of Toggling

Achieving Grantor Trust Status

674 Power to Affect Beneficial Enjoyment

674(c) – Power to Distribute Income or
Principal, or to add beneficiaries

Grantor holding power = inclusion
Achieving Grantor Trust Status

674 Power to Affect Beneficial Enjoyment

674(d) – Power to allocate income
 Power
granted to someone other than grantor or
“spouse living with grantor” to distribute, apportion
or accumulate income to or for beneficiaries if
limited by reasonably definite external standard
 Power creates grantor trust as to income only
 Possible to switch grantor trust status on and off
merely by spouse moving out and back in?
Achieving Grantor Trust Status

675 Administrative Powers (Page 28)

675(2) – Power given to nonadverse party to
make loans to grantor without adequate
interest or security
N/A if trustee has authority to make loans to
anyone without regard to interest or security
 Power alone will cause grantor trust status,
even if no loan is made

Achieving Grantor Trust Status

675 Administrative Powers

675(3) – Actual borrowing of funds
 Direct
or indirect loan to grantor or grantor’s
spouse which is unrepaid at the end of year
 N/A to loans with adequate interest and security
 Creates grantor trust to extent amounts are
unrepaid at year end, but . . .
 IRS has apparently ignored requirement that loan
remain outstanding until year end
Achieving Grantor Trust Status

675 Administrative Powers (Page 30)

675(4) – General
 Right
exercisable in a non-fiduciary capacity by
any person to reacquire trust corpus by
substituting other property
 Grantor can hold
Achieving Grantor Trust Status

675 Administrative Powers (Page 30)

675(4) – General
 Right
exercisable in a non-fiduciary capacity by
any person to reacquire trust corpus by
substituting other property
 Service’s position is that power alone isn’t
sufficient, and applies a facts and circumstances
analysis
 Defective as to both income and principal
 Grantor can release
 Protector can re-grant
Achieving Grantor Trust Status

677 Power to Use Income for Benefit of
Grantor (Page 34)
Grantor treated as owner of any portion of
trust, whether or not under §674, the income
of which, without the approval or consent of
adverse party is, or in discretion of grantor or
nonadverse party may be, distributed to or for
benefit of grantor or spouse
 Or used to pay premiums on life insurance on
the life of grantor or spouse

Achieving Grantor Trust Status

677 Power to Use Income for Benefit of
Grantor (Page 35)
Achieving Grantor Trust Status

677 Power to Use Income for Benefit of
Grantor
Trust should disallow use of income to satisfy
obligation of support
 Discretionary power to pay income to grantor
may cause inclusion under state law
 Some states have changed their laws to not
cause inclusion (Alaska, Delaware, and
others)

Achieving Grantor Trust Status

678 Persons other than Grantor Treated
as Owner (Page 35)
ONLY Code section attributing ownership to
someone other than the actual grantor
 Power to vest corpus or income exercisable
solely by that person

 surviving
spouse as sole trustee of bypass trust?
 limitation to ascertainable standard (HEMS)
prevents estate tax inclusion
 switch on/off grantor trust status by
appointing/firing co-trustee
Achieving Grantor Trust Status

678 Persons other than Grantor Treated
as Owner (Page 36)

Power to distribute income or principal which is
“partially released or otherwise modified” that
would cause grantor trust status under 671-677



5/5 power holder, until released, modified, or allowed
to lapse, is treated as grantor over portion of trust
subject to power
Upon lapse, power holder is treated as grantor of
amount in excess of 5/5
Crummey
Achieving Grantor Trust Status

§ 678 vs. §§ 671-677 (Page 36)
§ 678 N/A with respect to power over
“income” during any period actual grantor is
treated as owner under §§671-677
 Service has interpreted §678(b) as applying to
principal as well as income

Income Tax Reimbursement (Page 37)



Silence = prohibition?
Mandatory = inclusion
Discretionary = ??

