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Simple Techniques For the Estate Planner
hat estate-planning techniques remain in the tool box? Which approaches will remain viable as transfer-tax reforms arrive over the next decade? Those are billion-dollar questions that everyone would like to know ahead of time with certainty.
A real tool box contains a variety of seldom used thingamajigs, gizmos, whatchamacallits, and, without fail, the comprehensive socket wrench set that sits languishing beneath years of accumulated dust yearning for that one moment of glory that it will actually be called into service. Yet, ironically, it is the basic hammer, screwdriver, and pliers which continue to be the mainstays of daily handiwork.
By comparison, estate-planning professionals attend seminars and read articles about some of the most elaborate, experimental, and exotic arrangements.1 Yet, it is a small number of simple devices that, despite being taken for granted, actually carry out the vast majority of our estate-planning objectives. The basics should not be underestimated.
1. The Durable Power of Attorney
Alice, age 80, had always managed her commercial properties herself. But with her health becoming an issue, she executed a power of attorney to enable her nephew, Arlo, to act on her behalf. The power of attorney was "durable," so it remained effective even when Alice became incompetent.
Now, with his aunt's health failing and her various properties needing attention, Arlo has an opportunity to use that power of attorney in a manner that has estate-planning implications. The power to transfer property is a valuable tool for conserving assets, selling assets to create liquidity, or transferring assets to secure more favorable tax consequences. But several words of warning are essential.
First, the power of attorney is too powerful a tool to be taken for granted. An inexperienced family member who is entrusted with such a power can do serious damage to an estate. Second, the standards for powers of attorney vary from state to state.
For example, Decedent's daughter, acting in her capacity as an attorney-in-fact pursuant to a durable power of attorney, transferred Decedent's house to a qualified personal residence trust (QPRT) of which the daughter was the beneficiary. Decedent's daughter also transferred cash from Decedent to another trust for the benefit of Decedent's grandchildren.
Although the durable power of attorney document did not specifically authorize the attorney to make gifts, the language was sufficiently broad to create a general power of attorney, the value of gifts was small compared to the overall size of the estate, Decedent was not disadvantaged by the gifts, and the gifts were consistent with Decedent's intent as well as her history of gift giving. Therefore, the gifts were validly completed and the transferred assets were not included in Decedent's gross estate.2 However, the use of a power of attorney to transfer property cannot be assumed in every jurisdiction. For example, a trusted family advisor who had acted in the capacities of executor and trustee previously, made 38 inter vivos gifts, each in the amount of $10,000, on behalf of Decedent shortly before her death. The advisor made the gifts under the authority of a general durable power of attorney and under state law (California), gifts by such a fiduciary are not valid unless expressly authorized by the document in question. The Federal Court of Claims therefore determined that Decedent retained the power to revoke such gifts, so they remained in her estate.3
2. Disclaimer Trusts
A second basic tool for rearranging assets after a plan has been made is the disclaimer. By refusing to accept an interest created by a will or trust, a beneficiary causes that interest to be distributed to an alternate beneficiary. The disclaimant is treated as having predeceased the grantor or testator. Though simple, a disclaimer is very powerful.
For example, a testator divides his estate between his wife and his wealthy son. The testator's unified credit has been exhausted. The wealthy son doesn't need the additional inheritance. A disclaimer causes the funds to be lateralled to the testator's wife. Since the assets are therefore covered by the marital deduction, no transfer tax is due. The testator's wife can then transfer assets to her son or others using annual gifts and her own unified credit.
In anticipation of disclaimers being used, a professionally administered trust can be established. Such a trust can provide alternate beneficiaries who would benefit in the event one of the beneficiaries of the will disclaims assets. A trust can also provide guidance on how assets will be invested, supervised, and, ultimately, distributed.4
3. Powers of Appointment
While the durable power of attorney can be useful in adjusting assets just prior to death, and the disclaimer can be useful in adjusting assets immediately following death, subsequent adjustments can be made with a power of appointment.
