Using & Drafting
Trusts in
Estate Planning
2005 Edition
Table
of Contents
Chapter
One
Selected
State Law Issues
I. Discretionary
Support Trusts ...................................................................................... 1
A. Introduction
.............................................................................................................................. 1
B. Pure
Support Trust .................................................................................................................... 2
C. Pure
Discretionary Trust ........................................................................................................... 3
D. Discretionary
Support Trust ...................................................................................................... 4
II. Spendthrift
Trusts .............................................................................................................. 6
III. Choice
of Law ......................................................................................................................... 7
IV. Exculpatory
Clauses ......................................................................................................... 8
V. USING
TRUSTS IN MARYLAND ESTATE TAX PLANNING .................................................. 9
VI. DISCLAIMERS
AND DISCLAIMER TRUSTS ........................................................................... 10
A. Introduction
............................................................................................................................ 10
B. Sample
Bypass Disclaimer Trust Provisions ............................................................................ 11
C. Maryland
Uniform Disclaimers of Property Interests Act of 2004,
Md. Code Ann., Est. & Trusts § 9-201 et seq. ........................................................................ 11
D. Federal
Law: I.R.C. § 2518 ...................................................................................................... 12
Chapter
Two
Revocable
Living Trusts
I. ABOUT
REVOCABLE LIVING TRUSTS .................................................................................. 17
A. Definition
................................................................................................................................ 17
B. Advantages
of a Revocable Living Trust ................................................................................. 17
1. Property
management ........................................................................................................ 17
a. Trustee
as legal owner ................................................................................................. 17
b. Compared
with other asset management techniques ................................................... 18
c. Guardianship
alternative ............................................................................................. 18
2. Avoidance
of probate ........................................................................................................ 18
a. Advantages
of probate ................................................................................................ 18
b. Possible
disadvantages of probate ............................................................................... 19
c. Should
probate be avoided? ........................................................................................ 19
3. Out-of-state
property ........................................................................................................ 19
4. Ease
of amendment ........................................................................................................... 20
5. Tax
neutrality .................................................................................................................... 20
C. Disadvantages
of a Revocable Living Trusts ........................................................................... 20
1. No
death tax savings ......................................................................................................... 20
2. Higher
“start-up” costs ...................................................................................................... 20
3. Funding
concerns .............................................................................................................. 21
4. Bookkeeping
requirements ................................................................................................ 21
5. Client
confusion factor ...................................................................................................... 21
D. Using
Revocable Living Trusts ................................................................................................ 21
1. Education
.......................................................................................................................... 21
2. Hassle
factor ..................................................................................................................... 22
3. Costs
................................................................................................................................. 22
4. Potential
for contest .......................................................................................................... 22
E. Basic
Elements of a Revocable Living Trust ........................................................................... 22
1. Creation
of trust ................................................................................................................ 22
2. Lifetime
distributions ........................................................................................................ 23
3. Distributions
upon death ................................................................................................... 23
4. Settlor’s
reserved powers ................................................................................................... 24
5. Trustee’s
powers ............................................................................................................... 24
6. Spendthrift
provisions ....................................................................................................... 24
7. Identification
of trustee ..................................................................................................... 25
8. Waiver
of bond and court administration .......................................................................... 25
9. Trustee’s
compensation ..................................................................................................... 25
II. SAMPLE
REVOCABLE LIVING TRUST .................................................................................. 26
SECTION 1. Definitions ......................................................................................................... 26
SECTION 2. Creation of Trust ............................................................................................... 26
SECTION 3. Distributions During Settlor’s Life ..................................................................... 27
SECTION 4. Payments and Distributions Upon Death of
Settlor ........................................... 27
SECTION 5. Settlor’s Reserved Powers .................................................................................. 28
SECTION 6. Powers and Rights of Trustee ............................................................................ 29
SECTION 7. Spendthrift and Other Distribution
Provisions .................................................. 32
SECTION 8. Removal or Resignation; Successor Trustee ...................................................... 33
SECTION 9. Waiver of Bond and Court Administration ........................................................ 34
SECTION 10. Miscellaneous Provisions ................................................................................... 34
Chapter
Three
MARITAL
DEDUCTION
I. THE
MARITAL DEDUCTION RULES ..................................................................................... 37
A. Rules
for Transfers to Spouse Who is U.S. Citizen .................................................................. 37
B. Rules
for Transfers to Noncitizens .......................................................................................... 38
1. Estate
tax marital deduction ............................................................................................. 38
2. Gift
tax marital deduction ................................................................................................. 38
3. Jointly
owned assets .......................................................................................................... 39
II. TYPES
OF TRANSFERS THAT QUALIFY FOR THE MARITAL DEDUCTION ................. 39
A. Outright
Dispositions to Surviving Spouse ............................................................................. 39
B. Gifts
in Trust ........................................................................................................................... 39
III. TYPES
OF TRUSTS THAT QUALIFY FOR THE MARITAL DEDUCTION ......................... 39
A. Power
of Appointment Trusts ................................................................................................. 39
B. Estate
Trusts ........................................................................................................................... 41
C. Qualified
Terminable Interest Property (QTIP) Trusts ........................................................... 42
IV. Treatment
of Administration Expenses ............................................................... 46
A. The
Hubert Decision .............................................................................................................. 46
V. ESTATE
PLANNING DESIGN IN LIGHT OF LIMITED MARYLAND ESTATE
TAX EXEMPTION AND CHANGE TO FEDERAL DEDUCTION FOR STATE
ESTATE TAXES PAID ............................................................................................................... 48
A.. Estate
Tax Exemption Limits ........................................................................................... 48
B. Decoupling
of the Maryland Estate Tax Exemption ............................................................... 48
C. Creating
Flexibility .................................................................................................................. 48
D. Single
QTIP Trust ................................................................................................................... 49
E. Clayton
QTIP Trust ................................................................................................................ 49
F. Clayton
Trust Combined with Automatic $1 Million to Bypass Trust ..................................... 49
G. Use
of Disclaimers .................................................................................................................. 50