Prearrangement?
Terminating Grantor Trust Status


Maintain Flexibility
Power to terminate grantor trust status
should not be in hands of grantor
Reporting for a Grantor Trust

To File or Not to File (Treas. Reg. 1.671-4)

Option 1: No EIN or 1041
payors with Grantor/owner’s TIN
 Grantor provides W-9 to Trustee
 Trustee statement for Grantor/owner
 Provide

Option 2: EIN and 1041
payors with Trust’s TIN
 Trust files Forms 1099
 Trustee statement for Grantor/owner
 Provide

Page 134 – Letter to CPA
Removing & Replacing Trustees (Page 37)

Right to Remove and Replace
RR 77-182: No inclusion if trustee resigned
 RR 79-353: Inclusion if grantor removed
without cause
 PLR 9303018: Facts and circumstances
 Wall: No inclusion where replacement was
corporate fiduciary

Removing & Replacing Trustees (Page 41)

Right to Remove and Replace (con’t)
Vak: 8th Circuit said power to change trustee
did not prevent gift from being complete,
contrary to Tax Court’s position
 RR 95-58: 79-353 revoked, 77-182 modified;
No inclusion if successor was not “related or
subordinate” under §672(c)

Related or Subordinate – A Review


Not adverse AND
Any one of
Spouse, if living with grantor
 Parent
 Issue
 Sibling
 Employee
 Corporation where grantor has significant
voting control

Related or Subordinate – A Review


Does not include issue of siblings (nieces
and nephews, etc.)
Spousal attribution
Typically related or subordinate
 Literally adverse but not technically due to
spousal attribution

Removing & Replacing Trustees (Page 42)
No 2036(a)(2) or
2038(a)(1) concern.
No
Power to remove and replace
retained by the grantor?
Yes
2036(a)(2)/2038(a)(1)
concern. Beyond Wall
logic.
No
Is person being removed acting in a
fiduciary capacity?
Yes
2036(a)(2)/2038(a)(1)
concern. Beyond Rev.
Rul. 95-58.
No
Must replacement be not related or
subordinate to grantor with IRC
672?
Yes
Within Rev. Rul. 95-58
Removal of Trustee by Bene (Page 43)

For cause = Court; good or bad?
Corp Fiduciary Requirements (Page 44)


Be careful!
Exclude expressly named institutions?
Lifetime LPOA (Page 44)


Ejection button
Trustee vs. Protector
“Amending” an IRT (Page 44)







Lifetime LPOA
Sell assets to new IRT
Non-judicial modification per UTC
Judicial modification
Decanting (later)
Trust Protector
Other?
Trust Protectors (Page 46)



Common in offshore jurisdictions
Little guidance in American law
Role is different from trustee
Perspective of trusted family friend or advisor
 Counter-balance to impersonal institutional
trustee
 Enhanced flexibility without adverse tax
consequences

Trust Protectors (Page 47)

Who should serve?
Gift tax consequences
 Income tax consequences

Trust Protectors (Page 49)

Removal and Replacement?
No 2036(a)(2) or
2038(a)(1) concern.
No
Power to remove and replace
retained by the grantor?
Yes
2036(a)(2)/2038(a)(1)
concern. Beyond Wall
logic.
No
Is person being removed acting in a
fiduciary capacity?
Yes
2036(a)(2)/2038(a)(1)
concern. Beyond Rev.
Rul. 95-58.
No
Must replacement be not related or
subordinate to grantor with IRC
672?
Yes
Within Rev. Rul. 95-58
Trust Protectors (Page 49)
Trust Protectors (Page 50)

Fiduciary or Not?
Silence vs. express answer
 Statute?
 Ability to exercise power if fiduciary?

Trust Protectors (Page 51)
Distribution of Estate Tax Includable
Property (Page 53)

Marital deduction issues
Bypass(-type) Trust Issues (Page 54)

Mandatory vs. Discretionary Income


Trust income tax rates better?
5/5 Powers
Administration of Remaining Trust (Page 55)

Guidelines for discretionary distributions



Silences = required?
5/5 Powers
Providing for children-in-law
Standby SNTs (Page 55)

Why not?
Decanting Powers (Page 56)



Broad powers
Discuss with client
Tutorial
GST Exempt & Non-Exempt (Page 57)

Again, why not?
Generation Skipping (Page 57)

Annual GST Exclusion
Only for direct-skip gifts (outright or in trust)
 If in trust:

 Only
one beneficiary; and
 Trust assets fully included in donee’s estate
Generation Skipping (Page 57)

Annual GST Exclusion

Qualifying Trusts include:
 2503(c)
Trusts
 Separate Trusts for skip persons

Non-Qualifying Trusts include:
 Dynasty
trusts
 Common trusts
Generation Skipping (Page 59)

GST Exemption
$5.0M in 2011-2012
 $??M in 2013
 Can only be allocated by the transferor

 Crummey
Powers
Generation Skipping (Page 61)

