49Thheckerling Institute on Estate Planning

49thHeckerling Institute on Estate Planning

Zeydel - Portability

By: Martin M. Shenkman, CPA, MBA, PFS, AEP, JD

Portability and the Death of the Credit Shelter Trust.
General.
Zeydel’s power points illustrating the analysis she completed with JP Morgan are quite incredible and reflect answers that in some instances might be the opposite of what a practitioner might have suspected. They are well worth finding and reviewing.
Must consider various state laws and which state to site a trust in.
Credit shelter trusts are not dead.
Portability has made planning much more complex.
The exemption/DSUE is a descendable“asset” we can leave to our surviving spouse if we wish.
Portability facilitates getting a basis step up and the use of the shelter of the exemption of the first spouse to die.
But it is not really permanent.
Portability doesn’t cover all taxes we have, such as GST and state estate taxes. Think of loss of GST if don’t capture first exemption.
Portability is another step on thetax-continuum of treating spouses as a single economic unit, like gift splitting.
Portability is applicable when first spouse to die does not have adequate assets to use his/her exemption.
Filing.
There will be a DSUE to leave to the surviving spouse if and only if a return is filed.
Everyone wanted a Form 706EZ but it did not happen.
Can estimate assets to nearest $250,000 and if qualifies for marital/charitable don’t have to be as involved in appraisals.
IRS needs return from you and detail to determine how much exemption you are porting.
Say something about filing the estate tax return and paying for in it prenuptial agreement and estate planning documents.
What if you have a large estate and elect portability because all of estate goes to surviving spouse? What if everything goes to a QTIP trust (which is a planning technique with portability). Still must file to get portability.
There is no box to check for portability. Must file a complete and proper return to elect portability. If you do not want portability you must explicitly elect out.
Portability.
Was supposed to be simple but isn’t.
Solution for IRD.
Physician with homestead and large IRA, portability lends itself well for planning this type of estate.
If you create a bypass trust and the investment assets contained in that trust do not perform well you lose exemption. So if you deploy your exemption “asset” on the wrong thing your clients will lose. But on average this should not be a concern with a balanced portfolio, but it could be.
Comment: This is an incredible point that seems to be left off the table during many bypass trust discussions. After the “Great Recession” it is really a significant factor. For bypass trusts naming individual trustees in particular, which is certainly more common with lower wealth clients, what type of return on investments are they likely to realize? If they are not properly allocating investments, and panic when there is a turn of events, as so many individuals tend to do, this alone can make portability trump.
In a decoupled state the state shelter may be less than the federal shelter so you may use portability.
Use a plan to form and fund grantor trust after first spouse’s death. If you inherit DSUE and transfer it to a grantor trust that is beneficial because it can compound. Rev. Rule 2004-64 paying the income tax on a grantor trust is not a gift and income tax rates are higher so the benefits of a grantor trust are an incredible wealth mover. The surviving spouse’s may lose benefit unless a DAPT is used. We have not had much favorable law, although many of the cases have been bad facts. This is concerning.
Comment: There was extensive discussion of this planning technique in the 2014 Heckerling session on planning for estates under $10 million. As to the DAPT, see the comments/materials from Gideon Rothschild’s Special Session on asset protection planning. It does not appear that DAPTs are dead, merely that care should be exercised.
Negatives of Portability.
Loss of first spouse’s GST exemption. It is difficult to be comfortable losing a tax benefit. Use QTIP trust with a reverse GST to capture this.
Comment: A real challenge is for a “moderate” wealth client to convince them of the prudence of this planning. Without the fear of the estate tax driving them, will they entertain the prudence of this? If the Form 706 used to secure portability is prepared by the lowest cost return preparer the client can find planning like this will assuredly be overlooked.
If you don’t use QTIP are you protecting spouse from creditors and being taking advantage of.
Potential loss of tax credits if just bequeath all to surviving spouse and don’t file return you could lose PTP.
Risk of losing DSUE by remarriage. 2009 Census. What is the likelihood of being widowed twice? Men 70 and older 22.6% were widowed and 17.4% are currently widowed. Does this mean 78% remain single? Women 70+ 52% widowed and 48.3% currently widowed. 94% could remain single. 14 of 1,000 men 65+ remarried after being widowed.
Why are we so worried about stacking DSUEs when the wealthy client can do it by making an immediate gift? There is an inherent unfairness in that the wealthiest can afford to stack DSUEs but less wealthy cannot gift away the asset (or they have the cost and risks of a DAPT).
Options.
Basis versus portability. Do we want to have to address all of this now if client is not likely to die for 25 years? We want flexibility.
Plan to delay decision using disclaimer planning but will the surviving spouse do it?
Use a QTIP and disclaim back into a bypass trust. Start with a trust with greater benefits and disclaim into a trust with less benefits but get rid of power of appointment in bypass trust.
Clayton QTIP.
A spouse’s qualified income interest for life continuing and an executors election is a good QTIP.