H. I.R.C.
§ 2058 Deduction ......................................................................................................... 50
I. Conclusion
.............................................................................................................................. 51
VI. IS
IT ALWAYS BEST TO USE A MAXIMUM MARITAL DEDUCTION PLAN AND
AVOID ANY TAX AT THE DEATH OF THE FIRST SPOUSE? ........................................... 51
A. Equalization
vs. Deferral ........................................................................................................ 51
B. Instances
Where Equalization Should Be Considered ............................................................. 51
VII. Wealthy Spouse/poorer spouse estate
plan design ................................... 52
A. Marital
Trusts .......................................................................................................................... 52
B. Gift
to Contingent Lifetime QTIP Trust ................................................................................. 52
C. Revocable
Trust with General Power of Appointment ........................................................... 52
VIII. QUALIFIED DOMESTIC TRUSTS (QDOT’s) ....................................................................... 53
A. Qualifications
.......................................................................................................................... 53
B. Additional
Requirements ......................................................................................................... 53
C. Triggering
Events for Imposition of Estate Tax ...................................................................... 54
D. Calculation
of Tax ................................................................................................................... 54
E. QDOT
Regulations ................................................................................................................. 54
1. Large
estates have three options ....................................................................................... 54
2. Smaller
estates may merely keep their assets home ........................................................... 54
3. Indebtedness
and the value of the trust fund .................................................................... 55
4. Residence
exception .......................................................................................................... 55
5. Redetermination
of value of trust assets ........................................................................... 55
6. Duration
of bond or letter of credit ................................................................................... 55
7. Notice
of failure to renew bond or letter of credit ............................................................. 55
8. Foreign
trusts .................................................................................................................... 55
9. Forms
of ownership that are not trusts .............................................................................. 55
10. Authority
to waive requirement of U.S. Trustee for QDOT’s ........................................... 56
IX. SAMPLE
CLAUSES THAT QUALIFY FOR MARITAL DEDUCTION ................................... 56
A. Bequest
of Specific Property ................................................................................................... 56
B. Bequest
of Money ................................................................................................................... 56
C. Straight
Fractional Share of Residuary Estate ......................................................................... 56
D. Formula
Marital Deduction Bequests ...................................................................................... 56
1. Clayton
QTIP into Bypass Trust (Credit Trust) ................................................................ 56
2. Pecuniary
Credit Trust limited to amount that can pass free of state
estate tax — balance of estate divided into QTIP trust equal to balance of
federal credit and marital share QTIP ............................................................................... 58
3. Specific
bequest of amount of FET exemption over domiciliary state
exemption to separate QTIP trust...................................................................................... 59
4. Outright
to spouse with disclaimer funded credit trust ..................................................... 60
5. Special EGGTRA considerations in
drafting formula clauses ................................................. 61
E. Non-Formula
Bequest ............................................................................................................. 61
Chapter
Four
GENERATION-SKIPPING
TRUSTS
I. THE
BENEFITS OF GENERATIon-SKIPPING .................................................................... 63
II. REVIEW
OF BASIC PROVISIONS OF THE GENERATION-SKIPPING
TRANSFER TAX ......................................................................................................................... 63
A. In
General ............................................................................................................................... 63
B. Generation‑Skipping
Transfers — In General ......................................................................... 64
C. The
Tax ................................................................................................................................... 66
1. Predeceased
parent exclusion ............................................................................................ 67
2. Annual
exclusions ............................................................................................................. 68
3. The
GST exemption .......................................................................................................... 68
4. Grandfathered
transfers ..................................................................................................... 70
5.
