chapter 12 creative planning considering the changing

Chapter 12 Creative Planning Considering the Changing Political

Landscape and Possible Tax Consequences

Johnathan Blattmachr Sandra Glazier

Martin Shenkman

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Jonathan G. Blattmachr Jonathan G. Blattmachr is Director of Estate Planning for Peak Trust Company (formerly Alaska Trust Company) and a Director of Pioneer Wealth Partners, LLC in a boutique wealth advisory firm in Manhattan. He is a Principal at Interactive Legal Services Management, LLC, serving as its Editor-in-Chief and Co-Author of its cornerstone products, Wealth Transfer Planning™ and Elder Law Planning™ and a retired member of Milbank (formerly Milbank Tweed Hadley & McCloy LLP) and of the New York, Alaska and in California bars. He is recognized as one of the most creative trusts and estates lawyers in the country and is listed in The Best Lawyers in America in. He graduated from Columbia University School of Law, cum laude, where he was recognized as a Harlan Fiske Stone Scholar. He has written and lectured extensively on estate and trust taxation and charitable giving and is author or co-author of nine books and more than 500 articles on estate planning and tax topics. Jonathan was on active duty in the US Army from 1970 to 1972, rising to the rank of Captain and was awarded the Army Commendation Medal. He is an instrument rated land and seaplane pilot and a licensed hunting and fishing guide in the Town of Southampton, New York.

Sandra D. Glazier

Sandra D. Glazier is an equity shareholder at Lipson Neilson P.C., Bloomfield Hills, Michigan. She concentrates her practice in probate litigation, estate planning and administration, and family law. Sandra not only actively practices in these areas, she’s also been engaged to act as a testifying or consulting expert. She has also served as a mediator in probate and family court cases. Sandra is active with the Oakland County Bar Association (OCBA), having held numerous leadership positions, and the ABA Real Property, Trust and Estate Law (RPTE) section, where she currently sits on the Trust & Estate Diversity and Inclusion committee and is Vice-Chair of the Elder Law and Long Term Care Committee. Sandra has received an ABA Presidential appointment as Special Advisor to the Commission on Law and Aging for the 2021-2022 term and was elected to serve on the Michigan Probate Section’s Council for a 3 year term beginning September, 2021. She is a nationally recognized author in legal publications and presents nationally on issues such as undue influence, ethical duties to vulnerable adults, defending fiduciaries, and the attorney-client privilege. Sandra is on the Trust & Estates Magazine Editorial Advisory Board for Planning and Taxation, and is an Advisor to the Notre Dame Tax and Estate Planning Institute. Sandra was awarded the OCBA’s Distinguished Service Award; received Top Lawyer, Super Lawyer, Leading Lawyer, Martindale-Hubbell AV Preeminent, and Accredited Estate Planner (AEP) designations; and was awarded Trusts & Estates Magazine Distinguished Author in Thought Leadership and Bloomberg Tax Estates, Gifts and Trusts Tax Contributor of the Year in 2018. For more background about Sandra, see https://lipsonneilson.com/attorney/sandra-d-glazier.

Martin M. Shenkman

Martin M. Shenkman, CPA, MBA , PFS, AEP (distinguished), JD, is an attorney in private practice in Fort Lee, New Jersey and New York City, New York with Shenkman Law. Author of 43 books and more than l,275 articles. Editorial Board Member of Trusts & Estates Magazine, CCH (Wolter' s Kluwer) Co-Chair of Professional Advisory Board, CPA Journal, and the Matrimonial Strategist (through 2018). Has previously served on the editorial board of many other tax, estate, and real estate publications. Active in many charitable and community causes and organizations. ■Founded ChronicIllnessPlanning.org which educates professional advisers on planning for clients with chronic illness and disability and which has been the subject of more than a score of articles. ■Written books for the Michael J. Fox Foundation for Parkinson's Research, the National Multiple Sclerosis Society, and the COPD Foundation. ■Presented more than 60 lectures around the country on this topic for professional organizations, charities, and others. More than 50 of the

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https://lipsonneilson.com/attorney/sandra-d-glazier

articles he has published have addressed planning for those facing the challenges of chronic illness and disability. ■ American Brain Foundation - Board of Directors, Strategic Planning Committee, and Investment Committee. Education: ■Bachelor of Science degree from Wharton School, concentration in accounting and economics. ■MBA from the University of Michigan, concentration in tax and finance . ■Law degree from Fordham University School of Law . ■Admitted to the bar in New York , New Jersey, and Washington, D.C. ■CPA in New Jersey, Michigan, and New York. ■Registered Investment Adviser in New York and New Jersey. www.shenkmanlaw.com; www.laweasy.com; www.c hronicillnessplanning.org [under construction]; Twitter: http://twitter.com/martinshenkman; Linkedin : https://www.linkedin.com/in/martinshenkman/

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http://www.shenkmanlaw.com/

http://www.laweasy.com/

http://twitter.com/martinshenkman

http://www.linkedin.com/in/martinshenkman/

1 C:\Users\JM\Downloads\LISIKeeblerMatakBlattmachrShenkmanOutlinePDF4_5_2021.docx

Sanders Tax Proposal: Analysis and Suggestions for Immediate Action By: Robert Keebler, CPA, Joy Matak, Esq., Jonathan Blattmachr, Esq. and Martin Shenkman, Esq.

Table of Contents Introduction .................................................................................................................................................. 3

Clients Should Act Now ................................................................................................................................. 4

Reduction of the Exemption and Spike in the Estate Tax Rate ..................................................................... 4

Pre- and Post-Enactment Planning ............................................................................................................... 6

Illustration of the Value of 2021 Planning Prior to Enactment ................................................................. 6

Considerations for Post-Enactment Planning ........................................................................................... 8

A Different Gift Exclusion .............................................................................................................................. 9

Using Current Exemptions - A Short Window of Opportunity .................................................................. 9

Forever on the Chopping Block: Valuation Discounts ................................................................................ 10

Grantor Retained Annuity Trusts (GRATs”) ................................................................................................. 13

One Last Bite at the GRAT Apple? ........................................................................................................... 13

GRATs Post-Act ....................................................................................................................................... 13

Grantor Trusts ............................................................................................................................................. 15

Grantor Trusts Pre-Act ............................................................................................................................ 15

Grantor Trusts Post-Act .......................................................................................................................... 15

Non-Grantor Trust May Receive Increased Use but Be Careful ............................................................. 16

Life Insurance Trusts Pre-Act .................................................................................................................. 17

Life Insurance Trusts Pre-Act .............................................................................................................. 17

Life Insurance Trusts Post-Act ............................................................................................................. 17

ILIT Planning Considerations ............................................................................................................... 18

Change Durable Powers of Attorney to Permit ILIT funding/Loans.................................................... 19

Post-Act Inadvertent Contributions to a Grantor Trust .......................................................................... 19

A Possible Replacement for Grantor Trusts? .......................................................................................... 20

Grantor Trusts and Basis Step-Ups ......................................................................................................... 20

Dynastic Planning and GST Dramatically Changed ..................................................................................... 21

Considerations for Post-Enactment Multi-Generational Planning ......................................................... 22

Modification to the Annual Exclusion and Apparent Elimination of Crummey Powers and 2503(c) Trusts

.................................................................................................................................................................... 23

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Impact of Multiple Proposed Changes on Estate Planning ......................................................................... 25

Bringing It All Together: Some More Examples .......................................................................................... 25

Conclusion ................................................................................................................................................... 27

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Introduction

On March 25, 2021, Senate Budget Committee Chairman Bernie Sanders (I-VT) fired the opening salvo in

the debate over raising taxes by holding a hearing provocatively entitled “Ending a Rigged Tax Code: The

Need to Make the Wealthiest People and Largest Corporations Pay Their Fair Share of Taxes.” Sen.

Sanders decried “the economic absurdity of two people in this country, Jeff Bezos and Elon Musk,

owning more wealth than the bottom 40%” of American people and the “rigged and corrupt tax code

that gives trillions of dollars in tax breaks to the wealthy and huge corporations.”1

Sen. Sanders issued a lengthy preamble to the proposed legislation outlining the purposes of the For the

99.5% Act2 (the “Act”) enact a progressive estate tax that shifts wealth away from the top 0.5 percent in

order to “create an economy that works for the remaining 99.5 percent.” Notably, the Act is similar to

an earlier iteration introduced in 2019 by Sen. Sanders aimed to shift wealth from the top 0.2% to the

bottom 99.8 percent of the population.3 While it is unclear whether wealth shifted or expanded over

the past two years to account for this change, what has not changed is Sen. Sanders’s laser focus on

transforming the economy to address “income and wealth inequality.”4 The proposal by Senators

Bernie Sanders (I-VT) and Sheldon Whitehouse (D-R.I.) was joined by Senators Chris Van Hollen (D-Md.),

Jack Reed (D-R.I.) and Kirsten Gillibrand (D-N.Y.). Sen. Sanders reports that “companion estate tax

legislation will be introduced [in the House of Representatives] by Rep. Jimmy Gomez (D-Calif.).”5

In any event, Sanders acknowledges that “there is not unanimity within the Democratic Caucus,” as

highlighted by the bruising defeat of the push for a $15 dollar minimum-wage hike during the most

recent reconciliation fight in Congress when only 42 Democratic Senators voted for the increase.6 Sen.

Sanders views his job as Budget Committee Chairman “to rally the American people and to create a

strategy…” to get the Act passed to “reshape the economy.”7 In a press release touting the Act, Sen.

Sanders targeted specific wealthy families:

• The Walton family, the owners of Walmart, would pay up to $85.8 billion more in taxes on their $221.5 billion fortune.

