TOOLS OF THE TRADE —
Estate and Gift Techniques
Following Recent (and
Possible) Law Changes
Estate Planning Council
Birmingham, Alabama
January 3, 2012
C. Fred Daniels (205) 716-5232
Leonard Wertheimer (205) 716-5254
Anna F. Buckner (205) 716-5245
Cabaniss, Johnston, Gardner, Dumas & O’Neal LLP
2001 Park Place North, Suite 700
Birmingham, Alabama 35203
SPEAKER S
LEONARD WERTHEIMER, III — Leonard Wertheimer is a partner in the Birmingham, Alabama office of Cabaniss, Johnston, Gardner, Dumas, & O’Neal LLP, where his practice is concentrated in the areas of estates and trusts, tax litigation, and closely-held businesses. He received his B.S. degree from the University of Virginia and his J.D. degree from the Emory University School of Law. Mr. Wertheimer is a Fellow in the American College of Trust and Estate Counsel and is a Member of the Alabama Law Institute. He was a member of the Alabama Law Institute committees that revised Alabama’s Probate Code, Principal and Income Act (chairman) Estate Tax Apportionment Act (chairman), Trust Code and Power of Attorney Act. Mr. Wertheimer is currently serving as chairman of the Alabama Law Institute committee preparing legislation to authorize the use of unitrusts. In addition to being listed in Best Lawyers since 1987 in the field of Trusts and Estates he was named by Alabama Super Lawyers magazine as one of the best attorneys in Alabama in Trusts and Estates and has a Preeminent AV rating with Martindale Hubbell. Mr. Wertheimer is a frequent speaker at professional seminars presenting topics relating to estate planning, estate administration, business succession planning, generation-skipping tax planning and distributions from IRAs and qualified plans. Mr. Wertheimer is a former Adjunct Professor of the Masters in Tax Accounting Program at the University of Alabama School of Business as well as a former Adjunct Professor of the Birmingham Southern College School of Business.
ANNA FUNDERBURK BUCKNER — Anna Buckner is a partner in the Birmingham, Alabama office of Cabaniss, Johnston, Gardner, Dumas & O’Neal LLP, where she practices in the areas of estates and trusts, including estate planning and administration, taxation, real estate and corporate law. A former professional tennis player, Mrs. Buckner attended Auburn University (B.S., cum laude, 1993; M.B.A., 1995) and Cumberland School of Law (J.D., magna cum laude, 1999). Mrs. Buckner is trained in Collaborative Practice. She is a member of the International Academy of Collaborative Professionals (IACP), a consortium of lawyers, financial professionals and mental health professionals who are committed to helping resolve civil and domestic relations disputes in a collaborative manner outside traditional legal forums. She is also a member of the Birmingham Collaborative Alliance, serving on the training committee. For more information about this aspect of her practice, see www.collaborativepractice.com. Mrs. Buckner is a licensed real estate agent, and a former member of the National Association of Realtors and the Birmingham Association of Realtors. She is a member of the Alabama, Birmingham and American Bar Associations and participates in the Sections on Business Law, Taxation, and Real Property, Probate and Trust Law. Mrs. Buckner currently serves on the Board for the Make-A-Wish Foundation of Alabama and she also served on the Cumberland School of Law Annual Fund Committee and is a member of the Kiwanis Club of Birmingham. She served on the Board of Directors for the Auburn University Bar Association and was a member of the Charter Class of the Alabama State Bar Leadership Forum in 2005. She has also been an adjunct professor at Cumberland School of Law teaching Real Estate Transactions. Mrs. Buckner is a member of the Birmingham Estate Planning Counsel and the Alabama and National Associations for Charitable Planned Giving. She is a member of the Alabama Law Institute where she was a member of the committees that revised the Alabama Prudent Investor Act, the Alabama Uniform Trust Code, the Uniform Prudent Management of Institutional Funds Act, and the Alabama Durable Power of Attorney Act. She currently serves on the Alabama Law Institute Unitrust Act Committee and is an Alabama Law Institute Counsel Member. Mrs. Buckner frequently lectures on estate planning topics locally and regionally. She serves on the Board of Trustees of the American Institute on Federal Taxation and is a Fellow in the American College of Trust and Estate Counsel (ACTEC) where she also serves on the Fiduciary Litigation Committee.