Modifications to exempt trusts ......................................................................................... 71
III.
GENERATION-SKIPPING PLANNING IN GENERAL ........................................................ 71
IV.
PLANNING OPPORTUNITIES IN TESTAMENTARY INSTRUMENTS ............................. 72
A. Situation:
The Client Who Does Not Intend To Make a Generation‑Skipping Transfer ......... 72
B. Situation:
The Married Client Who Intends To Make a Generation‑Skipping
Transfer at the Death of the Surviving Spouse ........................................................................ 74
a. Allocation
of the entire available GST Exemption to a QTIP trust ............................ 75
C. Situation
— Generation — Skipping Trusts for the Benefit of Descendants
Following the Death of a Surviving Spouse, or in the Wills of Single
Individuals ................... 76
1. The
Exempt Trust ............................................................................................................. 76
2. The
Non‑exempt Trust ...................................................................................................... 77
D. Situation
— Planning for the Repeal of the Transfer Tax System ........................................... 77
V. OTHER
PLANNING OPPORTUNITIES. ................................................................................. 78
A. The
Irrevocable Trust — “Leveraging” the GST Exemption .................................................. 78
B. Charitable
Lead Trusts ............................................................................................................ 79
C. Section
2642(c) — Trusts for Grandchildren .......................................................................... 79
D. Educational/Medical
Trust for Skip Person ............................................................................ 80
Chapter
Five
Trusts
and Medical Assistance Long-Term Care Eligibility
A. Supplemental
Needs Trusts (SNT), In General ....................................................................... 81
B. Medical
Assistance Disqualifying Trusts ................................................................................. 81
C. Exemptions
from Federal Trust Provisions ............................................................................. 82
D. Maryland
Discretionary Trust — Supplemental Needs Trust .................................................. 84
F. Variations
in Treatment of SNTs ............................................................................................ 84
G. SNTs
and Other Public Benefits ............................................................................................. 84
B. 42
U.S.C. § 1396p(d)(4)(A) Supplemental Needs Trust Form ................................................ 86
C. COMAR
10.09.24.08-2 — Treatment of Trust Amounts ....................................................... 97
D. 42
U.S.C. § 1396p(c)(2)(B)(iii) Irrevocable Living Trust Form ............................................. 101
E.. Letter
to Roy R. Trudel, Center for Medicare and Medicaid Services, April 28, 2005 .... 116
F. Maryland
Medical Assistance Manual Release No.: MR-69, 800-117 through 122 ............... 118
G. Life
Expectancy Tables (Social Security Administration) ..................................................... 124
H. Maryland
Medical Assistance Manual Release No.: MR-113, 800-86a & 86b ...................... 126
Chapter
Six
Irrevocable
Life Insurance Trust
I. OVERVIEW
OF PROBLEM AND OPPORTUNITY ............................................................. 129
A. Problem
................................................................................................................................. 129
B. The
Opportunity ................................................................................................................... 129
C. Summary
of Solution ............................................................................................................. 129
D. Generation-Skipping
Transfer Tax Opportunity ................................................................... 130
E. Typical
Terms of ILIT ........................................................................................................... 130
1. While
insured is alive ...................................................................................................... 130
2. After
death of insured ..................................................................................................... 130
3. Spouse
as trustee ............................................................................................................. 130
4. Trustee
powers with respect to insurance ....................................................................... 130
II. SOME
FEDERAL ESTATE TAX TRAPS ............................................................................... 131
A. I.R.C.
§ 2042(1) — Life Insurance Received by Estate ......................................................... 131
1. Inclusion
in the gross estate ............................................................................................ 131
2. Restriction
on insurance beneficiary ................................................................................ 131
B. Section
2042(2) — Incidents of Ownership .......................................................................... 131
1. Inclusion
in the gross estate ............................................................................................ 131
2. Incidents
of ownership — defined .................................................................................. 131
3. Power
over the choice of settlement options .................................................................. 131
4. 5%
Reversionary interest ................................................................................................. 132
5. Controlling
shareholder or business owner ...................................................................... 132
6. Intentional
fiduciary ........................................................................................................ 132
7. Inadvertent
fiduciary ....................................................................................................... 132
a. Insured
serving as trustee will not cause FET ........................................................... 132
b. Rev.
