Decanting – A New Look at an Old Friend - PowerPoint Presentation

Decanting – A New Look at an Old Friend Diana S.C. ZeydelGreenberg Traurig, LLP333 S.E. 2nd AvenueMiami, FL 33131305-579-0575zeydeld@gtlaw.com

New Estate Tax Law Summary 2009 2010 2011-2012 2013 2014 Annual Exclusion Gifts (Don’t Count at All)$13,000$13,000$13,000$14,000 (unless adjusted )$14,000Tuition and Medical Direct Payment ExemptionUnlimitedLike BeforeUnlimitedLike BeforeUnlimitedLike BeforeUnlimitedLike BeforeUnlimited Like BeforeLifetime Exemption$1,000,000$1,000,0002011 - $5,000,000$5,250,000$5,340,0002012 - $5,120,000Estate Tax Exemption$3,500,000 (less what was used of $1,000,000 above)Unlimited2011 - $5,000,000$5,250,000(less portion of used lifetime gifting exclusion)$5,340,000(less portion of used lifetime gifting exclusion)2012 - $5,120,000** (less portion of used lifetime gifting exclusion)Estate Tax Rate45%35%35%40%40%Discounts and Installment Sales/GRAT’s, etc.AvailableAvailableAvailableAvailableAvailablePortability of First Dying Spouse’s $5,120,000 ExemptionsNoNoYesYesYes 2

2013 TAX RATES SUMMARY FROM BOOK ENTITLED THE ESSENTIAL PLANNING GUIDE TO THE 2013 INCOME AND ESTATE TAX INCREASESCopyright © 2012 Haddon Hall Publishing, LLP 2012 20132013 Medicare Tax 2014 Highest Tax Long Term Capital Gain15%20%3.8%23.8%Short Term Capital Gain35%39.6%3.8%43.4%C Corporation Dividend Income15%39.6%3.8%43.4%Ordinary Income35%39.6%3.8%43.4%Employment TaxesEmployer: 1.45%Employee: 1.45%Total: 2.9%Employer: 1.45%Employee: 2.35%Total: 3.8%(The additional .9% only applies as shown to the right.)Additional .9% on wages exceeding $200,000 for single taxpayers and $250,000 or married taxpayers.3.8% totalFICA/FUTA Taxes6.2% Employer/4.2% Employee on wages up to $110,100.6.2% Employer6.2% Employee on wages up to $113,700.N/A6.2% Employer6.2% Employee on wages up to $117,000.Estate Tax$5,120,000 Exemption35% Rate$5,340,00040% RateN/A$5,340,00040% Rate3

PROTECTIVE TRUST LOGISTICAL CHART First Dying Spouse’s Revocable Trust Surviving Spouse’s Revocable Trust $ 5,340,000* Remaining AssetsFamily(By-Pass)Generation Skipping Trust(Not taxed in surviving spouse’s estate)QTIP Non-GST Trust(Marital Deduction Trust that is not generation skipping)Generation Skipping Trusts for ChildrenChildren’s Trust (or distributions)Surviving spouse can have the right to redirect how assets are distributed on second death.Benefits children and grandchildren.Not estate taxable in their estates.Benefits children.Taxable in their estates.Surviving Spouse’s Revocable Trust(Will include assets owned jointly on first death)$5,800,000?*Remaining AssetsGeneration Skipping Trusts for Children(Will merge with first dying spouse’s Generation Skipping Trusts shown on left)Children’s Trust (or distributions)Benefits children and grandchildren.Not estate taxable in their estates.Benefits children.Taxable in their estates.During both spouse’s lifetimes:Upon first death in 2014:During surviving spouse’s remaining lifetime:Upon second death:After deaths of both spouses:*Assumes first spouse dies in 2014 and that the surviving spouse dies in a later year when the estate tax exemption has gone up to $5,800,000 (based upon 8.57% cumulative inflation). The estate tax exemption is $5,340,000 for those that die in 2014, and increases with inflation in $10,000 increments.If the first spouse does not use the entire exemption amount, what remains may be added to the surviving spouse’s allowance under the “portability rules” but will not grow with inflation.4

