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.