• The family of Jeff Bezos, the founder of Amazon, would pay up to $44.4 billion more in taxes on his $178 billion fortune.

• The family of Elon Musk would pay up to $40.4 billion more in taxes on his $162 billion fortune.

1 Ending a Rigged Tax Code, 117th Cong (2021). 2 For the 99.5% Act, S. 994, 117th Cong. (2021), available: https://www.sanders.senate.gov/wp-content/uploads/For-the-99.5-Act-Text.pdf. 3 For the 99.8 Percent Act, S. 309 116th Cong. (2019). 4 Kelsey Snell, Sen. Bernie Sanders’ Next Progressive Frontier: Reshaping a ‘Rigged’ Tax System, NPR (Mar. 25, 2021, 5:00 am), https://www.npr.org/2021/03/25/980778465/sen-bernie-sanders-next-progressive-frontier-reshaping-a-rigged-tax-system. 5 Press release by Sen. Bernie Sanders (I-VT), available: https://www.sanders.senate.gov/press-releases/sanders-and-colleagues-introduce-legislation-to-end-rigged-tax-code-as-inequality-increases/. 6 Snell, supra note 4. 7 Id.

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https://www.sanders.senate.gov/wp-content/uploads/For-the-99.5-Act-Text.pdf

https://www.sanders.senate.gov/wp-content/uploads/For-the-99.5-Act-Text.pdf

https://www.npr.org/2021/03/25/980778465/sen-bernie-sanders-next-progressive-frontier-reshaping-a-rigged-tax-system

https://www.npr.org/2021/03/25/980778465/sen-bernie-sanders-next-progressive-frontier-reshaping-a-rigged-tax-system

https://www.sanders.senate.gov/press-releases/sanders-and-colleagues-introduce-legislation-to-end-rigged-tax-code-as-inequality-increases/

https://www.sanders.senate.gov/press-releases/sanders-and-colleagues-introduce-legislation-to-end-rigged-tax-code-as-inequality-increases/


• Facebook CEO Mark Zuckerberg’s family would pay up to $25.3 billion more in taxes on his $101.7 billion fortune.8

Sen. Sanders goes through great pains to outline the net worth of “all 657 billionaires in America” and determining that, together, they would “owe up to $2.7 trillion in estate taxes.”9 Unfortunately, the proposed legislation casts a much wider net and has the capacity to impact many planning clients who are unlikely ever to make Sen. Sanders’s list. As will be discussed below, a family seeking to protect children by purchasing life insurance in a trust could face significant hurdles.

Clients Should Act Now In a related move, U.S. Senator Chris Van Hollen (D-Md.), joined by Senators Cory Booker (D-N.J.), Bernie

Sanders (I-Vt.), Sheldon Whitehouse (D-R.I.), and Elizabeth Warren (D-Mass.) announced a new proposal

to close the stepped-up basis income tax loophole. Other bills have and will no doubt be proposed. But

the theme is clear: a strong intent by a number in Congress to address tax increases. The message to

advisers should be just as clear: encourage clients to take planning actions now while they can, but

caution them about retroactivity risks and the risk that suggested planning may not succeed, depending

on the changes enacted.

Reduction of the Exemption and Spike in the Estate Tax Rate

Perhaps, the most talked about change the Act would accomplish is a reduction in the unified credit for

estate and gift taxes effectively slashing the exemption of $10 million, indexed for inflation to $11.7

million in 2021, and by increasing the estate and gift tax rate of 40 percent.

The Act would reduce the estate tax exemption from $11.7 million to $3.5 million and impose a

progressive estate tax that ranges from 45% to 65%.10 Despite what some in the media have suggested,

the new estate tax exemption is not indexed for inflation.11

8 Press release, supra note 5. 9 Id. 10 The Act, supra note 2 at Section 2. 11 Joint Committee on Taxation (March 24, 2021), scoring the For the 99.5 Act, available: https://www.sanders.senate.gov/wp-content/uploads/For-the-99.5-Act-JCT-Score.pdf. Proposed revision to Paragraph (3) of section 2010(c) of the Internal Revenue Code no longer includes subpart (B), which had previously provided the language allowing for an adjustment to the basic exclusion amount for inflation. That provision current reads as follows: “(B) Inflation adjustment In the case of any decedent dying in a calendar year after 2011, the dollar amount in subparagraph (A) shall be increased by an amount equal to— (i)such dollar amount, multiplied by (ii)the cost-of-living adjustment determined under section 1(f)(3) for such calendar year by substituting “calendar year 2010” for “calendar year 2016” in subparagraph (A)(ii) thereof. If any amount as adjusted under the preceding sentence is not a multiple of $10,000, such amount shall be rounded to the nearest multiple of $10,000.”

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https://www.sanders.senate.gov/wp-content/uploads/For-the-99.5-Act-JCT-Score.pdf


For very high net worth clients, the exemptions are largely insignificant. Rather, the significant factor is

the rate of transfer tax. Increasing from 40% to as much as 65% will have an impact on the tax cost,

especially when coupled with the other restrictions that would be enacted as part of the Act. As steep

as this incline from 40% to 65% may appear, Sen. Sanders has softened his approach from an earlier

iteration that would have required an astounding 77% for estates over $1 billion. For perspective, that

was the rate on estates above $10 million until 1977. It is curious that Senator Sanders would proffer a

less aggressive tax now that he holds the coveted budget committee gavel in the Senate. Could it be

that this somewhat moderated approach is the result of discussions among the Democratic caucus? If

so, the softening of Senator Sanders’ approach could be and could be a calculated step towards

enactment.

By reducing the estate tax exemption and increasing the tax rates, the Act significantly impacts estates

across the wealth spectrum, in many cases, assessing a tax where there had not been one due before.

Following is a table showing how estate taxes will increase, depending upon the value of the taxable

estate:

Estimated Taxable Estate

2021 Estate Tax under current law

Estate Tax under “For the 99.5%” Proposal

Proposed Tax Increase

$5 million -

675,000

675,000

$7.5 million -

1,800,000

1,800,000

$25 million 5,320,000

11,745,800

6,425,800

$60 million 19,320,000

29,745,800

10,425,800

$100 million 35,320,000

51,745,800

16,425,800

$2 billion 795,320,000

1,196,745,800

401,425,800

A reduction of the estate tax exemption from $11.7 million to $3.5 million, the rate that existed in 2009

will dramatically change the estate tax planning environment and substantially increase the number of

estates subject to estate tax. Millions of clients who have ignored the estate tax for years will have to

rethink their planning and documents to address estate tax planning and to do so under the new

regime that may be enacted. Many of these clients should consider taking immediate action to plan

before the enactment of the Act or similar legislation.

The proposed $3.5 million exemption would greatly reduce the ability of wealthy clients to shift wealth

out of their estates or into protective structures that may limit the reach of divorcing spouses or

claimants. This might mean that there is a great advantage for clients to using the current $11.7 million

exemption now, or as much of it as possible, before a change is enacted. Clients of moderate wealth

(“moderate” relative to the current exemption amount) may wish to consider making simple gifts before

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the end of 2021 to a trust to accomplish asset protection, estate tax planning, succession planning and

other objectives. Those gifts, to a GST exempt grantor trust, as will be discussed below, may secure

grandfathering some valuable current tax benefits that will no longer be available after enactment. The

Act curtails many of the wealth transfer strategies clients might need to use in order to avoid costly and

complex planning once a new law is enacted.

Pre- and Post-Enactment Planning Practitioners need to consider planning steps to discuss with clients prior to enactment, and separately

planning steps to discuss with clients after enactment. While it is certainly important to consider the

long-term implications of the Act on planning, practitioners should help clients focus in particular on

planning steps to take prior to the various effective dates contained in the Act now. Different planning

steps will be required for future action after enactment. For example, it may be possible for a moderate

wealth client to create a traditional and relatively simple irrevocable life insurance trust (“ILIT”) today

and fund it with sufficient cash to pay premiums for years to come. If that ILIT is created after the

various effective dates contained in the Act then the assets of that grantor trust, primarily life insurance,

will be included in the client’s estate defeating the primary objective of the plan (removing life insurance

proceeds from the estate). Also, if the client does not fund the ILIT now the cap on annual gifts,

discussed below, may inhibit planning. If the Act is passed, then practitioners, after its effective dates,

will have to focus on new planning techniques for owning life insurance, but that planning should not

detract from valuable planning that should be undertaken today. Some consideration will have to be

given to creating ILITs that are not grantor trusts. An Obama administration proposal exempted ILITs

and some other trusts but those exclusions have not found their way into the Sanders bill.

It has been a common practice to transfer assets to a Domestic Asset Protection Trust (“DAPT”) before

marriage to backstop a prenuptial agreement. That type of planning would have to rely on non-gift

transfers (e.g., transfers to an incomplete gift trust that may provide asset protection, but which do not

require the use of exemption), for any amount that exceeds the lifetime gift exclusion of $1 million or

else such planning may no longer be feasible with such a low gift exemption.

Illustration of the Value of 2021 Planning Prior to Enactment

In order to illustrate how much this proposal would raise the federal estate tax, consider a married

couple where each spouse owns approximately $16.5 million worth of assets, for a total marital estate

worth $33 million.

Assumptions for each of the following two scenarios:

• Enactment of the “For the 99.5% Act” in its current form, generally effective as of 1/1/2022 (but

caution is in order as many of the provisions in the Act are effective as of the date of enactment)

• Moderate 4% annual growth of the assets

• Death of first spouse occurs in 2022

• Death of survivor spouse occurs in 2023

• No taxable gifts prior to 1/1/2021

• Each estate pays about $100,000 in deductible administration expenses

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Scenario 1: The spouses use very simple planning. Each spouse has a will that establishes an credit

shelter trust equal to the federal exemption, with balance to surviving spouse on death of first spouse.