Rul. 84-179 ....................................................................................................... 132
8. Summary
......................................................................................................................... 133
C. The
Power to Remove the Trustee ........................................................................................ 133
1. Power
to appoint successor trustee under Rev. Rul. 77-182 ........................................... 133
2. Rev.
Rul. 95-58 modified Rev. Rul. 77-182 .................................................................... 133
3. Unlimited
power to remove trustee ................................................................................. 133
4. Prospective
effect of Rev. Rul. 79-353 ........................................................................... 134
5. Rev.
Rul. 79-353 revoked by Rev. Rul. 95-58 ................................................................. 134
6. Rev.
Rul. 95-58 is not the best answer ............................................................................ 134
7. Prospective
effect of Rev. Rul. 95-58 ............................................................................. 134
8. Solutions
to Rev. Rul. 79‑353 ......................................................................................... 134
a. Limit
the trustee’s power ........................................................................................... 134
b. The
“Trust Protector” ............................................................................................... 134
c. Consider
a “window” power to remove ..................................................................... 135
d. Consider
requiring “good cause” for removal ............................................................ 135
e. Maryland
legislative solution ........................................................................................... 135
f. Use
caution in giving beneficiary power to remove ................................................... 135
D. The
Reciprocal Trust Doctrine .............................................................................................. 135
1. Application
of the doctrine ............................................................................................. 135
2. Things
to avoid ............................................................................................................... 136
3. Practice
pointers .............................................................................................................. 136
III. THE
THREE YEAR RULE UNDER § 2035 ............................................................................ 136
A. Basic
Rule ............................................................................................................................. 136
1. Gift
within three years of death ....................................................................................... 136
2. Retained
“incidents of ownership” .................................................................................. 136
B. Insured’s
Payment of Premiums ............................................................................................ 136
C. Reducing
the Includable Proceeds: Have Transferee Pay Post-Transfer Premiums .............. 136
D. Eliminating
the Includable Proceeds ..................................................................................... 137
1. Have
trustee procure the policy ...................................................................................... 137
2. I.R.S.
may view trustee as insured’s agent ....................................................................... 137
3. Recent
cases .................................................................................................................... 137
a. Estate
of Leder v. Commissioner ..................................................................................... 137
b. Estate
of Headrick v. Commissioner ................................................................................ 137
c. Estate
of Perry v. Commissioner ...................................................................................... 138
d. Plan
carefully ............................................................................................................. 138
4. Planning
suggestions ....................................................................................................... 138
a. Have
gift exceed first year’s premium ....................................................................... 138
b. Gift
to the trust must be unconditional ..................................................................... 138
c. Have
insurance procured solely by trustee ................................................................ 138
d. Avoid
“incidents of ownership” ................................................................................ 138
e. Estate
of Clay v. Commissioner ................................................................................ 139
f. Avoid
power to change manner of enjoying trust proceeds ....................................... 139
E. Contingent
Marital Deduction ............................................................................................... 139
F. Term
Insurance to Cover Estate Tax Risk ............................................................................ 139
G. Avoid
Annual Accidental Death Insurance ........................................................................... 139
H. Exchange
of Policy by Trust ................................................................................................. 139
I. Chawla
v. Transamerica Occidental Life Insurance Company .......................................................... 139
IV. GROUP
TERM LIFE INSURANCE — SELECTED ASPECTS ............................................. 140
A. Assignment
— General Rule ................................................................................................. 140
B. Assignment
of Conversion Privilege ...................................................................................... 140
C. Change
of Insurance Carrier .................................................................................................. 141
1. Effect
on three-year period ............................................................................................. 141
2. New
policy identical to old ............................................................................................. 141
3. Planning
suggestions ....................................................................................................... 141
a. Narrow
the language ................................................................................................. 141
b. Sign
a “notice” .......................................................................................................... 142
c. Separate
“notices” and releases ................................................................................. 142
D. Incidents
of Ownership ......................................................................................................... 142
V. GIFT
TAX ASPECTS — THE CRUMMEY CLAUSE ............................................................. 142
A. Overview
and General Context ............................................................................................. 142
B. The Crummey Clause ............................................................................................................ 142
1. Creates
a present interest ................................................................................................ 142
2. The
right may be possessed by a minor ........................................................................... 142
3. Example
.......................................................................................................................... 142
4. Trigger
............................................................................................................................. 143
5. Notification
..................................................................................................................... 143
6. Invasion
right must exist for a significant period ............................................................. 143
7. Minors
............................................................................................................................. 143
8. Have
written notice sent ................................................................................................. 143
9. Adequate
notice .............................................................................................................. 143
10. Information
to include in the Crummey clause ................................................................ 144
11. Present
interest ................................................................................................................ 144
C. Group
Term Aspects ............................................................................................................. 144
1. The