Allocating the GST Exemption
Allocation is irrevocable
 Automatic allocation to:

 Lifetime
direct skips
 At death, of any remaining GST exemption to
trusts from which there could be a generation skip
 Lifetime indirect skips to a “Generation-Skipping
Transfer Trust”

Opt Out of Automatic Allocation on 709
IRS Form 709



If you aren’t preparing them ….
Part 1 – personal information
Schedule A

Part 1 – Gifts Subject Only to Gift Tax
 Gifts

Part 2 – Direct Skips
 Gifts

to children
to grandchildren
Part 3 – Indirect Skips
 Gifts
to trust for children and grandchildren
IRS Form 709

Part 4
Line 1 – total gifts
 Line 2 – annual exclusions
 Line 3 – net of the two



Schedule B – Prior returns
Schedule C – Computing GST

Part 2 – Allocating
 Remember
to allocate to entire gift, not just taxable
portion!!
 Use formula allocation just in case
Divorce Provision (Page 63)

Need to discuss to avoid appearance of
conflict
Gift Splitting (Page 63)




A legal fiction
Only to third parties (not to spouses)
All or nothing annually
Consent must be made on Form 709 Gift
Tax Return
Drafting for Lifetime Benefits (Page 64)

Loans to grantor
Trustee borrows against policy and re-loans
 If adequately documented and secured,
should be no incident of ownership
 No taxable income – trust is grantor trust
under IRC 675(3)
 Interest accrued is debt against estate (“Tax
Burning”)

Drafting for Lifetime Benefits (Page 65)

Inter-vivos Bypass Trust
Spouse has access
 Danger is spouse’s death


Self-Settled Trust Jurisdictions
Reciprocal Trust Doctrine (Page 65)

Estate of Grace (US Sup Ct.)

Applicable where trusts are interrelated and
grantors are left in the same economic
position as if no trusts had been created
Reciprocal Trust Doctrine (Page 65)


Estate of Grace (US Sup Ct.)
Estate of Bischoff (Tax Court)

Applied doctrine to trusts established by
grandparents for the benefit of grandchildren
and naming grandparents as trustees.
Reciprocal Trust Doctrine (Page 65)



Estate of Grace (US Sup Ct.)
Estate of Bischoff (Tax Court)
Estate of Green (2nd Cir)


Refused to follow Bischoff stating that Grace
court required benefit to be retained by
grantors before doctrine was applicable.
PLR 200426008
Insurance-Related IRT Issues
(ILITs)
Bill Conway
www.wealthcounsel.com
ILIT Benefits (Page 67)




Remove death benefits from taxable
estate
Control disposition of death proceeds
Utilize annual gift tax exclusion for gifts to
the trust
Asset Protection
ILIT Objections



Cost to set up
Administrative hassle
Perceived loss of access to cash value
build-up within policy
ILIT Alternatives (Page 67)



Continued individual ownership
Ownership by adult children
Family Insurance Partnership
Estate Taxation of Insurance (Page 68)

Insurance is included if:

Insured possessed incidents of ownership (IRC
2042)
Proceeds are payable to or for the benefit of
the estate (IRC 2042)
 Policy (or incidents of ownership) are
transferred within 3 years of death (IRC 2035)

Estate Taxation of Insurance (Page 68)

IRC 2042

Incidents of ownership
 Power
to change beneficiary
 Power to surrender or cancel the policy
 Power to assign the policy
 Power to revoke an assignment
 Power to pledge the policy
 A reversionary interest in the policy

Payable to or for the benefit of the estate
Valuation of Insurance (Page 69)

Generally:
Interpolated terminal reserve
+ Unused premiums
+ Accumulated dividends
- Policy Loans


Single premium policies valued by
replacement
Group term has no value but continued
payment of premiums are on-going gifts
from the employee
Income Taxation of Insurance (Page 69)

General Rule: Excluded from income
(IRC
101(a)(1))


Exception: Transfer for Value (IRC 101(a)(2))
Exception to the Exception:
Transferee determines basis from transferor’s
basis, i.e., carry-over basis (IRC 101(a)(2)(A))
 Transferee is insured, partner of the insured,
partnership in which insured is a partner, or
corporation in which insured is shareholder or
officer. (IRC 101(a)(2)(B))

Avoiding 3 Year Rule of 2035 (Page 70)





Never possess incidents of ownership
Purchase new policy
Sell policy to grantor trust
Sell policy to partner of the insured
Sell policy to partnership in which insured
is a partner
Avoiding 3 Year Rule of 2035 (Page 70)