The surviving spouse leaves his or her estate to their children in equal shares.

On death, the first spouse’s estate would be worth approximately $17.16 million. A credit shelter trust

would be funded with $3.5 million. There would be no federal estate tax on the death of the first

spouse. The surviving spouse would therefore have a gross estate at the end of 2022 worth $30.7

million, with $3.5 million of that in the credit shelter trust.

Assuming that the surviving spouse’s estate continued to grow at 4%, the surviving spouse would have a

gross estate worth approximately $31.95 million on death. Only $3.5 million would be exempt from

estate tax, so the estate would pay approximately $13.86 million in federal estate taxes, leaving $17.5

million of wealth to the family, including the amount available in the credit shelter trust.

Scenario 2: The spouses undertake aggressive planning in 2021 and each transfers assets to use their full

lifetime exemptions of $11.7 million (it is assumed that is not too large a portion of their estate to

transfer from a fraudulent conveyance perspective). On the death of the first spouse, the remaining

estate is left to the surviving spouse who leaves the balance on his or her later death to the children in

equal shares. If those shares are left in trust, which had been a common approach to planning for heirs,

the new GST restrictions discussed below would apply to those trusts. That rule cannot be avoided by

quick planning action. This is discussed below.

On the death of the first spouse, the value of each spouse’s estate would be around $5 million. After

expenses of administration, the value of the surviving spouse’s gross estate would be approximately

$9.9 million. Assuming moderate growth of 4%, the gross estate on the death of the surviving spouse

would be about $10.3 million. Federal estate tax of $4.35 million would be due.

In the meantime, assuming the same moderate growth rate, the value in the trusts would be

approximately $25.3 million. Thus, in the second scenario, the remaining balance to the family

including the assets in the trusts would be $31.17 million. Simple trust planning in 2021 could save the

couple’s wealth over $13.6 million in federal estate taxes. It may also grandfather grantor trust status

without causing estate inclusion, as discussed below.

Upstream planning is another topic that may deserve attention prior to any changes in the law. Any

upstream planning that may have been done in the wake of enactment of the 2017 tax legislation

should be evaluated.12 Upstream planning was used to salvage otherwise unusable exemptions that

elderly relatives of clients have. For example, if a parent has an estate of only $4 million, an adult child

might have created a trust with $7 million and give parent a general power of appointment (“GPOA”)

over that trust. The GPOA could require the consent of a non-adverse party, could be crafted as a

limited power of appointment and someone could hold the right to convert it to a GPOA, etc. The intent

of the plan was that parent’s estate would include the assets in the trust and those assets would obtain

an estate tax free adjustment (hopefully step-up) in income tax basis on parent’s death. If the

exemption is reduced to the $3.5 million as in the Act, most or all upstream planning would be obviated.

12 An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018., H.R. 1, 115th Cong. (2017), Pub. L. 115-97, available: https://www.congress.gov/115/plaws/publ97/PLAW-115publ97.pdf

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https://www.congress.gov/115/plaws/publ97/PLAW-115publ97.pdf


If that occurs, practitioners might want to review that planning to be certain that the estate inclusion in

the upstream plan does not inadvertently trigger an unintended estate tax on the senior generation’s

death. While many such upstream plans were likely crafted to only include in the senior generation’s

estate an amount that would not trigger an estate tax, the more prudent course of action would be to

confirm that and make any modifications as may be necessary.

In order to effect upstream planning, the younger generation must transfer wealth to the senior one.

That may well result in gift taxation to the younger generation unless a plan to transfer wealth to the

more senior generation occurs without gift tax as it might with a GRAT. However, the time to do that

and still garner the benefits of the larger exemptions the senior family members have may soon be

foreclosed.

Considerations for Post-Enactment Planning

While the planners and particularly clients have mostly enjoyed an estate tax exemption exceeding $5

million for the past decade, the exemption was $3.5 million in 2009 which was not too long ago. In

2009, a common practice was for married couples to fund a credit shelter trust up to the largest amount

that would not generate a state or federal estate tax. As the exemption grew, the default plan for some

married couples evolved. QTIP trust planning became more common, wherein the surviving spouse

would have the right to disclaim into a family trust, or perhaps gave an independent executor the right

to elect the portion of the QTIP qualifying for the marital deduction thereby shifting funds to a credit

shelter trust (the Clayton QTIP approach). A reduction in the exemption to a $3.5 million level might

suggest that reverting back to this historic credit shelter default plan may prove better for some clients.

A key point I that all estate planning documents will have to be reviewed if the Act is passed. Note that

the Clayton QTIP approach is not apparently available for gift tax purposes.

As the federal tax exemption increased dramatically over the past ten years, some states adjusted their

estate taxing regimes to increase exemptions as well. To the extent that the federal exemption is

reduced to $3.5 million and if a state does modify its own tax code “quickly” enough, the federal

exemption might be the lower of the two exemptions to which an estate is subject.

▪ A common drafting technique is to fund a credit shelter trust at the lesser of the state or federal

exemption amount. If the federal exemption amount is reduced to $3.5 million and a state does

not quickly adjust their laws, the federal exemption might be the factor which limits the use of the

state estate tax exemption. This quandary harkens back to the creation of the state-only QTIP so

that a trust could be funded up to the higher federal exemption amount. Will necessity soon

invent the federal-only QTIP that is to be treated as a state credit shelter (not marital trust) so that

the trust may be funded with and secure a higher state exemption amount. The legality of a

testamentary state-only QTIP/federal credit shelter trust will depend on a state-by-state analysis

and require significant revisions to wills that would allow for its creation. Even to the extent that

such an option was to exist, it may not be available for any significant period of time as states are

also struggling financially from the pandemic’s economic restrictions and may match any federal

government in reduction in estate tax exemptions. Practitioners who may draft to create a state

only credit shelter in a will or revocable trusts should consider adding a mechanism to modify

that bequest if state law catches up and reduces its exemption to match the lower federal

exemption. In particular, practitioners may wish to review "Quadpartite Will Redux: Coping with

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the Effects of Decoupling," 32 Estate Planning 15 (October 2005).

A Different Gift Exclusion

The Act modifies the gift tax exclusion amount by pulling it apart from the estate tax basic exclusion and

reducing it to $1 million.13 Notably, the gift exclusion is also not indexed for inflation, thereby capping

the ability of modest clients to accomplish gifting prior to death.

This proposed $1 million gift tax exclusion would dramatically alter not only gift tax planning but could

affect asset protection and divorce planning as well. If the gift exemption were reduced to $1 million,

the ability of clients to leverage wealth out of their estates, to implement asset protection planning, to

safeguard assets for matrimonial purposes, etc. could all be hindered. For example, a physician with

several millions of dollars of non-pension assets would be precluded from transferring those assets to a

trust to provide asset protection planning, since any transfer exceeding $1 million would trigger gift tax,

unless the transfer is to an incomplete gift trust.

Using Current Exemptions - A Short Window of Opportunity

Section 2 of the Act is effective for gifts made after December 31, 2021, providing a tremendous albeit

short window of planning opportunity to complete planning to use exemptions in 2021. With a current

gift and GST exemption of $11.7 million and a potential reduction of gift exemption in 2022 to only $1

million, it is hard to conceive of many clients who should not create trusts, notwithstanding the

limitations of those trusts under the Act, if enacted, and use as much remaining exemption as feasible.

But there are several important planning considerations to exemption use. Of course, many property

owners will be hesitant to transfer significant wealth which they believe they may need to maintain their

lifestyles.

Even, unrelated to tax planning, moderate wealth clients might consider having their wealth adviser

and/or CPA prepare a budget and financial projections so that the client can determine the extent to

which they are comfortable making the transfers and will not face undue financial worries as a result. A

second and related analysis is to demonstrate that post-transfer the clients can meet their ongoing

lifestyle and other expenses so that a fraudulent conveyance challenge can be deflected. It is not clear in

such an analysis what access to transferred assets should be factored into the calculations. For example,

if the client is creating a special power of appointment trust (“SPAT”) factoring in an assumption of

certain distributions by exercise of that power might be argued to suggest an implied agreement to

make distributions. (See “SPATs: A Flexible Asset Protection Alternative to DAPTs,” 46 Estate Planning 3

(Feb. 2019).) So, caution is in order and consideration should be given to the nuances of the planning in

creating an analysis to support transfers of a large percentage of wealth.

By setting forth an effective date that does not begin until January 1, 2022, the Act removes the worry

that had plagued planners at the end of 2020 and beginning of 2021, that somehow Congress would

enact legislation that upon signing would reduce exemptions retroactively to January 1, 2021. With a

13 The Act, supra note 2, at Section 2.

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risk of retroactivity reduced, can practitioners ignore prior discussion of using formula clauses in transfer

documents and disclaimer provisions in trusts when planning? While it would appear that, perhaps,

there may no longer be a need for cautious disclaimer and formula clauses in 2021 planning documents,

that could be a risky gambit that clients should decide upon. There is absolutely no certainty as to what

might ultimately be enacted, or its effective date. Some clients might still prefer to incur the additional

cost and complexity of integrating adjustment mechanisms to address the risk of retroactivity.

Another consideration is very important. If the Act were to become law relying on the December 31,

2021 date to make transfers to use exemption could be a terrible mistake. Other provisions of the act,

such as those affecting inclusion in the settlor’s estate of grantor trust assets, apply to trusts created

after enactment, not created after the effective date of the act. Therefore, practitioners really should

advise clients to plan as quickly as possible as the effective dates cannot be known. Relying on a year

end date may be a material disadvantage to the planning that may remain feasible.