Diana S.C. Zeydel is a shareholder of the law firm of Greenberg Traurig, P.A., in Miami, Florida, and a member of the Florida, New York and Alaska Bars. She is a member of the Board of Regents and immediate past Chair of the Estate & Gift Tax Committee of the American College of Trust and Estate Counsel. She is a member of the Executive Council of the Real Property, Probate and Trust Law Section of the Florida Bar and an ACTEC liaison to the Section. Diana is a frequent lecturer on a variety of estate planning topics. She has authored and co-authored several recent articles, including “Portability or No: The Death of the Credit Shelter Trust,” Journal of Taxation, May 2013; “Imposition of the 3.8% Medicare Tax on Estates and Trusts,” Estate Planning, April 2013; “Congress Finally Gives Us a Permanent Estate Tax Law,” Journal of Taxation, February 2013; “Tricks and Traps of Planning and Reporting Generation Skipping Transfers,” 47th Annual Heckerling Institute on Estate Planning, 2013; “New Portability Temp. Regs . Ease Burden on Small Estates, Offer Planning for Large Ones,” Journal of Taxation, October 2012; “When Is a Gift to a Trust Complete: Did CCA 201208026 Get It Right?” Journal of Taxation, September 2012; “Turner II and Family Partnerships: Avoiding Problems and Securing Opportunity,” Journal of Taxation, July 2012; “Developing Law on Changing Irrevocable Trusts: Staying Out of the Danger Zone,” Real Property, Trust and Estate Law Journal, Spring 2012; “An Analysis of the Tax Effects of Decanting,” Real Property, Trust and Estate Law Journal, Spring 2012; Comments submitted by ACTEC in response to Notice 2011-101 on Decanting, April 2012; Comments submitted by ACTEC in response to Notice 2011-82 on Guidance on Electing Portability of the DSUE Amount,” October 2011; Contributor to A Practical Guide to Estate Planning, Chapter 2 Irrevocable Trusts, 2011; “Estate Planning After the 2010 Tax Relief Act: Big Changes, But Still No Certainty,” Journal of Taxation, February 2011; “The Impossible Has Happened: No Federal Estate Tax, No GST Tax, and Carryover Basis for 2010” Journal of Taxation, February 2010; “Tax Effects of Decanting – Obtaining and Preserving the Benefits,” Journal of Taxation, November 2009; “Estate Planning in a Low Interest Rate Environment” Estate Planning, July 2009; “Directed Trusts: The Statutory Approaches to Authority and Liability,” Estate Planning, September 2008; “How to Create and Administer a Successful Irrevocable Life Insurance Trust” and “A Complete Tax Guide for Irrevocable Life Insurance Trusts,” Estate Planning, June/July 2007; “Gift Splitting - A Boondoggle or a Bad Idea? A Comprehensive Look at the Rules,” Journal of Taxation, June 2007; “Deemed Allocations of GST Exemption to Lifetime Transfers” and “Handling Affirmative and Deemed Allocations of GST Exemption,” Estate Planning, February/March 2007; “Estate Planning for Noncitizens and Nonresident Aliens: What Were Those Rules Again?” Journal of Taxation, January 2007; “GRATs vs. Installment Sales to IDGTs: Which is the Panacea or Are They Both Pandemics?” 41st Annual Heckerling Institute on Estate Planning, 2007; and “What Estate Planners Need to Know about the New Pension Protection Act,” Journal of Taxation, October 2006. Diana received her LL.M. in Taxation from New York University School of Law (1993), her J.D. from Yale Law School (1986), and her B.A., summa cum laude, from Yale University (1982), where she was elected to Phi Beta Kappa.About our Presenter – Diana Zeydel5

Introduction to Decanting What is decanting? EPTL 10-6.6: The first decanting statuteMotivation for actLegislative history statements: declaratory of the common lawBasic requirements of original statute 6