For example, Husband leaves an income interest in certain assets to Wife, along with the power to appoint the principal in accordance with whatever guidelines he establishes. Suppose he limits the power of appointment to a disposition to his children, but allows Wife to determine how to divide the assets. This provides Husband with a certain amount of assurance that the assets will reach the beneficiaries he has selected, his children, even if Wife remarries.
On the other hand, the power of appointment incorporates flexibility in that Wife, can leave more assets to one child than the other, based on the different needs, tax consequences, or liability exposures of the respective beneficiaries. The precise guidelines of the appointment power can be structured with a range of customized possibilities. It may include other classes of relatives such as parents, grandparents, nieces and nephews, cousins, or specific friends.
Note that when a power of appointment becomes so broad that it enables the holder to appoint the power to his or her own estate or creditors of the estate, the assets subject to the power will be included in the power holder's estate. The power holder can be given some discretion to invade the principal for his or her own benefit if the power is limited to an ascertainable standard.5
4. Revocable Living Trusts
A variety of trusts remain valuable estate-planning tools. The ever-popular all-purpose revocable living trust remains the vehicle of choice for non-tax-oriented purposes. During life, the revocable living trust provides asset management. At death, the trust can terminate or continue. If it continues, the trust becomes irrevocable since, to state the obvious, the grantor is no longer alive to revoke it.
For estate-planning purposes, the living trust provides a mechanism for avoiding probate and whatever expenses, delays, or publicity drawbacks that probate may entail. An additional advantage is the trust's strength in rebutting challenges from disappointed heirs. It is hard to contest a dispository scheme that was already in place and tacitly accepted during the grantor's lifetime.
5. Irrevocable Living Trusts
Irrevocable living trusts are less flexible, but they also offer tax advantages and more asset protection. The irrevocable trust can be a separate taxable entity from the grantor. Moreover, creditors of a grantor who are able to place liens against a revocable trust that remains within the grantor's control may be stopped by an irrevocable trust that was not set up in an attempt to defraud creditors.
6. Life Insurance
Life insurance is a means of creating an instant estate or replacing portions of an estate. It is also useful in supplying liquid assets at a time when estate settlement costs are due.
For married couples, such costs may be minimal when the first spouse dies, since no estate tax would generally apply to assets passing to the surviving spouse. An effective technique, therefore, is to purchase a second-to-die policy. This would be a more affordable policy that would pay benefits just when needed at the death of the surviving spouse.
When assets are donated to charity for various tax benefits, life insurance can be used as a wealth-replacement mechanism. For example, assets are donated to a charitable remainder annuity trust (CRAT) which pays annual income. The annual income can be used to pay the premiums on an insurance policy, which in turn may end up providing benefits that exceed the value of the donated property.
7. Life Insurance Trusts
When irrevocable trusts and life insurance are combined into an irrevocable life insurance trust, the result is greater than the sum of its parts. This combination is as classic as peanut butter and jelly. Ideally, the trust is established with sufficient assets to purchase the insurance directly. So long as the insured does not retain incidents of ownership, the insurance proceeds can be kept out of the insured's estate.
8. Charitable Remainder Trust
Property that is transferred to a charitable remainder trust (CRT) can then be used throughout the lifetime of the trust beneficiaries, and the remainder will then pass to the charitable beneficiaries. From a tax perspective, the CRT offers several benefits. A lifetime transfer to a CRT generates an immediate income tax deduction. When the property passes to the charity, it is not included in the grantor's gross estate. Nor are capital gains taxed.6
9-11. Acronym Grab Bag
There are several combinations of trusts and other arrangements that work well together. A married couple using a two-trust plan that takes advantage of the unified credit and the marital deduction may want to use a QTIP to secure additional assets for beneficiaries other than the spouse-three basic techniques that work well together.
There are many other useful approaches. A reverse GST exemption can take advantage of the donor's exemption from the generation-skipping transfer tax. GRAT, QPRT, or FLP -the combination that works for a particular estate needs to be customized. It is this mix of tax-oriented objectives that will be most impacted by the proposed transfer-tax reforms.7
12. The Annual Gift
A gift of $10,000 doesn't sound like much, but over time, many increments of $10,000 can add up. Gift splitting with a spouse enables $20,000 to be given to each donee each year. Caveats: Avoid making gifts too close to the end of the year. Avoid elaborate Crummey arrangements that invite IRS scrutiny.8
13. The Baker's Dozenth
No baker's dozen is complete without one additional technique for good measure.