Sell policy to grantor trust
Revocable
Living
Trust
$150,000 + other
assets
$150,000
Policy
ILIT
Avoiding 3 Year Rule of 2035 (Page 71)

Sell policy to partner of the insured
Assets
Limited Partnership (or LLC)
G.P. &
L.P. Int.
Other
assets
Revocable
Living
Trust
$150,000 + other
assets
$150,000
Policy
ILIT
L.P.
Int.
Drafting to Provide Liquidity (Page 71)



Trustee is authorized to lend to the estate
Trustee is authorized to purchase assets
from estate
WD provides these options
Community Property Issues (Page 71)


Non-insured spouse cannot contribute to
trust of which he or she is beneficiary
Solution is Partition Agreement
ILITs for Survivorship Policies (Page 72)




Neither spouse/insured can be trustee
Incidents of ownership exist even in
fiduciary capacity
Co-trustee may solve
Joint trust can hold individual policies
Trustee Liability for Policy Performance
(Page 72)



Recent lawsuits
Trend to statutorily reduce liability
Audits
Sale Transactions to Grantor
Trusts
Bill Conway
www.wealthcounsel.com
Introduction (Page 74)




Chapter 14
Lack of certainty with GRAT
Grantor trust rules remain
Less frequency with $5 million gift
exemption
Sequence



Grantor establishes defective IRT
Grantor contributes assets, allocates GST
exemption
Grantor engages in sale (or part-gift/partsale) with IRT
Initial Funding (Page 74)

Seeding the trust
10% “Rule”
 Guarantees as alternative

Types of Consideration (Page 76)

Case


Not typically
Installment Note
Interest-only vs. Self-amortizing
 Refinancing
 Income tax concerns at death

 IRD?
 Step-up
in basis?
Types of Consideration (Page 74)

Self-Canceling Note
Term > life expectancy = Private Annuity
 Even for the young and healthy


Private Annuity
Even for the young and healthy
 Exhaustion test

2036 Recharacterization (Page 82)



LaFarge & Lazarus (9th Cir.)
Weigl
Key is cash flow!
Defined Value Formulas (Page 82)


Procter, King, Ward
McCord

Tax Court
 Lots
of politics
 Full Tax Court Decision
 See Judge Laro’s dissent (Page 86)

5th Circuit
Defined Value Formulas (Page 82)

Christiansen
Formula disclaimer of 75% to near-zero CLAT
and 25% to Foundation
 Disclaimant was CLAT remainderman
 8th Circuit slams IRS – see page 88


Petter
UPS stock
 LLC with three classes
 Sale for promissory notes three days after gift
 Defined value amount; excess to charity

Reporting a Sale to Grantor Trust
(Page 90)


New Question 12(e) on 706
Better to report now or later?
Asset Protection Trusts (APTs)
and Self-Settled Trusts
Bill Conway
www.wealthcounsel.com
Asset Protection & Estate Taxation (Page 91)

Creditor may reach beneficiaries’ interest
based on:
Enforceability of spendthrift provision;
 Beneficiary’s control over trust; and
 Whether beneficiary has property interest

4 Exceptions to Spendthrift (Page 92)




Self-Settled Trusts
3 Exceptions under Restatement (Second)
of Trusts
Tort creditor
Misc. case law exceptions
Enforceability of Spendthrift Provision
(Page 92)

Self-Settled Trust Exception to Spendthrift
No protection except in twelve states and
twenty offshore jurisdictions
 More states are changing laws
 Common self-settled trusts:

 Revocable
“Living” Trusts
 Charitable Remainder Trusts
 Grantor Retained Annuity Trusts
Enforceability of Spendthrift Provision
(Page 93)


Self-Settled Trust Exception
Restatement of Trusts Exceptions
Alimony or child support;
 Necessary services or supplies rendered to
beneficiary (such as medical services)
 Claim by US or State (such as tax liens)

Enforceability of Spendthrift Provision
(Page 94)



Self-Settled Trust Exception
Restatement of Trusts Exceptions
Tort Public Policy Exceptions

MS court vs. MS legislature
Enforceability of Spendthrift Provision
(Page 94)




Self-Settled Trust Exception
Restatement of Trusts Exceptions
Tort Public Policy Exceptions
Case Law Exceptions
ERISA protects assets until paid out
 NY statute exposing principal “unnecessary
for reasonable requirements of judgment
debtor”
 Income paid is exposed