Forever on the Chopping Block: Valuation Discounts

Remember the panic over the proposed 2704 Regulations? Well, as Yogi Berra said, "It's like déjà vu all

over again. "The Act takes direct and deadly aim at the heart of valuation discounts for “nonbusiness

assets” which is defined to mean “any asset which is not used in the active conduct of 1 or more trades

or businesses.”14 In addressing valuation discounts, the Act targets minority discounts with specificity,

disallowing any discounts “by reason of the fact that the transferee does not have control of such entity,

or by reason of the lack of marketability of the interest” in cases where “the transferor, transferee and

members of the family (1) have control of such entity, or (2) own the majority of the ownership interests

(by value) in such entity.”15 By particularly identifying marketability and lack of control discounts, the

Act appears to leave intact other types of discounts such as a blockage or saturation discount.

Example: Client wants to make a gift of her interests in real estate LLCs that own neighborhood

shopping centers. Client’s interest in the LLCs is restricted by operating agreements that limit her ability

to sell her interests or control the entities.

Because these are non-controlling interests under current law, a valuation professional determines that

her interest in the entities is worth a little more than $11 million, determined as follows:

14 The Act, supra note 2 at Sec. 6. 15 Id.

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Using her current lifetime gift exemption of $11.7 million, the client might be able to gift all these

interests to a trust for descendants. The issue of discounts has a long history, with taxpayers and the

Service battling in multiple high-profile cases. Ultimately, the Courts have mostly sided with taxpayers

who have argued that the fair market value must reflect the reality that minority interests cannot be

used to control the entity and are not readily marketable. The Act undoes all of that jurisprudence with

the stroke of a pen, all but eliminating minority discounts for so-called nonbusiness assets.

In this example, the interests that the Client owned would be valued, post-enactment at both a gross

and net value of $16 million under the Act, notwithstanding her inability to sell or exercise any control

over the interests.

These provisions of the Act indiscriminately attack discounts based on the use of the asset, without

consideration for the actual nature of the asset. It abandons the concept of fair market value as “the

price at which the property would change hands between a willing buyer and a willing seller, neither

being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”16

Indeed, it is far different to give away one-third of a portfolio than it is to give away one-third of a

house; yet generally the Act recognizes no such distinction. In both cases, the value for gift purposes

would be the gross value of the entire asset times the percentage in It that is transferred. This simple

arithmetic turns a blind eye to the realities of co-ownership of an asset that cannot be split easily into

fractional shares.

The Act addresses valuation discounts for non-controlling positions in an entity on assets that are

deemed “non-business” even within an operating company. That is to say, the Act appears to suggest

that non-business assets are valued without discount, but to avoid duplication, the entity is valued

without the inclusion of such assets. In this way, the Act appears poised to usher in a new regime of

valuation analysis whereby professionals will need to identify all of the assets of an entity and then

categorize them as either “business” (and therefore eligible for certain discounts) and “nonbusiness”

(discounts do not apply). Conceptually, the final value determined under the Act would be a discounted

value of the business interests plus the non-discounted value of the pro-rata interests in non-business

16 Treas. Reg. Sec. 20.2031-1(b).

Gross Asset Value 16,000,000

Less Discount for Lack

of Marketability 28% (4,400,000)

Value of Non-

Marketable Interest 11,600,000

Less Lack of Control

Discount 5% (580,000)

Fair market value of

Non-Marketable,

Non-Controlling

Interest: 11,020,000

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assets. Note, however, that a similar provision has been in Section 6166(b)(9) relating to the deferral of

payment of estate tax on certain business interests for decades.

Example: The gross value of the active business operations of an entity are worth $6.5 million. A

qualified valuation professional concludes that the appropriate discount is 30%. The same entity holds

$450k worth of marketable securities. None of the marketable securities are considered “business”

assets. The owner seeks to make a gift of a 20% interest in the entity to an adult child, which has a value

as determined under the Act of $1 million, as follows:

The Act specifically carves out an exception for the “working capital reasonably required” for the

operation of a trade or business, though it does not define how a business owner might demonstrate

how to meet the standard. (Again, this is the same as the provision in Section 6166(b)(9).) Arguably, the

business owner could refer to the type of analysis used to avoid personal holding company (“PHC”)

penalties, though that is far from clear from the face of the proposed Act. Practitioners may find that

each year an analysis will need to be completed to determine the potential fund reasonably required by

the business, followed by minutes of the board (or a consent of managers for an LLC) documenting the

working capital needs of the busines. While it is not yet clear what will suffice, small businesses that

lack the internal infrastructure and sophisticated advisors to produce such records. Ultimately, the risks

and complexity of this may outweigh the benefits of any valuation discounts that might be realized.

Additionally, the Act would create specific “look-through” rules to prevent tiers of entities that might

circumvent these restrictions on discounts of non-business assets.

Example: Assume passive real estate is deemed a non-business asset because the client does not

materially participate in accordance with the requirements of IRC Sec 469 and related regulations.

Where a Client wishes to transfer 20% of the real estate interests to an heir (or trust for an heir), the

planning professional may have recommended using a family real estate holding entity to make the

transfer. Such a transfer would likely have qualified for a discount of around 35% (more or less,

depending on the facts and circumstances).

Under the Act, the asset will have to be valued as if transferred directly. However, it appears that

discounts inherent to the asset itself may apply. In other words, if the entity owned interests in

Gross Asset Value of

Business Assets 6,500,000

20% of the Gross

Asset Value of the

Business Assets:

1,300,000

Less: 30% Valuation

Discount (390,000)

20% of Gross Asset

Value of Non

Business Assets 90,000

Total value of

interest conveyed: 1,000,000

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warehouses in the particular county and the family interests had such a substantial interest in

warehouses in that county that it could take, by the estimate of a real estate appraiser, 15 years to sell

all of their interests, an absorption discount may still apply.

Restrictions on valuation discounts only apply if an entity is controlled by a member of the same family,

as that term is defined to mean an ancestor, spouse, lineal descendant of such individual, the

individual’s spouse or a parent, or the spouse of any lineal descendant.17 While it is not likely that the

Act would apply to conglomerates of different families joining together to enjoy discounts as they had

before, there does appear to be some opportunity for closely knit family friends to take advantage of

valuation discounts in planning. Perhaps, a new “marriage penalty” would be the loss of discounts on

transfers between families.

Grantor Retained Annuity Trusts (GRATs”)

One Last Bite at the GRAT Apple?

As it relates to GRAT (grantor retained annuity trust described in Reg. 25.2702-3) restrictions, the Act

applies to transfers made after the date of the enactment (not the effective date of the Act which could

be January 1, 2022). Commentators expect that enactment of the next tax bill could occur as earlier as

July 2021 but more likely will not happen until sometime in October 2021. But there is no certainty as to

any of that and the Act might be appended to an infrastructure bill and pass into law much sooner.

Clients may have one last opportunity to use GRATs in order to leverage wealth out of their estates but

only if they act quickly in the next few months.

Several of the concepts that practitioners might want to consider for application of GRATs before

enactment might include using a long-term, perhaps 99-year GRAT to potentially leverage large values

outside the estate. This is really an interest play and if the rates of interest increase significantly

between the date the GRAT is completed and the settlor dying as only a portion (and, perhaps, only a

small portion) of the GRAT corpus will be included in the estate. Another approach might be to create a

tiers of GRATs now to lock in the GRAT benefits, still historically low interest rates, etc. This might be

beneficial since GRATs, as explained below, may not be feasible after enactment. So, depending on age

and health, a client might create a ladder of a 6, 8, 10 a 12-year GRATs. If there is a concern about

mortality risk so some of the GRATs fail, life insurance in an ILIT might be used to negate that cost.

Finally, a GRAT or tiers of GRATs may be made payable to a non-GST life insurance trust to fund the ILIT

in light of proposed limitations on the amount annual gifts exclusions allowed.

GRATs Post-Act

Practitioners must also consider the range of other “restrictions” proposed in the Act on GRATs. Sec. 7

of the Act proposes limits on the use of a Grantor Retained Annuity Trust described in Reg. 25.2701-2,, a

planning tool long favored by some planners. A key benefit of GRATs is that clients can create these

trusts to shift wealth out of their estates without using any significant gift tax exemption or, if not

17 IRC Sec. 2032A(e)(2).

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exemption is left, without significant gift tax. To the extent the assets in the trust grow at a rate above

the Section 7520 rate used to value the annuity stream in the trust or its remainder, that excess will be

shifted outside the estate. Many, perhaps most, GRATs were structured by practitioners as so-called

“zeroed-out GRATs.” Specifically, a zeroed-out GRAT is structured so that the present value of all

annuity payments required to be made from the trust to the grantor equaled (or almost equaled) the

value of assets transferred to the GRAT. Some practitioners preferred to have a modest gift value to

report on a gift tax return.

Upside appreciation in the trust above the rate of return (Section 7520 rate) would inure to the

beneficiaries of the GRAT with no gift tax cost. The Act seeks to undermine the viability of the GRAT

technique by requiring a minimum 10-year term for any GRATs created after the enactment of the Act.

The imposition of a ten-year requirement would dramatically reduce the efficacy of a GRAT for some

clients because if a client does not outlive the term of the GRAT, some or all the assets (generally) are

included in the client’s estate.