Decanting Statutes Alaska, Arizona, Delaware, Florida, Illinois, Indiana, Kentucky, Michigan, Missouri, New Hampshire, New York, Nevada, North Carolina, Ohio, South Dakota, Tennessee, Texas, Virginia, Wyoming 7

Common Law Cases:Phipps, 142 Fla. 782 (1940)“The general rule gleaned from the foregoing and other cases of similar import is that the power vested in a trustee to create an estate in fee includes the power to create or appoint any estate less than a fee unless the donor clearly indicates a contrary intent.”Estate of Spencer, 232 NW 2d 491 (Iowa 1975)Wiedenmayer v. Johnson, 106 NJ Super (1969) 8

Wiedenmayer “The son's ‘best interests' is not defined in his father's trust indenture. The expression is not limited to a finding that distribution must be to the son's best ‘pecuniary’ interests. His best interests might be served without regard to his personal financial gain. They may be served by the peace of mind, already much disturbed by matrimonial problems, divorce and the consequences thereof, which the new trust, rather than the old contingencies provided for in his father's trust indenture, will engender.” 9

Wiedenmayer “Of what avail is it to rest one's ‘best interests' on a purely financial basis, and without regard to the effect upon a man's mind, heart and soul, if the end result would produce a wealthier man, but a sufferer from mental anguish?” 10

Morse v. Kraft – Massachusetts Supreme CourtCourt cited Phipps but appeared more inclined to rely on WiedenmayerCourt relied on fundamental principle that in interpreting a trust the intent of the settlor is paramountThe court focused on the authority to distribute “for the benefit of” as evidence of the settlor’s intent that the trustee have authority to distribute in further trustThe court admitted affidavits of the settlor, attorney/draftsperson and the trustee 11

Morse v. KraftThe court indicated that a more recent trust instrument without express decanting authority may create a negative inference Declined, as requested in the Boston Bar Association amicus brief, to recognize an inherent power of trustees of irrevocable trusts to exercise their distribution authority by distributing property in further trust, irrespective of the language of the trust 12

In re Kross – Nassau County Surrogate’s CourtDecanting under EPTL 10-6.6(j)(1) Original Trust settled by beneficiary’s grandparentsBeneficiary was special needs and the purpose of the decanting was to preserve eligibility for government benefitsWholly discretionary trust until age 21, at 21 mandatory income quarterly, principal at 25, 30 and 35 13

In re KrossAttorney General’s arguments Trustees had no authority to decant because the beneficiary would be entitled to mandatory payments in the futureCourt disagreesDecanted trust is self-settledDecanting Notice sent May 1, 2012, beneficiary attained 21 on May 7, 2012On May 2, beneficiary’s father consented on behalf of the beneficiary to the decantingTrust instrument provided that parent or guardian who is not a trustee may act on behalf of the beneficiary 14

In re KrossCourt holds as follows: Trustees are an authorized trusteesTrustees complied with the statuteConsent by parent was effective to shorten the 30-day notice periodDecanting was effective May 2, 2012, prior to the beneficiary attaining age 21The appointed trust is an effective third party special needs trustNo requirement for a payback provision in the appointed trust 15

Reasons to Decant Correct a drafting errorAvoid an adverse tax effect such as qualifying “fixing” a trust so it can be a qualified subchapter S trustExtend the time or event when a trust will endAdd or eliminate a spendthrift provisionChange the situs of a trust Avoid a state or local tax 16

Reasons to Decant Grant a presently exercisable or later exercisable power of appointmentPLR 200243026Discretionary power to invade for care, support, maintenance, education, advancement of life and comfortable livingRev. Rul. 75-550Calculating value of life estate under 2013Include “estimated amount of all possible invasions” for the benefit of others Make a trust a grantor trust or reverseDividing one trust into separate trusts for asset protection or separate share reasons 17

Tax ConcernsIncome Tax Gift TaxEstate TaxGST Tax 18

ConclusionDecanting provides an opportunity to change the terms of an existing trust Can preserve or even enhance the tax benefits 19

To register for one of the seminars please email Janine Gunyan at Janine@gassmanpa.com 20