Beneficiary’s Control (Page 95)

Non Self-Settled Trusts

Bene/Sole Trustee can’t protect from own
improvidence therefore no protection – FL
 AR
expressly states otherwise
 Check your state law!
Co-trustee provides protection
 Fiduciary duties prevail if other benes

Beneficiary’s Control (Page 96)

Self-Settled Trusts in AP Jurisdictions
Statutory specificity
 Classic jurisdictions:

 Isle
of Man
 Jersey
 Guernsey
Conflicts of Laws issues
 Contempt Orders

 Affordable
Media
Property Interest (Page 97)



Creditors may recover against debtor’s
property interests
A discretionary interest in a trust is not a
property interest
A property interest is one that can be sold
or exchanged
Property Interest (Page 97)


Spendthrift precludes
Mandatory distributions – “shall”
QTIPs
 GRTs & CRTs


Ascertainable Standards – “shall” for
HEMS
Beneficiary can sue under state law
 Creditor stands in beneficiary’s shoes


Special Needs Trusts
Property Interest (Page 99)

Conflicting Provisions
Discretionary language + ascertainable
standards
 “may” for HEMS
 Have to consult state law to determine how
provision is interpreted

Discretionary Trusts (Page 101)


Beneficiary may not sue trustee
Erosion of protection for:
Necessities of beneficiary
 Tax liens
 Alimony

Contingent Remainder vs. Dynasty Trust
(Page 102)

Trend to treat contingent remainder as
property interest
CO – child bene has property interest in
bypass trust during life of surviving spouse
 CO – property interest in inter vivos trust even
during life of grantor


Logic doesn’t apply to Dynasty Trust
Offshore or Domestic APT (Page 103)

Self-settled trusts
Questionable protection in other than APT
jurisdiction
 Split-interest trusts




Non-Self Settled has fewer concerns
Divorce – equitable division
Cost/Benefit
Domestic Self-Settled Trust (Page 104)


More states changing laws
Having it and not having it




Ownership vs. Exclusion
Interplay between asset protection and
estate tax exclusion
State law and creditor’s ability to reach
trust assets
Prearrangement
Domestic Self-Settled Trust (Page 105)








Alaska
Delaware
Nevada
Rhode Island
Utah
South Dakota
Oklahoma
Missouri?





Tennessee
New Hampshire
Wyoming
Colorado
Hawaii
Domestic Self-Settled Trusts (Page 106)

The evolution of the case law

Herzog
 Augustus
Hand
 NY trust; completed gift

Holtz
 External

standard for distributions = incomplete
Outwin
 MS
trust; incomplete gift
Domestic Self-Settled Trusts (Page 107)

The evolution of the case law

Irving Trust
 Augustus
Hand again
 NY trust; assets excluded

Uhl
 IN



trust; assets included
Rev. Rul. 77-378
Retained “Right” is the problem
Alaska’s Logical Next Step
Split-Interest Trusts
Bill Conway
www.wealthcounsel.com
Split-Interest Trusts (Page 78)


Techniques for leveraging gifts
Distinct economic interests
Division of time of ownership
 Division of the type of interest


That which is not given away is retained
Gifted Asset
Grantor
Retained
Benefit
Remainder
Split-Interest Trusts (Page 111)

Common Split-Interest Trusts
CRTs
 CLTs
 GRTs
 QPRTs


We’re going to focus on the taxable gift
trusts, i.e., non-charitable split-interest
trusts
Split-Interest Trusts & Ch. 14 (Page 112)

Chapter 14
Designed to reduce intra-family
undervaluations of split-interest transfers
 Valuation provisions
 2702- Fixed annuity or unitrust amount

Benefit of Split-Interest Trusts (Page 112)

Assumes:
Property will produce income equal to 120%
of Federal Mid-Term Rate (§7520 rate)
 Principal value neither increases or decreases

General Rules (Page 113)

Who Can Serve as Trustee
During income interest, may be grantor
 After income interest, other than grantor

General Rules (Page 113)

Problems with Gift-Splitting
If spouses gift-split and one dies, only onehalf of the applicable credit is restored
 All or nothing in any given year

General Rules (Page 113)

Estate Tax Inclusion Period & GST
2642(f)(3) values transfer of asset at end of
period “during which the value of the property
involved would be included in the gross estate
of the transferor under chapter 11 if he died
immediately upon making such transfer.”
 Not appropriate for split-interest trusts
 Cannot allocate GST until after ETIP period
 Grant GPOA if trust provides for skip persons