While the mortality risk of a ten-year GRAT may be offset with life insurance, the Act Sec. 7 imposes

another significant restriction on GRATs that may signal the death knell for this popular technique: a

minimum gift amount. In other words, zeroed-out GRATs will no longer be permitted and a transfer to a

GRAT must result in a remainder interest gift amount “determined as of the time of the transfer, which

is not less than an amount equal to the greater of 25% of the fair market value of the property in the

trust or $500,000.”18 A fundamental aspect of GRAT planning was to be able to make transfers that

used only a nominal amount of exemption. This change alone will make many planned GRATs ineffectual

tools after enactment unless a new application of the technique is possible. Also, consider this change in

the context of a $1 million gift exemption. In other words, unless the gift of the remainder is below the

grantor’s gift tax exemption, gift tax will be due with no assurance that any wealth will be transferred to

the beneficiaries (other than the grantor).

These two changes could make GRATs impractical for wealthy taxpayers that have used GRATs when

they no longer had gift tax exemption remaining. The Act eliminates the commonly used technique of

“rolling-GRATs”, where practitioners would create a 2-year GRAT, and the client would “re-GRAT” each

annuity payment received to a new GRAT and attempt to continue to shift appreciation above the Sec.

7520 rate.

If GRATs, discounts, and other techniques are also “closed down” as proposed in the Act, the ability to

plan around a $1 million exemption will be more limited than it had been in the past years when the $1

million exemption was law. In the past, discounted FLP interests inside GRATs, rolling GRATs, etc. all

facilitated wealth transfers “around” the low $1 million exemption. If changes as sweeping as has been

proposed under the Act are enacted, the prior tools for addressing a low exemption will largely not be

available.

18 The Act, supra note 2, at Sec. 7.

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Grantor Trusts Grantor trusts have been at the foundation of many estate planning techniques for decades. That all

may change if the Act becomes law. The planning steps to discuss with clients prior to enactment are

quite different than those that might become necessary after enactment.

Grantor Trusts Pre-Act

Under current law, and until the date of enactment, clients can create grantor trusts and transfer assets

to them to use their exemption or to consummate sale of assets to the trust in exchange for a note (a

so-called “note sale transaction). Post-enactment, as explained below in more detail, new grantor trusts,

or existing grantor trusts to which additional assets are transferred, will be included in the settlor’s

estate (see detailed discussion below). This may make it very important for some clients to create and

fund grantor trusts prior to the date of enactment. In fact, for some clients, creating and funding the

grantor trust may be more valuable than just the use of exemption. Also, because the use of the current

high exemption is permitted under the Act until December 31, 2021, some clients may be confused to

focusing on that as the operative date when in fact the date of enactment, which could be at any time, is

the governing deadline. To whom other than a grantor trust should client’s gift large remaining

exemption amounts? Post-enactment that will not be possible. Practitioners should be careful to

communicate this subtle point to clients. And note there may be even more limited “grandfathering” for

grantor trusts described in Section 678 (sometimes call BDITs or variants call BDOTs.)

Grantor Trusts Post-Act

In a direct assault on the foundation of modern estate planning, the Act Sec. 8 creates “Special Rules for

Grantor Trusts” that will require the assets of certain grantor trusts, described in dealt with primarily in

Section 671 to 679,to be included in the estate of the settlor. Since completed gift grantor trusts have

been a foundation for much of recent estate planning for years, these new rules will have a significant

and adverse impact on planning. In short, the Act would include in a client’s gross estate the value of

those assets owned by grantor trusts reduced only by taxable gifts made to the trust.

Grantor-type trusts are those trusts whose income is taxed to the settlor creating the trust (or to certain

persons deemed to be the owner of the trust under Section 678) . Additionally, sales to the Beneficiary

Defective Inheritor’s Trust (BDITs) are specifically targeted, requiring inclusion of some portion of the

asset in a trust over which a person, other than the settlor of the trust, is deemed the owner for income

tax purposes, to the extent that such a person engages in a “sale, exchange or comparable transaction”

with the trust.19

As a matter of current law, the income tax characterization as a grantor-type trust permits a settlor, or

person who is treated as the owner for income tax purposes, to buy or sell appreciated assets to and

from the trust without causing gain recognition. In addition, the creator of the trust will report any

income attributable to the trust on his or her own tax return, therefore paying the income tax on trust

income, permitting greater growth of wealth inside the trust. This also simultaneously reduces the

19 The Act, supra note 2 at Sec. 8.

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settlor’s taxable estate because the IRS has conceded that the grantor paying income tax on the trust’s

income attributed to him or her is not a gift. See Rev. Rul. 2004-64. In fact, over a long-term period, the

income tax shifting can be the most valuable of all estate tax benefits. It also permits the client to sell

assets to the trust without recognition of gain due to that sale and shift growth outside the grantor’s

estate. These sales, often done for a note issued by the trust, have been a mainstay of planning in the

estate planner’s arsenal.

As written, the Act would require an estate to include the value of assets owned by a grantor-type trust

established after enactment of the Act, less any taxable gifts to the trust made by the owner. The

exclusion of taxable gifts avoids duplication or doubling of tax. If a gift is made to a grantor trust post-

enactment, e.g., $1 million. That grows to $2.5 million. When the owner dies, the entirety of the trust

corpus of $2.5 million is included in the settlor’ taxable estate and a reduction for the $1 million

previously given is available. The result, however, is that all appreciation is included in the settlor’s

estate, thereby defeating any planning benefit. If instead the initial gift had been made to a non-grantor

trust, inclusion might be avoided. The Act is an effort to eliminate the benefit of the “tax burn” enjoyed

by grantor trusts, that is, the payment of the income taxes by the grantor on income earned by the

trust. It also would eliminate for new trusts the ability to have a swap power because a non-grantor

trust cannot engage in a swap, and a new grantor trust will be impractical to use in many instances as it

will not remove assets from the settlor’s estate.

There have been four key tax benefits that have been the focus of much of estate planning: 1) Removal

of future appreciation from the client’s estate which this new rule restricts for post-Act transfers to

grantor trusts; 2) locking in valuation discounts which have also been restricted; and 3) “burning” the

client’s estate by the client paying the income tax cost on income earned by an irrevocable trust that is

outside the client’s estate; and 4) grow assets inside dynastic trusts for as long as feasible. This new

grantor trust rule eliminates two of these four benefits and another provision of the Act eliminates the

third and restricts the fourth.

Non-Grantor Trust May Receive Increased Use but Be Careful

As explained above, post-enactment, clients will have to consider the viability of using new non-grantor

trusts, since the use of new grantor trusts will not result in the removal of assets from the settlor’s

estate. In a separate, seemingly unrelated, development, the IRS has included incomplete gift trusts

(“INGs”) in its annual no-rule list, indicating that it will not issue letter rulings until it reaches some

resolution on outstanding concerns through future guidance.20 By including INGs on this odious list, the

Service is sending a signal that “these strategies could be challenged in the future,” causing some

trepidation among the planning community.21 This may prove particularly concerning post-Act if clients

have to shift planning to non-grantor trusts to avoid the estate inclusion rules that may become

applicable to grantor trusts.

20 See Rev. Proc. 2021-3, 2021-1 IRB 140. 21 Incomplete Gift Trusts Hit IRS’s No-Rule List in Foreboding Move (Mar. 22, 2021), available: https://www.taxnotes.com/tax-notes-today-federal/trusts-and-estates-taxation/incomplete-gift-trusts-hit-irss-no-rule-list-foreboding-move/2021/03/22/3th7q, quoting Justin Miller of BNY Mellon.

12-27

https://www.taxnotes.com/tax-notes-today-federal/trusts-and-estates-taxation/incomplete-gift-trusts-hit-irss-no-rule-list-foreboding-move/2021/03/22/3th7q

https://www.taxnotes.com/tax-notes-today-federal/trusts-and-estates-taxation/incomplete-gift-trusts-hit-irss-no-rule-list-foreboding-move/2021/03/22/3th7q


With the IRS reversing its position on ING trusts, the Act’s reduction of the gift exclusion to $1 million

could make asset protection extremely difficult.

Another issue that will become more nettlesome if grantor trusts are used more commonly in planning

is assuring S corporation status for trusts that will hold S corporation stock. Grantor trust were easy to

use in the context of S corporation planning as a grantor trust will qualify as an S corporation

shareholder. A non-grantor trust must meet the rules of a Qualifying Subchapter S Trust (“QSST”) or an

electing small business trust (“ESBT”) in order to hold S corporation stock.

Life Insurance Trusts Pre-Act

Irrevocable life insurance trusts (“ILITs”) have been one of the most common estate planning techniques

for many years. The key objective of most ILITs has been to assure that the life insurance proceeds are

excluded from the client’s estate. The Act could upend this traditional planning tool used by many

families for protection (e.g., protect the insurance proceeds if the surviving spouse remarries, etc.), not

only by the wealthy. A number of different provisions of the Act could undermine this common

planning tool and require estate planners and insurance consultants to revisit planning.

Life Insurance Trusts Pre-Act Since under current law (i.e., prior to the date of enactment) clients can have assets held in grantor

trusts without estate inclusion, the goal should be to assure that any client who might need an ILIT has a

grantor ILIT created. In addition to preserving grantor trust status, which can be particularly useful for

life insurance, the restrictions on annual gifts will have to be evaluated in light of most insurance plans.

The typical insurance plan has relied on annual gifts, and issuances of annual demand or Crummey

powers, to fund the insurance trust and then fund the payment of premiums. With the caps on annual

gift exclusions to trusts, it may be advantageous to overfund an ILIT now using annual exclusion gifts and

unused exemption so that the ILIT will have premium dollars for years to come. Another approach that

may be viable for some clients is to shift the life insurance from an old style ILIT that had only a modest

bank account and relied on annual gifts to fund premium costs, into a robust spousal lifetime access

trust (“SLAT”) or other irrevocable trust so that the large value of income producing assets can be used

to fund insurance premiums without annual gifts. That might be accomplish by a decanting or merger of

the old ILIT into the newer SLAT (be mindful of different GST exclusion ratios), or a sale of the policy

from a grantor ILIT to a grantor SLAT. Another approach may be to create a tier of GRATs that pay over

into the ILIT (assuming the ILIT is not GST exempt) as discussed above.