21 To view this webinar please email Mark Carrington at mcarrington@bna.com or Alan Gassman at agassman@gassmanpa.com

Planning with Self-Cancelling Installment Notes and Private Annuities: Don’t Get Burned Wednesday, November 20, 201312:30 – 2:00 p.m.Professor Jerry Hesch, Lawrence Katzenstein, Edward P. Wojnaroski, Jr., Alan S. Gassman, J.D., LL.M. and Kenneth J. Crotty, J.D., LL.M. To register for this event please visit:http://www.bna.com/planning-selfcancelling-installment-w17179878865/ For discount information please email agassman@gassmanpa.com 22

MORE THAN ONE WAY TO SCIN A GRAT? (The “SCGRAT”) WHAT IF THERE IS NOT TIME TO APPRAISE THE UNDERLYING ASSETS AND ENTITY DISCOUNTS BEFORE COMPLETING A SELF-CANCELLING INSTALLMENT NOTE TRANSACTION? GRAT LLC SCIN $1,500,000CLIENT/GRANTORAssets estimated to be worth $2,000,000($500,000 in cash plus $1,500,000 in Grandpa’s LLC interest (90%))Cash $500,000GRANDPALLC$1,928,571 in assets($1,928,571 x .9 x .7 = $1,500,000)Grandpa, 10% 90%Step 1 – Client places assets in LLC owned by client and receives back a Self-Cancelling Installment Note.Step 2 – Client gifts 100% ownership in the LLC to the GRAT.Step 3 – A valuation firm values the assets under the LLC and actuarial tables are used to determine the SCIN value.Step 4 – The excess of asset value over the SCIN value is the GRAT contribution amount.Step 5 – The GRAT may provide for holding assets equal to $400,000, and distributing back 5 annual payments based upon any excess over $400,000. $2,000,000 - $1,500,000 = $500,000 . $500,000 - $400,000 = $100,000. $100,000/5 = $20,000Step 6 – If the IRS determines that the valuation assumptions used are incorrect, any excess value will pass back to the Grantor over 5 annual payments, and will qualify for the estate tax marital deduction if the grantor dies during the first 5 years survived by a spouse.GRAT provides that first $400,000 worth of assets remain in GRAT and any excess from initial contribution will be payable over 5 annual installments of excess amount plus the 7520 Rate. 100%Can benefit spouse and descendants after 5 years of payments to Grantor.23

SCIN PRIVATE ANNUITY GRAT Can be valued based upon standard life expectancy tables, if taxpayer has better than 50% chance of living one year. This is being contested by the IRS. Safe, under Treasury Regulation Sections 20.2031-7(d); 20.7520-3(b) Safe, under Internal Revenue Code Section 2702(a)(2)(B); 20.7520-3(b).Must pass the “probability of exhaustion test” (significant minimum value held under trust and/or by guarantors).No.Yes- According to Treasury Regulation Section 1.7520-3(b)(2)(i); 20.7520-3(b)(2)(i); 25.7520-3(b)(2)(I), but is the IRS’s position under the Regulation incorrect? – See Katzenstein, Turning the Tables: When do the IRS Actuarial Tables Not Apply?, Thirty-Seventh Univ.of Miami Inst. On Est. Planning, Ch. 3 (2003).No, if structured as a Walton-style GRAT.Must make annual payments.Probably, interest only until it balloons.No- The Kite case allowed no payments for the first 9 years.Yes.Compatible with defective grantor trust.Yes.Subject to probability of exhaustion test.Yes, it is a Grantor Trust.Payments must include principal.Not until it balloons.Probably not- as in the Kite case.Equal or increasing payments would represent income and principal conceptually.Explainable to the client.Yes.Yes.Slightly more complicated.Income tax imposed upon death.Possibly not, but IRS may not agree. (See Zaritsky, Tax Planning for Family Wealth Transfers §12.04[h], (4th ed. 2002))No.No- but on death, there is a negative estate tax impact.SCIN vs. PRIVATE ANNUITY vs. GRAT24