Crummey clause ....................................................................................................... 144
2. “Liquidity
seed” .............................................................................................................. 144
D. The
Five and Five Exception ................................................................................................ 144
1. Non-exercise
by donee of power to withdraw ................................................................. 144
2. ERTA
.............................................................................................................................. 145
3. “Release”
v. “Lapse” ....................................................................................................... 145
4. Creating
more Crummey clause protection ...................................................................... 145
E. The
Hanging Power ............................................................................................................... 145
1. Generally
......................................................................................................................... 145
2. Example
.......................................................................................................................... 145
3. Multiple
beneficiaries ...................................................................................................... 145
4. Defining
power of withdrawal to include entire trust corpus .......................................... 146
5. Suggestion
....................................................................................................................... 146
F. Dealing
With TAM 8901004 ................................................................................................. 147
1. Beware
the “naked” power of withdrawal ....................................................................... 147
2. Privite
Letter Ruling 880603 ........................................................................................... 147
3. TAM
9045002 ................................................................................................................. 148
4. Estate
of Cristofani v. Commissioner .............................................................................. 148
5. Planning
suggestions ....................................................................................................... 148
a. Crummey
clause drafted ............................................................................................ 148
b. Grant
some continuing interest in the trust ............................................................... 148
c. Example
.................................................................................................................... 149
d. Financial
emergencies ............................................................................................... 149
e. Testamentary
limited power of appointment ............................................................. 149
f. Hanging
powers ......................................................................................................... 149
g. Sham
transactions ..................................................................................................... 149
h. Suggested
general rule ............................................................................................... 150
i. Minimize
number of donees of withdrawal powers ................................................... 150
j. If
donee exercises power to withdraw ....................................................................... 150
k. Have
donee withdraw ............................................................................................... 150
G. Generation-Skipping
Tax Aspects ......................................................................................... 150
1. Prior
to TAMRA ............................................................................................................. 150
2. After
March 31, 1988 ...................................................................................................... 150
3. GST
liability .......................................................................................................................... 150
H. Income
Tax Aspects .............................................................................................................. 151
1. §§ 677(a)
and 678(b) ....................................................................................................... 151
2. In
the year of lapse .......................................................................................................... 151
3. Taxation
of trust income in year of creation .................................................................... 151
4. Life
insurance policy only property in trust ..................................................................... 151
5. Gift
of cash to pay insurance premium ............................................................................ 151
6. Taxation
after the year of the lapse ................................................................................. 151
7. Payment
of income tax liability by grantor ...................................................................... 152
I. Valuation
Issues — Generally ............................................................................................... 152
1. Value
immediately after transfer ..................................................................................... 152
2. Value
of a paid-up policy ................................................................................................ 152
3. Value
of existing policy with premium payments due ..................................................... 152
4. Value
of term insurance .................................................................................................. 152
5. Value
of assets transferred to trust .................................................................................. 152
6. Transfer
of amount to discharge premium payment ........................................................ 153
7. Cash
donations to unfunded trust ................................................................................... 153
J. Valuation
Issues — Group Term .......................................................................................... 153
1. Initial
transfer of group term insurance to the trust ......................................................... 153
2. Value
of group term insurance to the employee .............................................................. 153
3. Treas.
Reg. § 1.79-3(d)(2) ............................................................................................... 153
VI. GENERATION-SKIPPING
TRANSFER TAX ASPECTS ...................................................... 153
A. Overview
and General Context ............................................................................................. 153
1. Tax
Reform Act of 1986 ................................................................................................. 153
2. Review
Chapter 13 .......................................................................................................... 154
3. Technical
and Miscellaneous Revenue Act of 1988 ........................................................ 154
4. Examples
involving generation-skipping transfer tax ...................................................... 154
5. Examples
not involving generation-skipping transfer tax ................................................ 154
B. Nontaxable
Gift Exception ................................................................................................... 154
1. Annual
exclusion gifts were not subject to GST prior to TAMRA .................................. 154
2. Effect
of TAMRA on GST Tax ....................................................................................... 154
3. Achieving
GST exemption for the “Typical” ILIT .......................................................... 155
4. Importance
...................................................................................................................... 155
5. Constructive
additions to grandfathered trust ................................................................. 155
6. Automatic
allocations of GST exemption ....................................................................... 155
7. Form
709 — U.S. Gift and GST tax return ..................................................................... 156
C. Leverage
the Exemption ....................................................................................................... 157
1. Exemption
....................................................................................................................... 157
2. Leveraging
the exemption ............................................................................................... 157
3. Leveraging
the applicable credit and the GST tax exemption ......................................... 157
4. Keep
the ILIT exempt from GST tax .............................................................................. 157