These special rules for grantor trusts become effective upon enactment of the Act, thereby providing a

tremendous incentive without delay before the enactment of the new law. Planning now should not

merely be about using exemption but also about avoiding the harsh impact of the new provisions

causing inclusion in the settlor’s estate of assets in a grantor trust.

Life Insurance Trusts Post-Act

Unfortunately, even modest taxpayers who set up insurance trusts after the enactment of the Act may

suffer some collateral damage from the approach the Act takes to grantor trusts and annual gifts. This

can be illustrated as follows:

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Scenario: Divorced attorney with three children purchases a life insurance policy with a benefit amount

of $5 million so that she can fund her children’s education in the event of her untimely death. She

creates a standard life insurance trust (ILIT) using a template that she found online in early 2022, after

the enactment of the Act. She dies after paying approximately $240,000 in life insurance premiums.

She has a modest lifestyle and manages to accumulate assets with a value of $3.3 million as of the date

of her death, with no debt as of the date of her death.

Pursuant to IRC Sec. 677(a)(3), the life insurance trust is a grantor trust because her trustee had the

power, without the approval or consent of any adverse party, to apply income of the trust to the

payment of premiums on policies of life insurance on her life. Thus, the Act would appear to require her

estate to include value of $4,760,000 in her taxable estate ($5 million less the premiums paid). As a

result, it would seem that the Act would require the estate to pay federal estate taxes of $2,052,000

assuming none of the $3.5 million estate tax exemption is available. The Act would require the trust to

pay the estate taxes attributable to the assets of the trust (insurance proceeds) included in her gross

estate, rather than reduce the assets in the estate. Under prior law there would have been no estate tax

due as the result of her use of a relatively simple and common ILIT. No longer.

ILIT Planning Considerations

Option 1 – Plan Now: Fortunately, grantor trusts (including ILITs) that are established prior to the

enactment of the Act will not suffer from this terrible result (although new additions to the trust are not

grandfathered). Anyone considering this type of planning should complete it now while the current law

is still in force. This is discussed above.

Option 2 – Structure Post-Enactment ILITs To Mitigate the Harsh new Rules: Insurance trusts can be

viable after the enactment of the Act, so long as they are structured carefully:

• Consider making the ILIT a nongrantor trust by requiring an adverse party to consent to the

payment of premiums from the income or principal of the trust and distributions from the trust

to the grantor’s spouse (and any other provision that would trigger grantor trust status).

• Make gifts outright to beneficiaries who can then loan the funds immediately to the trust.

Perhaps, these loans might be structured as split-dollar insurance loans described in Reg.

1.7872-15 to avoid any need to make current interest payments. Alternatively, the settlor might

make split dollar loans to the ILIT.

• Exercise considerable caution in any transactions with the trust since the “tax” safety of a

grantor trust will not exist. Thus, the client will not be able to sell insurance to the trust to avoid

the 3-year estate inclusion rule of Section 2035 on a gift of a policy to the trust. (Even that gift

will have to run the gauntlet of lower annual gift exclusions and the lower lifetime gift

exemption). The ILIT will not be able to sell a policy to another trust without potentially

triggering gain.

Option 3 – Use Other Structures: A family limited partnership (FLP) or limited liability company (LLC)

might own a life insurance policy on the life of an individual, say a parent. The children might own the

partnership or membership interests. Perhaps, a small 1% interest in the FLP or LLC could be owned by a

trust that could control distributions and liquidation decisions, analogous to the approach some

12-29


practitioners have employed to deflect a Powell challenge. If annual gifts are made to the heirs and they

recapitalize the entity each year to fund insurance premiums it might avoid the new cap on annual gifts

to trusts and of interests in entities. Using the FLP/LLC structure will provide asset protection and

centralized management. The individual the client would have named as trustee of the ILIT might be

named as the general partner or manager of the FLP/LLC. Perhaps the heirs that receive annual gifts

directly might have their FLP/LLC interests owned by a trust they create using some portion of their 1-

million gift exemption.

Change Durable Powers of Attorney to Permit ILIT funding/Loans

Practitioners should review client’s durable powers of attorney in light of the various Act restrictions,

especially on annual gifts. If the client is disabled and the agent under the power of attorney takes over

for the client’s financial matters, will the agent have authority to continue to fund the life insurance plan

to allows for contributions to an entity so that the entity will have sufficient resources to pay premiums

on the life insurance policy?

Post-Act Inadvertent Contributions to a Grantor Trust

The Act imposes these new special rules to that portion of any grantor trust “attributable to a

contribution made on or after [enactment].”22 Thus, future planning may be complicated as

practitioners will have to discern when trusts were created, whether additional contributions were

made post-effective date of the Act, and whether or to what extent the new law applies. Interestingly,

the Act uses the term “contribution” in this section (2). To the extent that a grantor trust is established

prior to enactment of the Act, would a grantor still be able to sell an asset to a grantor trust without

implicating the Act? If a sale is not considered a contribution for these purposes, it would seem that

may be possible to use older grantor trusts to which no new gift transfers are made after enactment to

accomplish an estate tax freeze using a sales transaction. But a gift component to a transfer could not

only trigger an inadvertent gift tax (and remember the lowered gift exemption) but would cause a

portion of the trust to be included in the settlor’s estate as well.

Extreme caution must be exercised with older trusts executed prior to enactment. Despite the planner’s

best intentions, clients may unknowingly trip the wires that would implicate the Act’s special rules, as in

the following:

Example: Settlor creates a trust in 2020 and believes that no later additions are made. However, Settlor

each year pays the institutional trustee fee of $10,000/year directly and pays the accountant’s fee for

trust income tax filings and related accounting work of $5,000 directly. These indirect gifts continue for

10 years before the Settlor dies. Following enactment of the Act, Following enactment of the Act, this

practice continues eight more times, resulting in contributions of approximately $120,000 to the trust.

As a result, the Act would seem to require the executor of the Settlor’s will to analyze how much of the

value of the trust corpus is included based on a fraction where the value of the contributions made to

the trust is the numerator and the total value of all contributions made since inception is the

22 Id. at Sec. 8.

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denominator. The analysis may be akin to that done in a matrimonial matter to determine the impact of

commingled funds.

A Possible Replacement for Grantor Trusts?

Post-enactment, perhaps FLPs and LLCs and other structures might be used instead of what is, under

present law, handled in grantor trusts in order to achieve asset protection objectives for the family. In

some of these structures, a 1% general partnership interest might be owned by a trust with the 99%

nonvoting interests owned outright by various family members. A restrictive operating agreement may

inhibit access to the underlying investments by the creditors of the individual owners but it would not

seem to foreclose the attachment of the ownership interest in the partnership itself unlike a trust where

the beneficiary’s interest in a spendthrift trust usually cannot be attached.

Non-grantor trusts will likely reappear as a more necessary approach if the Act becomes law. This may

occur because of the Act’s including in the settlor’s gross estate assets of a post-Act grantor trust

(funded post-Act or created post-Act). A non-grantor trust differs from a grantor trust in that there is a

hybrid approach to income taxability. Specifically, ordinary income earned by the trust from various

sources, including interest, dividends, rental income, etc. may be retained by the trust or else

distributed out to beneficiaries. To the extent income is distributed to a trust beneficiary, the trust will

receive an income distributions deduction. Generally, capital gains and losses will remain within the

trust and not be passed through to beneficiaries, though there are some exceptions.

The income tax rates for nongrantor trusts are severely compressed as compared to those applied to

individuals. In 2021, nongrantor trusts will be taxed at the highest income tax rate (37% plus 3.8% net

investment income tax, if it applies) on all income over $13,050. If the Biden administration raises

marginal tax rates to 39.6% the rate the impact would be even greater. Nongrantor trusts may be

taxable in states based on the laws of each state. Even though income taxes may be higher and

reporting more cumbersome for non-grantor trusts, it may be more advantageous in the long run to use

non-grantor trusts if the Act is ultimately passed in its current form.

Sales to non-grantor trusts have infrequently been used but may become a more popular planning tool

in certain circumstances.

Example: there may be a planning opportunity following enactment using a sale to a nongrantor trust.

Client’s spouse died and interests in the family business received a step-up in income tax basis (since the

Bill, at least in its current format, does not limit the step up in basis on death). Surviving spouse sells

those interests to a non-grantor trust. While that trust will be subject to the new GST tax restrictions

(inclusion ratio of 1) in year 50, the assets with all appreciation should be outside the client’s estate.

Grantor Trusts and Basis Step-Ups

While the assets owned by the grantor trust that are included in the taxable estate would be stepped up

to the date of death value, the Act proposes to codify the disallowance of a step-up in basis for property

held in certain grantor trusts, to the extent of any amount that is not includable in the gross estate of

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the transferor.23 Under current law some commentators have argued that appreciated assets in a

grantor trust do receive a basis step up. See, in particular, “Income Tax Effects of Termination of Grantor

Trust Status by Reason of the Grantor's Death,” Journal of Taxation 149 (Sept. 2002). The fact that

Congress is considering a specific legislation prohibiting that position might be viewed by some as a tacit

confirmation of the validity of that position.