SCIN PRIVATE ANNUITY GRAT Stepped up basis on death of seller if assets are sold or transferred to individuals or non-grantor trusts. Only to the extent of payments made before the death of the seller. The purchaser only gets basis to the extent of payment actually made. Only to the extent of payments made before the death of the seller. The purchaser only gets basis to the extent of payment actually made. Non-applicable– GRATs do not involve sales of assets. Stepped up basis if assets are sold or transferred to grantor trusts. Yes, hopefully. (See Blattmachr, Gans and Jacobson, Income Tax Effects of Termination of Grantor Trust Status by Reason of the Grantor’s Death, Journal of Taxation, September 2002)Yes, hopefully. (See Blattmachr, Gans and Jacobson, Income Tax Effects of Termination of Grantor Trust Status by Reason of the Grantor’s Death, Journal of Taxation, September 2002)Yes, hopefully. Depending upon structuring.Possible usury issues for older taxpayer.Yes, unless the risk premium is applied to the note principal.No.No.Are Payment Rights Creditor Protected?Generally not, but can be held by family limited partnership or other entities that provide charging order or creditor protection. Yes, in several states. Yes, in several states. SCIN vs. PRIVATE ANNUITY vs. GRAT(Continued)25

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SCENARIO: SAMPLE DATAVisualization over 20 Year Time SpanHarland Sanders Life Expectancy is 9.2 Years Claudia Sanders Life Expectancy is 19 YearsToday Upon 1 st Death (in Year 10) GIFTING TRUST(S)Value$0 Annual Gifts$56,000 (adj for inflation)Annual Growth Rate10.98% less 15% feesILIT - HARLAND    Death Benefit$100,000 Annual Premium$5,000 ILIT - CLAUDIA    Death Benefit$100,000 Annual Premium$5,000 HAROLD AND CLAUDIA SANDERSResidence  Investments$750,000   $6,500,000 Annual GrowthAnnual AdditionsAnnual Growth Rate Rate 3.03% $50,000 10.98%less 15% fees ILIT - SURVIVORSHIP         Death Benefit $100,000 Annual Premium $5,000 CLAUDIA SANDERS Residence     Investments $850,000     $4,000,000 Annual Growth Annual Additions Annual Growth Rate Rate 3.03% $50,000 10.98%less 15% fees BY PASS TRUST Initial funding upon first death - $3,500,000         Annual Growth Rate 10.98% less 15% fees GIFTING TRUST(S) Value $914,316 Annual Gifts $28,000 (adj for inflation) Annual Growth Rate 10.98% less 15% fees ILIT - HARLAND         Death Benefit $100,000 Annual Growth Rate 10.98% less 15% fees ILIT - CLAUDIA         Death Benefit $100,000 Annual Premium $5,000 ILIT - SURVIVORSHIP         Death Benefit $100,000 Annual Premium $5,000 Upon 2 nd Death (in Year 25) CLAUDIA'S ESTATE Residence Investments Exclusion/Portability $850,000 $16,000,000 ($10,000,000) Net Taxable Estate: $6,850,000 TOTAL PASSED TO BENEFICIARIES       Claudia's Trust $4,110,000   Bypass Trust $6,589,000   Gifting Trust $2,356,246   ILIT - Harland $230,000   ILIT - Claudia $100,000   ILIT - Survivorship $100,000       TOTAL:   $13,485,246       ESTATE TAX $2,740,000 28

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32 SAVINGS AFTER 21 YEARS WITH DISCOUNTED GIFT, LOW INTEREST NOTE, AND GRANTOR PAYS INCOME TAX IS $5,112,565

SAVINGS AFTER 21 YEARS WITH NO DISCOUNT IS $3,888,882. DISCOUNTING SAVED IS $1,223,683. 33

34 SAVINGS AFTER 21 YEARS WITH TRUST PAYING INCOME TAX IS $2,903,932. SAVINGS FROM GRANTOR PAYING INCOME TAX IS $2,208,633.

35 SAVINGS USING A 20 YEAR SCIN IF THE CLIENT DIES IN YEAR SEVEN IS $2,686,697.