5. “Family
Liquidity Fund” ................................................................................................. 158
D. Incomplete
Inter Vivos Transfers .......................................................................................... 158
1. The
estate tax inclusion period ........................................................................................ 158
2. Prevention
of leveraging .................................................................................................. 158
3. New
subsection 2642(f) .................................................................................................. 158
4... No
three-year rule ..................................................................................................... 158
5. Preservation
of GSTT avoidance benefits ....................................................................... 159
E. Definition
of Transferor ........................................................................................................ 159
1. Definition
of transferor amended .................................................................................... 159
2. Prior
law .......................................................................................................................... 159
3. New
helpful language ...................................................................................................... 159
VII. ESTATE FREEZE PROVISIONS —
§ 2036(c) AND CHAPTER 14 .................................. 159
A. Section
2036(c) ..................................................................................................................... 159
B. Chapter
14 ............................................................................................................................. 159
VIII. JOINT AND SURVIVOR LIFE ............................................................................................. 160
A. Overview
.............................................................................................................................. 160
1. Rationale
for joint and survivor life policy ...................................................................... 160
2. Low
premium cost ........................................................................................................... 160
3. Downside
........................................................................................................................ 160
IX. Appendix
................................................................................................................................ 160
Form 1. — Life Insurance Policies and
Proceeds of Policies ...................................................... 160
Form 2. — Power to Loan to or
Purchase Property from Settlor’s Estate .................................. 161
Form 3. — Irrevocable Trust with no
Incidents of Ownership ................................................... 161
Form 4. — Income and Principal after
Settlor’s Death while Spouse Surviving.......................... 162
Form 5. — Family Invasion Right —
Hanging Crummey Power ................................................ 162
Chapter
Seven
Charitable
Split Interest Trusts
I. CHARITABLE
REMAINDER TRUSTS ................................................................................... 165
II. BASIC
REQUIREMENTS ......................................................................................................... 166
III.
PAYMENT OF ANNUITY AND UNITRUST AMOUNTS .................................................... 168
IV.
SOME RULES COMMON TO CHARITABLE REMAINDER TRUSTS ............................... 169
A. Sum
Certain and Fixed Percentage ........................................................................................ 169
B. Minimum
Amounts ............................................................................................................... 169
C. Taxation
................................................................................................................................ 170
D. Valuation
of Remainder Interest ........................................................................................... 170
1. Annuity
trust ................................................................................................................... 170
2. Unitrust
........................................................................................................................... 171
3. Flip
unitrust ..................................................................................................................... 171
4. Some
planning considerations ......................................................................................... 172
V. CHARITABLE
LEAD TRUST .................................................................................................. 173
Chapter
Eight
GRITs,
QPRTS and GRATs
I. INTRODUCTIOn
..................................................................................................................... 177
A.
Synopsis ............................................................................................................................... 177
B. Estate
Freezes ....................................................................................................................... 177
C. Conventions
.......................................................................................................................... 177
D. Customary
Disclaimer ........................................................................................................... 177
II. BACKGROUND .............................................................................................................................. 177
A. GRITs
in General .................................................................................................................. 177
B. GRITs
as an Estate Planning Technique ............................................................................... 178
C. Tax
Consequences ................................................................................................................. 178
1. Gift
tax ............................................................................................................................ 178
a. Value
of retained interest consisting of the right to receive income only .................. 178
b. Value
of a retained contingent principal interest ....................................................... 178
c. Calculating
the amount of the gift ............................................................................. 179
2. Estate
tax ........................................................................................................................ 180
a. Grantor
survives term ............................................................................................... 180
b. Grantor
dies during term ........................................................................................... 180
3. Income
tax ....................................................................................................................... 180
a. Section
673 ............................................................................................................... 180
b. Section
675 ............................................................................................................... 180
c. Section
674 ............................................................................................................... 181
d. Section
677 ............................................................................................................... 181
e. Consequences
of grantor trust status ......................................................................... 181
f. Basis
.......................................................................................................................... 182
4. Generation‑skipping
transfer tax ..................................................................................... 182
III.
CONGRESS AND THE INTERNAL REVENUE SERVICE RESPOND ............................. 182
A. Section
2036(c) and Notice 89-99 ........................................................................................ 182
B. Section
2702 and Its Impact on GRITs ................................................................................. 182
1. General
rule ..................................................................................................................... 182
2. Members
of the grantor’s family ...................................................................................... 182
3. Effect
of the general rule ................................................................................................. 183
4. GRITs
for nieces and nephews ........................................................................................ 183
5. The
personal residence exception to the general rule ...................................................... 183
6. The
“Qualified Interest” exception to the general rule .................................................... 183
IV.