Dynastic Planning and GST Dramatically Changed

Perhaps, no provision in the estate tax code engenders more derision than the generation skipping

transfer tax (GST) exemption. According to Sen. Sanders, “[b]illionaires like Sheldon Adelson and the

Walton family, who own the majority of Walmart’s stock, have for decades manipulated the rules for

trusts to pass fortunes from one generation to the next without paying estate or gift taxes.”24 For this

reason, the Act seeks to strengthen the generation-skipping tax by requiring that, for any distribution

from a new trust that is not a qualifying trust, “the inclusion ratio with respect to the property

transferred in such transfer shall be 1.”25 A qualifying trust means “a trust for which the date of

termination is not greater than 50 years after the date on which such trust is created.”26 For any trusts

created before enactment, any such trust shall be considered a “qualifying trust” for a period of 50

years, starting on the date of enactment.27

Dynastic planning has been at the foundation of modern trust and estate planning. The goal had been to

shift value to an irrevocable trust and allocate GST exemption to the trust. Properly done under the

current system, the value of assets in that GST exempt trust, no matter how much they appreciate and

no matter how long held in trust, might never be subject to the transfer taxation system. The

compounding of wealth outside the estate tax system can provide incredible wealth shifting

opportunities. When this is coupled with a long-term trust (dynastic trust) wealth can compound outside

a client’s estate forever. The Act seeks to limit the application of the GST exemption to a maximum of 50

years.

The scope of this provisions seems broad, and its application destroys traditional non-tax planning. An

obvious reason to create long term trusts is to protect assets from divorce or an heir’s divorce, from the

litigious nature of society, etc. Yet, if assets are transferred in trust, they will be subject to a GST tax

after 50 years thereby potentially reducing the value of the assets in an amount greater than the divorce

threat the client is seeking to protect an heir against.

Example: Prior to enactment, a physician client in her late 30s is concerned about asset protection

planning and safeguarding as much of the current exemption as possible. She created a self-settled

domestic asset protection trust (DAPT) under current law. A primary goal was to grow assets outside her

estate during the remainder of her career and safeguard those assets from malpractice claims so that

she may be provided access to them to pay for her retirement. At ages 75-90 she draws funds from the

DAPT for living expenses. There is no transfer tax, and she continues to pay income tax as the trust is a

23 Id. at Sec. 5, modifying IRC Sec. 1014. 24 Press release by Sen. Bernie Sanders (I-VT), supra note 5. 25 The Act, supra note 2 at Sec. 9. 26 Id. 27 Id.

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grantor trust. At age 91 she withdraws funds from the DAPT but since more than 50 years have passed

the new GST rules under the Act appears to apply. However, there are no tax consequences because the

distribution is to the settlor, who is not a skip person to which the GST tax does not apply. However, in

the year, which is 50 years after the date of enactment, the trust will have an inclusion ratio of 1 for GST

purposes. A GST tax will be assessed on any distribution made from the trust to a grandchild, regardless

of the fact that the trust was GST exempt when funded.

While some commentators have concluded that this provision requires a trust to terminate on the date

on which it no longer meets the definition of a qualifying trust, this does not appear to be the case.

Rather, the trust, created before the enact date of the Bill, would automatically have an inclusion ratio

of 1, meaning that distributions from the trust would be subject to a GST tax to the extent distributed to

a skip person (that is, a grandchild, more remote descendant or someone assigned to such a generation)

as of the date of distribution. Despite this nuance in interpretation, all commentators appear to agree

that this rule serves its intended purpose of decimating multi-generational planning, regardless of when

the trusts were created.

Considerations for Post-Enactment Multi-Generational Planning

Given the harsh implications of the potential new GST taxing regime, taxpayers may wish to plan

differently for how formerly GST exempt dynastic trusts can be treated. For example, if the inclusion

ratio becomes 1 in year 50 a distribution to a skip person will trigger a GST tax at the new increase

transfer tax rates.

A trustee may opt to distribute assets in year 49 before the inclusion ratio for GST purposes changes.

Also, a gift tax may be triggered on grantor trusts created after the date of enactment under what would

be new Section 2901. On the other hand, if the gift had been made to a non-grantor trust, it would

appear that no gift tax will be incurred. Thus, perhaps assets in a grantor trust created before

enactment or a nongrantor trust can be distributed to the beneficiaries in year 49 thereby avoiding both

the gift tax and the GST tax. A practitioner would need to exercise caution in facilitating these

distributions in order to avoid attachment by a beneficiary’s creditors and predators. All of this might

result in very different planning.

Several different planning ideas might be addressed in planning such a distribution before the change in

the GST inclusion ratio.

• Trust assets might be first contributed to an FLP or LLC so that on distribution there is some

measure of asset protection, control over distributions since the trust will no longer hold assets,

etc. Then the entity interests, perhaps non-controlling entity interests, can be distributed. This

will not be the traditional application of discount planning (which will be prohibited for non-

business assets in any event by the Act) but rather to substitute for the trust structure.

• Another consideration might be to retain in the trust sufficient cash and marketable securities

that reasonably can be used to pay for educational and medical expenses of skip person

descendants, and for lifestyle expenses of non-skip persons (since those distributions will not

trigger GST tax even after the 50-year time period).

▪ When the distribution is made perhaps a concept similar to “generation jumping” that has

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previously been proposed in other contexts might be used. Instead of distributing to grandchildren,

make the distributions to the youngest generation then living. That may avoid layers of future GST

tax. This concept of generation jumping may be more important than ever in light of the restrictions

on trust and GST planning contained in the Act. The concept is discussed in “Selected Planning

and Drafting Aspects of Generation-Skipping Transfer Taxation,” The Chase Review (Spring

1996).

▪ It should be noted that for trusts created before enactment of the Bill, they need not provided for

them to terminate at all time. It is just that their inclusion ratio will be 1 after the 50 year period.

And although a (new) “qualifying trust”, to have an inclusion ratio of more than 1 must terminate

within 50 years of its creation, there does not seem to be a prohibition that it then be transferred to

another trust, so asset protection for its assets might continue although generation-skipping transfer

tax exemption could be gone.

Post Enactment Grantor Trust: Taxpayer creates a grantor trust after the date of enactment. A

distribution from the trust will trigger a gift tax under Section 2901. Therefore, the only planning option

would be to compare the potential gift tax exposure to the GST tax that would be assessed on

distributions to skip persons. Recall that the gift exemption is not indexed for inflation.28

Modification to the Annual Exclusion and Apparent Elimination of

Crummey Powers and 2503(c) Trusts Despite some initial commentary suggesting that the Act reduces the annual exclusion down to $10,000,

this does not appear to be the case. In the calendar year beginning after enactment, taxpayers will still

be able to make gifts of $15,000, to continue to be indexed for inflation to any donee.29

However, the Act does remove the present interest requirement for annual exclusion gifts but then caps

any gifts to a trust by two times the annual exclusion. Thus, the good news is that practitioners no

longer have to chase clients for Crummey notices for gift tax return purposes (but estate panning

counsel may still do so for trust compliance). Practitioners will be free of the endless debates as to

whether the notices need to be in writing for not. The bad news is that annual gifts to trusts are limited

to $30,000 in the aggregate no matter how many distant cousins have been granted a withdrawal

power. This raises the question as to what happens with trusts that mandate that the trustee notify

beneficiaries of their right to withdraw. Unless that right can be eliminated by a decanting it may be that

the trustee will have to continue to comply with the terms of the governing instrument and give notices

even if the intended tax effect of those notices is irrelevant.

Clients with life insurance or other plans funded with annual gifts should endeavor to shift value to

those trusts before enactment of this restrictions.

Current Planning Option 1: Client has a typical ILIT with Crummey powers. Premiums are $75,000/year

and are easily covered by the annual demand powers available to children and grandchildren who are

beneficiaries of the trust. If a new law similar to the Act is enacted and transfers to trusts are capped at

$30,000 per donor, indexed for inflation, the client will not be able to fund premiums without incurring

a costly current gift tax cost. The client might be able to transfer marketable securities to the trust now,

28 See, generally, the JCT scoring of the Act, supra note 11. 29 The Act, supra note 2 at Sec. 10. This section specifically modifies paragraph (1) of section 2503(b), leaving paragraph (2) of section 2503(b) unscathed. Sec 2503(b)(2) provides for inflation adjustments in $1,000 increments. See also JCT supra note 11.

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using her exemption, so that the future premiums can be paid from a combination of the income and

principal of the gift made. Alternatively, perhaps the client might prepay future premiums currently in

order to minimize the future income tax costs.

Current Planning Option 2: Since GRATs are also on the chopping block, a wealthier client who does not

have adequate exemption remaining to complete a large gift in 2021 before the new Act becomes

effective as in the prior example, might create and fund a GRAT that terminates in favor of the ILIT. This

had been a common approach when exemptions were lower for a non-GST exempt ILIT. The GRAT

could be established to shift value to the ILIT, hopefully avoiding the need for additional gifting to the

trust. This type of GRAT/ILIT plan might also be structured different than such plans had been

historically. The traditional GRAT/ILIT plan would have entailed creating a two-year GRAT with the ILIT as

the beneficiary. Each time an annuity payment was made, the client would re-GRAT the annuity into a

new GRAT also benefiting the ILIT. Since GRATs are slated for restriction in the Act, then perhaps a tier

of GRATs with different terms might be created now, before the new GRAT restrictions are enacted, so

that the existing GRATs may be grandfathered and continue to fund insurance premiums for years to

come, despite the restriction on annual gifts to trusts.