Practical Matters to Consider (Page 114)

Effect of Interest Rate


Higher rate = higher retention = lower gift
Term
Longer term = more retained = lower gift
 Mortality risk increases over longer term
 Hedge mortality risk with insurance



Appraisal – Get them!
EIN
Grantor trust during initial term
 May or may not be grantor trust after initial
term

GRITS (Page 116)



Income to Grantor for term
Remainder paid to remainder beneficiary
Significant benefit with
Non-income producing property
 Low income producing property



2702 eliminates use with family members
Specific exception for personal residence QPRT
GRITS (Page 117)

Still useful for
Business situations
 Gift to nieces and nephews
 Non-family settings

QPRTs (Page 117)

Gift to family members with retained right
to live in the residence for term of years
QPRTs generally overvalue use
 QPRTs assume no appreciation

QPRTs (Page 118)

Income Tax Consequences
Grantor trust during term
 Mortgage interest deduction passes through
to grantor
 IRC 121 exclusion still available

QPRTs (Page 118)

Gift Tax Consequences

Ch. 14 doesn’t apply
QPRTs (Page 118)

PRTs
Residence can’t be sold
 May not hold cash
 No contemplation of destruction of home


QPRT

Residence may be sold
 Reinvest
within 2 years
May hold cash
 Residences must be “personal residence”

 Principal
residence
 One other residence of grantor
Attributes of QPRTs (Page 119)



Attributes
Prohibitions
Requirements
QPRTs (Page 121)


Sale or disuse of residence disqualifies
Upon disqualification, may
Distribute outright to grantor
 Convert to GRAT

 Payment
based on original 7520 rate
 Begins on date of sale, disuse, destruction, etc.
QPRTs (Page 122)

Effect of transferring property subject to
mortgage
If non-recourse, gift is FMV – debt; Continued
payment on debt are recurring gifts
 If recourse, gift is FMV; Continued payments
on debt are not additional gifts

QPRTs (Page 123)

Joint Property
Each spouse can contribute one-half interest
to separate QRPTs
 Beware Reciprocal Trust Doctrine!

QPRTs (Page 123)

Options at End of Term
Lease
 Life-estate in non-grantor spouse

QPRTs (Page 124)



Capital Gain Tax on Sale
Prohibition of Repurchase by Grantor
Grantor Trust Beyond Term where
Administrative Powers Retained
QPRTs (Page 125)

Asset Protection
After term, asset is removed
 During term, income interest is likely
reachable by creditors
 Regs require trustee to dispose of residence if
not used by grantor
 Conversion to GRAT may help

 Remainder
is protected
 Annuities are exempt in many states
GRUTs (Page 125)

Why They Do NOT Work
Payout is unitrust amount
 As trust increases, payout increases
 Effect is that corpus remains about same as if
property had been gifted
 Direct gift has no reversion possibility

GRATs (Page 125)



Assets best suited are appreciating assets
Discounts provide leverage
No-Lose Propositions
GRATs (Page 127)




Rules for GRATs
Can Increase Payouts (up to 120%)
Gift Tax Valuation
Estate Taxes


Income Taxes


If grantor fails to survive term, inclusion of all
property
GRAT is a grantor trust
Spousal Annuity Interest
GRATs (Page 129)

Zero’ed Out GRATs- Walton Case
GRATs (Page 130)

“Amoeba” or Rolling GRATs
GRATs (Page 131)

Effects of Rolling GRATs
Lifetime QTIPs (Page 132)




Trust created by one (“propertied”) spouse
for another (“non-propertied”) spouse
Equalize estates without propertied
spouse giving up control
Requires all income be paid at least
annually to donee spouse
Can create secondary life estate for donor
spouse
Lifetime QTIPs (Page 133)

Asset Protection
During life of donee spouse – spendthrift trust
 After death of donee spouse

Lifetime QTIPs (Page 133)

Elements
Only permissible beneficiary is donee spouse
 All income paid at least annually
 No person has power to appoint property
during life of donee spouse
 QTIP election is timely made on 709

 No
cure if you miss this!!! See PLR 201109012
Lifetime QTIPs (Page 134)

Estate Tax Effects


Death of donee before donor renders donee
transferor for future trusts
Can Allocate GST Exemption
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Bill Conway
www.wealthcounsel.com