D has will establishing trust and from the portion of the trust executor elects to treat as QTIP and the portion the executor the executor does not elect to treat as QTIP passes to child. It is not a partial QTIP. The disposition shifts to another trust or beneficiary. That is OK and you have a QTIP as to the portion that you make the election for.
Caution, many commentators recommend that an independent fiduciary make this determination.
The problem of using a QTIP and relying on portability is that the DSUE may be diverted. What if surviving spouse remarries and gifts splits with the surviving spouse? The DSUE may be lost and wont’ be available to shelter the QTIP that was intended for children of the first marriage. This is difficult to cover in a prenuptial agreement so it is difficult to do the ultimate protection.
What about IRC Sec. 2519 as a possible solution to the loss of DSUE by the second spouse.
Gift income interest in QTIP and trigger 2519 but you don’t give up whole income interest away, just a slice to trigger 2519. This works to capture the DSUE.
You will have 2036 inclusion as you kept some income interest so it will all be included in the surviving spouse’s estate, but you will recapture the DSUE and will not have to worry about it be diverted elsewhere.
Comment: In last year’s Institute several presentations discussed using a IRC Sec. 2519 disclaimer of the entire income interest to trigger a gift of the entire QTIP thereby using the DSUE. Under that plan the surviving spouse would have lost her entire income interest but perhaps been willing to do so as she remained a discretionary principal beneficiary of the QTIP after the income disclaimer. This is an interesting spin on a planning idea that certain would resonate better with every surviving spouse as some of the income interest is retained. How much must be disclaimed to trigger 2519?
Supercharged Credit Shelter Trust.
The key elements are in the Regulations.
Goal – trying to have a credit shelter trust that is a grantor trust. Try to deploy tax benefits without the spouse losing access to assets. Get grantor trust status and get leverage.
What are we doing with the strategy? We are creating inter-vivos QTIP.
Navigate the reciprocal trust doctrine. Each QTIP is included in the client’s gross estate. These are not the reciprocal trusts like SLATs endeavoring to remove from the estate. Under IRC Sec. 2044 are included in the gross estate. This is not the same level of issue/risk as other trust plans. Do, however, make the trusts different.
At the end you will only have one credit shelter trust under one QTIP.
The opportunity is that if H creates QTIP for W. Make a reverse QTIP election and currently allocate GST exemption. This will leak income interest but on a total return investment plan this is not that big a deal.
When H dies the exemption is allocated to the QTIP trust and it comes back to Was a credit shelter trust. QTIP regulations provide that if you set up a QTIP for spouse there should be no issues under IRC Sec. 2036 or 2038.
IRC Sec. 2041 is a potential issue – creditor rights. This may be viewed as a self-settled trust. Because it was included in my spouse’s gross estate. In Florida have specific legislation that provides if you have a QTIP for spouse and you become a beneficiary on spouse’s death it is not deemed a self-settled trust. So this planning must be done in a DAPT state or a state that has legislation similar to Florida’s. This can be argued to be estate planning not creditor avoidance. Arizona has a similar statute.
What is the opportunity for this? Because the beneficiary/surviving spouse funded the trust it will be a grantor trust.
What is an issue with this strategy? The notion that this property was included in the spouse’s estate for estate tax purposes. Will this shift the grantor? The Regulations provide that unless there is a general power of appointment, and you exercise it, nothing has happened with the identity of the grantor. Gratuitous transfer. 1.671-2(e)(5) grantor of transferor trust is generally treated as grantor of transferee trust subject to the exercise of a general power of appointment. Do I have a GPOA over QTIP I created for my spouse? No.
Basis issue.
What if you gift $5M zero basis asset using exemption? When is this a good idea and bad idea?
If asset appreciates to $6M you have a $400,000 estate tax savings but the income tax at 20% capital gain + 3.8% tax is more than $1M.
What if asset appreciates to $10M? Estate tax savings on $5M is $2M. Capital gain is $2,800,000 still more costly.
If $5M appreciates 3 fold to $15M. Estate tax savings on $10M appreciation is $4M and capital gains is about $3.5M so you are finally ahead.
Comment: Eye popping the amount of appreciation that is necessary to make the transfer advantageous.
Using a low basis asset for lifetime planning may not be advantageous. If client does not have low basis asset it may be viable. Gifting a diversified portfolio.
What if an event in the future will triple the value of the asset? Use grantor trust with substitution strategy even if you have to take on debt.
Look at wealth and spending levels.
3% spending level living 20 years a $10M couple has a 27% chance of having an estate tax issue. But if spending 5% the likelihood of a tax is down to 3%.
Comment: Unless a client has had a professional adviser create a real financial plan few have a realistic measure of what they are spending as a percentage of their wealth. This is a great illustration of why estate planning cannot be done well without the active involvement of a wealth manager or financial planner.
Pure portability, credit shelter trust, estate tax exclusion, grantor trust after first death, use exemption today, all can increase substantially the portion of assets that will be GST exempt by using lifetime planning.

CITE AS:

LISIEstate Planning Newsletter #2272(January 16, 2015) at 2015 Leimberg Information Services, Inc. (LISI).Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.