THE QUALIFIED PERSONAL RESIDENCE TRUST .......................................................... 183
A. The
Approach of the Regulations to the Personal Residence Exception ............................... 183
1. The
committee reports .................................................................................................... 183
2. The
regulations ................................................................................................................ 183
3. I.R.S.
Form of QPRT ...................................................................................................... 184
B. Governing
Instrument Requirements in General ................................................................... 184
1. Incorporation
by reference .............................................................................................. 184
2. Saving
language ............................................................................................................... 184
3. The
two trust approach ................................................................................................... 184
C. The
Personal Residence ........................................................................................................ 184
1. The
principal residence of the term holder ...................................................................... 184
2. One
other residence of the term holder ........................................................................... 184
3. Undivided
fractional interest in either ............................................................................. 185
D. Use
of the Residence ............................................................................................................. 185
E. Trust
Income ......................................................................................................................... 186
F. Distributions
to Persons Other Than the Grantor ................................................................. 186
G. Trust Assets .......................................................................................................................... 186
1. General
rule ..................................................................................................................... 186
2. Exceptions
...................................................................................................................... 186
a. Cash
.......................................................................................................................... 186
b. Improvements
........................................................................................................... 186
c. Sale
proceeds ............................................................................................................. 187
d. Insurance
and insurance proceeds ............................................................................. 187
H. Commutation
Power ............................................................................................................. 187
I. Cessation
of Use as a Personal Residence ............................................................................. 187
J. Disposition
of Trust Assets on Cessation as a QPRT ........................................................... 188
1. Payment
.......................................................................................................................... 188
2. Amount
........................................................................................................................... 189
3. Example
.......................................................................................................................... 189
4. Inconsistent
I.R.S. rulings ................................................................................................ 189
K. Sale
of Residence to Grantor Prohibited ............................................................................... 189
1. The
Service’s rationale .................................................................................................... 190
2. The
real reason for the new regulation ............................................................................ 190
3. Trusts
created prior to May 16, 1996 .............................................................................. 190
4. Reformation
.................................................................................................................... 190
V. PLANNING
FOR THE QPRT .................................................................................................. 190
A. The
Trustee ........................................................................................................................... 190
B. Use
of the Residence Following the Expiration of the Grantor’s Retained Interest .............. 191
1. Purchase
of the residence ................................................................................................ 191
a. Gain
.......................................................................................................................... 191
b. Basis
.......................................................................................................................... 191
c. Payment
.................................................................................................................... 191
d. Consequences
............................................................................................................ 191
e. A
new QPRT ............................................................................................................. 191
2. Rental
of the residence .................................................................................................... 191
a. Estate
tax consequences ........................................................................................... 192
b. Income
tax consequences .......................................................................................... 192
3. Continuance
of the trust for the benefit of the grantor’s spouse ..................................... 192
C. Residence
Owned by Husband and Wife .............................................................................. 192
1. Transfer
of residence to one of the spouses followed by conveyance to the QPRT ........ 192
2. Transfer
of fractional interests by both spouses .............................................................. 193
D. Multiple
QPRTs for a Single Grantor .................................................................................... 193
E. The
Length of the Trust Term ............................................................................................... 193
F. More
about the Contingent Reversion ................................................................................... 194
G. Effect
of Interest Rates ......................................................................................................... 195
H. Transfer
of a Residence Subject to a Mortgage ..................................................................... 195
1. Gift
of residence subject to non‑recourse obligation ....................................................... 195
2. Gift
of residence subject to recourse obligation .............................................................. 196
I. Transfer
of Adjacent Land .................................................................................................... 196
J. Trust
Remaindermen ............................................................................................................. 196
1. Continuation
of trust ....................................................................................................... 196
2. Termination
of the trust .................................................................................................. 196
K. Trust
Expenses ............................................................................................................................ 197
VI.
GRATs ...................................................................................................................................... 197
A. GRATs
in General ................................................................................................................ 197
B. GRUTs
Distinguished ........................................................................................................... 197
C. The
Regulations — in General .............................................................................................. 197
D. The
Governing Instrument Requirements ............................................................................. 197
1. In
general ......................................................................................................................... 197
2. Payment
of the annuity amount ...................................................................................... 197
3. Incorrect
valuations ......................................................................................................... 198
4. Payment
date ................................................................................................................... 198
5. No
additional contributions ............................................................................................ 198
6. No
distribution to others ................................................................................................. 198
7. Term
................................................................................................................................ 198
8. Commutation
prohibited ................................................................................................. 199
E. Tax
Consequences ................................................................................................................. 199
1. Gift
tax ............................................................................................................................ 199
2. Estate
tax ........................................................................................................................ 199
a. Section
2036 ............................................................................................................. 199
b. Section
2039 ............................................................................................................. 199
3. Income
tax ....................................................................................................................... 200
4. Generation-skipping
transfer tax ..................................................................................... 200