Let's see, has anything been left out? Oh yes, a will. To state the obvious, the simplest, old-fashioned ball-peen hammer of the estate planner's tool box remains the basic last will and testament. So much time and energy are devoted to testamentary alternatives for asset protection or probate avoidance purposes that one might get the impression that wills are unnecessary or even undesirable.
Yet, the will remains the linchpin of the estate plan and would remain relevant even if all transfer taxes were abolished. Consider the function and purpose of a will, and its importance is immediately apparent.
A will is the game plan that coordinates all of the other asset-transferring devices or strategies.
A will names fiduciaries such as guardians for children, trustees, and an executor.
A will is the formal expression of intent that ends all speculation as to a testator's intentions.
Start out with a good will, and your estate-planning toolbox is half full.
Recent Decisions
Extension to Make Reverse QTIP Election
D's will established a marital trust for which his estate made a qualified terminable interest property (QTIP) election. Under the terms of the will, the trust was to be divided into two trusts, one of which was to be exempt from the generation-skipping transfer tax (GSTT). Although the estate allocated D's $1-million GSTT exemption to the marital trust on Schedule R, it initially failed to indicate that the trust was to be severed into GSTT-exempt and non-exempt trusts and made a reverse QTIP election as required under Sec. 2652(a)(3). However, an extension was granted and the estate was permitted to file amended schedules to the tax return. Letter Ruling 200005030.
ESOP Assumed Estate Tax Liability
An employee stock ownership plan (ESOP) sponsored by a closely held business acquired stock in the business from a decedent's estate. At the time, Sec. 2210 allowed an estate to make an ESOP election that relieved the estate of estate-tax liability when an employer's securities were transferred to an ESOP. (That section was subsequently repealed.) Thus, the ESOP agreed to assume the estate-tax liability for the shares it acquired. However, when the ESOP defaulted on this obligation, the estate ended up paying the tax and seeking a refund. Affirming the district court, the court of appeals found that the executor had been relieved from personal liability for the tax under Sec. 2210(a)(3) as had the estate. Wilkes v. U.S., CA-11 (Feb., 2000).
Insurance Proceeds Were Gifts Despite Property Settlement
Under the terms of a divorce settlement agreement, H was required to maintain a life insurance policy on his life, with W, his former spouse, having the right to limit H's ability to designate the beneficiaries of the policy. Yet, the IRS ruled that the payment of the insurance proceeds to H's two adult children was not a transfer to W for full and adequate consideration under Sec. 2516-and, thus, was treated as a gift-for several reasons. First, the agreement did not make the spouse and children the only permissible beneficiaries; it merely gave the spouse the right to veto a change of beneficiaries. Second, the children were adults at the time of the settlement. Third, and most significantly, the spouse did not accept a lower maintenance settlement in order to obtain the ability to restrict H's designation of the beneficiaries. TAM 200011008.
References
1 For example, The private split-dollar life insurance trust or the accelerated charitable remainder unitrusts (see F.R. 56718-56720 10/22/99, Prop. Reg. 1.643(a)-80) raises complex and/or unresolved issues.
2TAM 199944005.
3Swanson v. U.S., Ct. of Fed. Cl (March, 2000).
4Using disclaimers to shape the final estate, The Estate Analyst (Jan., 1996).
5§ 2041(b)(1)(A); Reg. Sec. 20.2041-1(c)(2) establishes safe harbors such as powers for the holder's "support in reasonable comfort," "maintenance in health," "support in an accustomed manner of living," "education, including college and professional education," and "medical dental hospital and nursing expenses."
6Current strategies for charitable gifts, The Estate Analyst (April, 1999).
7Estate planning with FLPs, The Estate Analyst (March, 1999). Avoiding a GST Asteroid, The Estate Analyst (Aug., 1998).
8A current look at family gifts, The Estate Analyst (July, 1997).
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Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
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