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Table of Contents
Page
I. INTRODUCTION. - 1 -
A. Where Are We and How Did We Get Here? - 1 -
B. Planning Prior to TRUIRA 2010. - 3 -
II. PORTABILITY; GREAT FOR CLIENTS, DANGER FOR ADVISORS. - 5 -
A. Doubling of the Applicable Exclusion Amount. - 5 -
B. Calculation of DSUEA. - 6 -
C. Estate Tax Return Requirement. - 8 -
D. Serial Spouses . - 10 -
E. DSUEA Tax Audits. - 11 -
F. Traps for the Unwary . - 12 -
G. Continued Desirability of Credit Shelter Trusts . - 13 -
H. Clauses Concerning the Filing of Estate Tax Returns. - 14 -
III. DISCLAIMER TRUSTS. - 16 -
A. Sample Language . - 16 -
B. Some Circumstances that Suggest the Use of Disclaimer Trusts . - 17 -
C. Pitfalls . - 17 -
IV. TOTAL RETURN TRUSTS. - 18 -
A. Total Return Trust Structure . - 18 -
B. Additional Features and Considerations . - 18 -
C. Marital Deduction Trusts . - 19 -
V. FORMULA ALLOCATION AND WANDRY DEFINED VALUE CLAUSES. - 20 -
A. Formula Allocation Clauses . - 20 -
B. Wandry or Formula Transfer Clauses . - 21 -
C. The Proctor Issue . - 22 -
D. Planning. - 23 -
VI. NINETY-NINE YEAR GRATs. - 23 -
A. Traditional GRAT Planning. - 23 -
B. Extremely Long-Term GRATs - 24 -
C. Operation of the GRAT Following the Grantor’s Death. - 26 -
D. Payment of Estate Taxes. - 28 -
E. Payment of the Grantor’s Income Taxes. - 29 -
F. Legislative Concerns. - 30 -
VII. SPOUSAL LIMITED ACCESS TRUSTS. - 31 -
A. The Reciprocal Trust Doctrine . - 31 -
B. The Levy Case . - 31 -
C. Non-Reciprocal Trust Strategies . - 32 -
D. Exercise of Power of Appointment in Favor of the Donor Spouse . - 33 -
VIII. CLAWBACKS. - 35 -
IX. GIFTS TO PARENT’S TRUSTS. - 35 -
A. Structure of the Trust . - 35 -
B. Tax Effect of the Gifts . - 36 -
X. SUPERCHARGED CREDIT SHELTER TRUSTS. SM - 37 -
A. Structure of the Supercharged Credit Shelter Trust . SM - 37 -
B. Grantor Trust Treatment for the Credit Shelter Trust . - 39 -
C. Effect of Creditor Rights . - 39 -
D. Income Tax Basis Following Death of First Spousal Beneficiary . - 40 -
XI. PLANNING FOR THE CREDIT FOR TAX ON PRIOR TRANSFERS. - 41 -
A. Property not Included in Second Decedent’ Estate . - 41 -
B. Application to Life Interests . - 42 -
C. Percentage Limitations . - 43 -
D. Limitations Based Upon Amount of Tax . - 43 -
(ii)
{B0519491.1}
TOOLS OF THE TRADE —
Estate and Gift Techniques Following
Recent (and Possible) Law Changes
C. Fred Daniels [*]
Presented by Leonard Wertheimer and Anna F. Buckner
I. INTRODUCTION.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“TRUIRA 2010”) increased the estate tax exclusion amount to $5,000,000 for decedents dying in 2011 and 2012 and indexed it for inflation. There is a possibility that the $5,000,000 applicable exclusion amount might continue after 2012. It is not likely that it will be reduced below $3,500,000, although a failure by Congress to act will result in a $1,000,000 applicable exclusion amount.
A. Where Are We and How Did We Get Here?
It is often perceived that only in the last decade has the estate tax been constantly changing. As indicated in the table below, there have only been two periods when there was not constant change — 1948 to 1976 and 1987 to 1997.
Excluded
Year Amount Rates
1916 $50,000 1% to 10%
1917 $50,000 2% to 25%
1918–23 $50,000 1% to 25%
1923–25 $50,000 1% to 40%
1924 Gift tax added
1926–31 $100,000 1% to 20%
1932–33 $50,000 1% to 45%
1934 $50,000 1% to 60%
1935–39 $40,000 2% to 70%
1940 $40,000 2% to 70% plus 10% surtax
1941 $40,000 3% to 77%
1942–76 $60,000 3% to 77%
1948 50% marital deduction enacted
1977 $120,000 18% to 70%
Gift and estate tax unified
Minimum marital deduction of $250,000
1978 $134,000 18% to 70%
1979 $147,000 18% to 70%
1980 $161,000 18% to 70%
1981 $175,000 18% to 70%
1982 $225,000 18% to 65% unlimited marital deduction
Qualified disclaimers authorized
1983 $275,000 18% to 60%
1984 $325,000 18% to 55%
1985 $400,000 18% to 55%
1986 $500,000 18% to 55%
GST enacted
1987–97 $600,000 37% to 55%
1987 5% surtax over $10,000,000
1998 $625,000 37% to 55%
1999 $650,000 37% to 55%
2000–01 $675,000 37% to 55%
2002 $1,000,000 41% to 50%
2003 $1,000,000 41% to 49%
2004 $1,500,000 45% to 48%
2005 $1,500,000 18% to 47%
2006 $2,000,000 46%
2007 $2,000,000 45%
2008 $2,000,000 45%
2009 $3,500,000 45%
2010 $5,000,000 35% or no tax if elected
2011 $5,000,000 35%
2012 $5,120,000 35%
B. Planning Prior to TRUIRA 2010.
1. Marital Formula Wills. The 50% marital deduction was added to the estate tax law in 1948 for non-community property, and it led to marital formula wills for couples whose combined net worth exceeded what was then $60,000.00 exemption from estate tax. [1]
(a) Formulas Prior to 1977. From 1948 until 1977, the basic marital formula was to give 50% of the so-called adjusted taxable estate to what is now called a credit shelter trust and to give the remainder outright to the spouse or to a marital deduction trust that included a general power of appointment.[2] This practice created the need to equalize a husband’s and wife’s separate estates, but equalization often involved gift tax consequences because the gift tax marital deduction was only 50%, not unlimited.