VII. PLANNING FOR GRATs — LESS IS MORE ........................................................................ 200
A. What
Makes a GRAT Work .................................................................................................. 200
B. The
Theoretical Ideal GRAT ................................................................................................ 200
C. Zeroed-Out
GRATs: I.R.S. Position Successfully Challenged .............................................. 201
1. The
Service’s position ..................................................................................................... 201
2. Taxpayer
victory .............................................................................................................. 201
3. No
taxable gift ................................................................................................................. 201
D. Revocable
Spousal Annuities ................................................................................................ 201
E. Short-Term
Trusts Are Better Than Long-term Trusts .......................................................... 202
F. Single
Asset Trusts Are Better Than Multiple Asset Trusts .................................................. 202
G. Layered
GRATs .................................................................................................................... 202
H. Paying
the Annuity ................................................................................................................ 202
I. Continued
Trust after Termination of Grantor’s Annuity ..................................................... 203
1. Continuation
of trust ....................................................................................................... 203
2. Termination
of the trust .................................................................................................. 203
J. Generation-Skipping
............................................................................................................. 203
K. Trustee
.................................................................................................................................. 203
Chapter
8
APPENDIX
A. Form
of QPRT ...................................................................................................................... 207
B. Form
of GRAT ...................................................................................................................... 215
C. Comparison
of Different Interest Rates on QPRT Performance ........................................... 221
D. I.R.S. — Sample Declaration of Trust for Qualified Personal
Residence Trust — (Rev. Proc. 2003-42) ..................................................................................................... 223
Chapter
Nine
Qualified
Subchapter S Trusts (“QSSTS”)
A. Introduction
.......................................................................................................................... 231
B. S
Corporation Basics ............................................................................................................. 232
1. Number
of permitted stockholders .................................................................................. 232
2. Classes
of stock ............................................................................................................... 232
3. Types
of permitted shareholders ..................................................................................... 232
4. Excluded
shareholders .................................................................................................... 232
5. S
Election. ....................................................................................................................... 233
a. Time
for making election. ......................................................................................... 233
b. Shareholder
consent .................................................................................................. 233
c. Form
.......................................................................................................................... 233
6. Revocation
of S election ................................................................................................. 233
a. Required
consent ....................................................................................................... 233
b. When
effective .......................................................................................................... 233
7. Events
that trigger termination of election ...................................................................... 233
8. Five-year
rule .................................................................................................................. 234
9. Inadvertent
terminations ................................................................................................. 234
C. Use
of Trusts ......................................................................................................................... 234
1. Grantor
Trusts ................................................................................................................. 235
2. Section 678
Trusts .......................................................................................................... 235
3. Testamentary
Trusts ........................................................................................................ 235
4. Voting
Trusts .................................................................................................................. 235
5. Qualified
Subchapter S Trusts (“QSSTs”) ....................................................................... 235
6. Electing
Small Business Trusts (“ESBTs”) ..................................................................... 235
D. Characteristics
of a QSST ..................................................................................................... 236
E. Electing
QSST Status ............................................................................................................ 237
F. Time
for Making Election ..................................................................................................... 238
G. Effect
of QSST Status ........................................................................................................... 238
H. Revocation
............................................................................................................................ 238
I. Marital
Trust ......................................................................................................................... 239
J. Credit
Shelter Trust ............................................................................................................... 239
K. Section
2503 (c) Trust ........................................................................................................... 240
L. Charitable
Remainder Trusts ................................................................................................. 240
M. Special
Planning Problems with a QSST ............................................................................... 241
1. Paying
tax liability ........................................................................................................... 241
2. Definition
of “Income” ................................................................................................... 241
3. Disposition
of S corporation stock by QSST ................................................................... 241
N. Electing
Small Business Trust ............................................................................................... 241
1. Generally
......................................................................................................................... 241
2. Qualification
................................................................................................................... 241
3. Election
........................................................................................................................... 242
4. No
interest acquired by purchase .......................................................................................... 242
5. Beneficiaries
.................................................................................................................... 242
6. Taxation
.......................................................................................................................... 243
O. Bibliography
.......................................................................................................................... 243
Chapter
Ten
Bypass
or Credit Shelter Trusts
I. INTRODUCTION
TO BYPASS OR CREDIT SHELTER TRUSTS ....................................... 245
A. Basic
Definition .................................................................................................................... 245
B. Reasons
for a Bypass Trust ................................................................................................... 245
C. The
Applicable Credit Amount ............................................................................................. 245
D. Maryland
Estate Tax ............................................................................................................. 246
E. Income
Tax Planning ............................................................................................................. 248
F. Powers
of Appointment ........................................................................................................ 248
1. What
constitutes a general power of appointment? ......................................................... 248
2. The
“ascertainable standard” exception .......................................................................... 249
3. The
“five-and-five power” .............................................................................................. 250
5. Can
the spouse be given power to remove the trustee of the bypass trust? ..................... 253
G. Gift
tax problems associated with powers of appointment .................................................... 253
H. Remedial
Statute ................................................................................................................... 254
Table of Authorities............................................................................................................ 255
Table of Cases........................................................................................................................... 263