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.