(b) Formulas from 1977 to 1981. The 1976 Tax Reform Act increased the marital deduction to the greater of $250,000 or 50%. Marital formulas were modified accordingly.
(c) Formulas after the Unlimited Marital Deduction. The Economic Recovery Act of 1981 added the unlimited marital deduction effective 1982, and the formula changed dramatically. The predominant formula allocated the maximum exempt amount to the credit shelter trust and the balance, if any to the surviving spouse.
2. QTIP Trusts. The Economic Recovery Tax Act of 1981 extended the marital deduction to qualified terminal interest property (“QTIP”). Thereafter, martial trusts tended to be in the form of QTIP trusts instead of pay-all-income trusts coupled with a general power of appointment.
3. Lifetime Gifts and Unification. There was an independent gift tax until 1977 that had a $30,000.00 lifetime exclusion and rates that were three-fourths of the estate tax rates. This resulted in an incentive to use the lifetime exclusion rather than lose it and also to take advantage of the lower gift tax rates. The 1976 Tax Reform Act unified the estate tax and the gift tax by replacing the gift tax and estate tax exclusions with a unified credit against the combined taxes and increasing the amount exempted in annual steps from $60,000.00 in 1976 to $175,000.00 in 1981. Various enactments since then gradually increased the exempt amount to $5,120,000, after the 2012 inflation adjustment. Unification eliminated the differential between estate and gift tax rates.
(a) Gifts of Future Income and Growth. Notwithstanding unification, lifetime gifts continue to remove future income and growth for the donor’s estate, which is a valuable technique.
(b) Eliminate the Tax on a Tax. The estate tax base includes the funds that a decedent’s estate uses to pay the estate tax, i.e., a tax on a tax. If a gift is made that results in the payment of gift tax and the donor outlives the gift by three years, the gift tax is excluded from the transfer tax base, thereby eliminating the tax on tax. See § 2035(b) (inclusion of gift tax on gifts made during 3 years before death).
4. Life Insurance.
(a) Spouse as Life Insurance Owner and Beneficiary. Because the estate tax marital deduction was only 50% until 1977, it was popular for an insured’s spouse to be designated as the owner and beneficiary of the insured’s life insurance. This ceased to be useful in 1982 when the marital deduction became unlimited.
(b) Irrevocable Life Insurance Trusts. A prevailing technique throughout most of the history of the estate tax has been the irrevocable life insurance trust. They were made more effective by the Ninth Circuit Court of Appeals decision in Crummey v. Comm ’ r, 397 F.2d 82 (9th Cir. 1968), that confirmed that trust additions coupled with a withdrawal were present gifts that qualify for $13,000 annual gift tax exclusion.
.
5. Disclaimer Trust Planning. If a couple’s combined estate was close to the exempted amount, one technique that has been available since 1982 is to devise the estate to the surviving spouse, but provide that, if the spouse disclaims, the disclaimed assets are devised to a credit shelter trust. See § 2518.
6. Generation-Skipping. The Tax Reform Act of 1986 added the generation skipping-transfer tax and its exemption. This resulted in complex dynasty trusts designed to utilize the GST exemption.
II. PORTABILITY; GREAT FOR CLIENTS, DANGER FOR ADVISORS .
Commentators often claim that husbands’ and wives’ exemptions from estate tax are twice the exclusion amount. A $5,000,000 exclusion amount supposedly means that a husband and wife have $10,000,000 exempt from estate tax.[3] To “double” the exemption prior to 2011, however, it was necessary that the assets be properly titled between the husband and wife and that the first spouse to die have a marital formula will — a will that contained a “credit shelter trust” to which an amount equal to the deceased spouse’s exclusion amount was devised. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“TRUIRA 2010”) attempts to achieve the same result without trusts and to simplify the preservation of both spouses’ exclusion amounts by introducing portability. However, practitioners representing small estates, preparing pre-nuptial agreements or seeking a substantial wrongful death award for a decedent’s spouse may find themselves in the cross-hairs of a malpractice action if they fail to recognize the weaknesses of estate tax portability. Temporary regulations on the portability of a deceased spousal unused exclusion amount (“DSUEA”) for estate and gift tax purposes were issued on June 15, 2012. REG-141832-11. The text of the temporary regulations also serves as proposed regulations.