Interestingly, the Act strikes Sec. 2503(c) from the Code, eliminating the option enjoyed by modest

taxpayers to set up trusts for the benefit of younger individuals, usually grandchildren. Section 2503(c)

trusts are not generally a tool of the ultra-wealthy but more of an alternative for grandparents to make

a gift up to the annual exclusion amount for a minor which would have to be withdrawn before the child

turns age 21. It is hard to understand the abuse sought to be remedied by this decision. Practitioners

will need to scour old trusts and determine whether any clients need to be advised if this provision is

ultimately stricken from the Code. Perhaps, individuals will make greater use of Uniform Transfers (Gift)

to Minor Act transfer in lieu of Section 2503(c) trusts,

Importantly, it appears that the Act does not affect contributions to a qualified tuition program which

meets the statutory requirements of IRC Sec. 529 (“529 Plans”).30 Nothing in the Act appears to liken

529 Plans to trusts to which excluded gifts are capped at twice the annual exclusion. Further, the Act

does not appear to disrupt the ability of taxpayers to bunch contributions to a 529 Plan and treat them

as ratable annual exclusion gifts over five years.31 Thus, taxpayers looking to reduce wealth without

making outright gifts may wish to fund 529 plans. However, it is important to be careful not to overfund

a 529 plan as in the next example:

Example: Assume that a parent established a 529 account for the benefit of her son, Jerry. Jerry is newly

married and has a daughter. The family would like for the 529 account to benefit Jerry’s newborn

daughter. The account has approximately $100k in it.

30 IRC Sec. 529(b)(1) the term “qualified tuition program means a program established and maintained by a State or agency or instrumentality thereof or by 1 or more eligible educational institutions— (A) under which a person— (i) may purchase tuition credits or certificates on behalf of a designated beneficiary which entitle the beneficiary to the waiver or payment of qualified higher education expenses of the beneficiary, or (ii) in the case of a program established and maintained by a State or agency or instrumentality thereof, may make contributions to an account which is established for the purpose of meeting the qualified higher education expenses of the designated beneficiary of the account, and (B) which meets the other requirements of this subsection.” 31 IRC Sec. 529(c)(2)(B).

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Although plans must allow transfers from one family member to another, Prop. Reg. Sect. 1.529-

5(b)(3)(ii) indicates that when there is a change of beneficiary on a 529 account from the child to the

grandchild, the transfer will be treated as a taxable gift from the child to the grandchild.

Thus, the change of beneficiary will be deemed a gift from Jerry, which he can split with his wife and

treat ratably over 5 years. In other words, each of Jerry and his wife can make an election so that each

is only deemed to have made a gift of $10,000 to their daughter each year for 2021, 2022, 2023, 2024,

and 2025. This is well under the expected annual exclusion in each of those years.

To the extent that this progressive wave in Congress continues, educational costs might be significantly

reduced over the next few years. Taxpayers should carefully tailor contributions to 529 Plans in order to

avoid overfunding them and creating another tax problem for their beneficiaries.

Impact of Multiple Proposed Changes on Estate Planning

With the restrictions on discounts, GRATs and other techniques, it will not only be difficult to leverage

asset transfers to lessen the effects of gift and estate taxes, but also shift assets for asset protection

purposes. Thus, for asset protection planning, planners will need to shift focus away from completed gift

asset protection trusts (“DAPTs”) to the use of FLPs, LLC and, possibly incomplete gift trusts. The ability

to shift the value of FLP/LLC interests to trusts to fractionalize ownership will be more challenging.

The result might be a greater use of multi-member entities with other parties contributing assets to the

partnership on formation so that the client seeking asset protection will have his or her interests and

control diluted from inception. This will require a different approach to planning. The risks of triggering

the investment company rules and unintentional gain if diversification results from the funding of a

securities partnership may be more common an issue to review.32 The use of assets protected under

state law will grow in importance.

From a transfer tax planning perspective, it will be even more important to shift business opportunity

outside the client’s estate as that remains a transfer that may be difficult for the IRS to tax. Thus, a client

with a new business endeavor, or, possibly, an expansion of an existing business, might endeavor to use

that expansion or new endeavor as an opportunity to create a new entity owned by a trust already

outside the estate. The analysis of the use of guarantees rather than seed gifts will have to be

reconsidered. Under current law, a client seeking to transfer by sale $90 million asset might make a

seed gift to the purchasing trust of $10 million and thereafter sell the target asset for its $90 million

value. Under various interpretations of the mythical seed gift requirement (9:1 or 10:1), the above plan

suffices. The Act’s $1 million limitation on gifting may portend wider use of guarantees to support

certain transfers.

Bringing It All Together: Some More Examples

32 See IRC Sec. 721.

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The Act is a comprehensive attempt to reshape the transfer tax that has been used by planners for the

past several decades to help their clients achieve estate planning, business succession and asset

protection goals. Some might say that the author of the Act used a sledgehammer instead of a scalpel in

crafting some of the most onerous provisions. In order to understand how each provision of the Act

might work together, please consider the examples set forth below.

Distributions from a Grantor Trust created or funded Post-Enactment: Following enactment of the Act,

Jack makes a gift of $1 million to a grantor trust for the benefit of his sister, Jill and her descendants,

using up his entire gift exemption. In year 49, Jack is still alive. The trust has enjoyed growth of

approximately 4% but made no distributions so has an approximate value of $6,840,000. The Trustee is

considering whether to distribute the balance in trust to Jill and her 11 descendants in order to avoid

implication of the GST tax provisions under the Act.

The annual exclusion is indexed for inflation pursuant to IRC Sec 2503(b)(2), which was not changed by

the Act. For the purposes of this example, assume that the annual exclusion in year 49 is $20,000.

Further, the Act does not limit application of the annual exclusion to gifts of a present interest so it

would seem that even though distributions are being made from a trust that was funded years earlier,

the distribution should be eligible to be reduced by annual exclusions.

Jack’s spouse has agreed to split the transfers.

Based on the foregoing, the total gift tax[ why is gift tax due? --now I see; it is a grantor trust but you

didn’t say that] due would be $837,000, calculated as follows:

Since the gift tax and the GST tax are separate, it would seem that this plan would necessarily need to

be undertaken prior to year 50 for a grantor trust subject to the special rules under the new Sec 2901.

Otherwise, any distribution from the trust would be subject both to a gift tax and have an inclusion ratio

of 1, meaning that any such a distribution from the trust in year 50 or beyond to a skip person would

likely be subject to both taxes.

It is not clear whether distributions made for health or education would be eligible for an exemption

from either the gift tax or GST tax under this new taxing schema although there is no indication they

would disappear.

Might it be advantageous for family members to serve in fiduciary positions and earn fees to lessen the

assets in the trust subject to GST tax? That might provide some marginal benefit if the fees could be

Approximate Value of the

trust in Year 49: 6,840,000

Less exclusion for prior

gifts to trust: (1,000,000)

Less annual exclusions

under 2503(b) split with

spouse: 12 (480,000)

Total taxable gift: 5,360,000

Total tax: 837,000

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supported as reasonable under state law. However, those fees would trigger income tax at what may be

new higher rates. Further, to the extent that the trust is a grantor-type trust, the grantor would not be

able to deduct the fiduciary fees as a matter of current income tax law. It would not seem that paying

out fiduciary fees would present any benefit to the family in this circumstance.

Distributions from a NonGrantor Trust: If the trust at issue in the earlier example had instead been a

nongrantor trust created by Jack for Jill’s benefit after the date of enactment, a distribution from the

trust should not trigger a gift tax under what would be new Section 2901. Thus, a planning option might

be to distribute assets out of the trust in year 49 to avoid implicating the GST tax on distributions from

the trust in year 50 and beyond. While that may avoid the early imposition of a GST tax, it also exposes

the formerly protected trust assets to the reach of an ex-spouse and creditors. . However, although a

trust must terminate in 50 years to be a “qualifying trust” to have an effective Inclusion Ratio of less

than 1, the Bill does not appear to prohibition the trust assets from being distributed to another trust

which could provide asset protection and fundamental management that an outright distribution might

not.

Assets in the trust could be held in family partnership or limited liability company structures so that

when distributed, commingling can be limited or avoided to minimize divorce risk and also to provide

creditor protection following distribution. Once the distribution is received, perhaps each beneficiary

should make transfers to incomplete asset protection trusts in order to provide an additional measure of

protection from divorce or creditor claims. If the beneficiary has unused exemption, they might be able

to use that amount, but that too is limited to $1 million under the new law and is not indexed for

inflation. However, using that exemption on receipt of the benefactor’s trust distribution, while limited,

may make some sense. Since grantor trusts will be subject to so many restrictions it may not be feasible

to create a grantor trust in order to accomplish a tax-free sale of the FLP/LLC interests, since those

assets will be subjected to estate inclusion, etc.

Distributions from a Pre-Enactment Trust: Taxpayer creates a trust prior to the date of enactment. The

GST tax will apply 50 years hence. In year 49 the assets can all be distributed to avoid the GST tax. No

gift tax will be incurred under proposed new Section 2901 as the trust is grandfathered from that

provision so long as no contributions were made after enactment of the Act. The assets, as discussed in

the preceding example, can be restructured into FLP/LLC solution to provide divorce and asset

protection although paying the assets to another trust (even DAPTs the beneficiaries create likely would

be preferable. The beneficiary could evaluate the same options suggested above.

Conclusion

The Act is an aggressive opening argument in what will likely be the soundtrack of the next few months

for tax practitioners. Even Senator Sanders recognizes that it faces an uphill battle in a divided Senate.

Still, it appears to have the support of an ever-growing number of progressive politicians and their

constituents for whom the concerns wealth inequality has resonated, particularly over the course of the

pandemic. But it is impossible to predict what may be enacted or when it will be effective. Therefore,

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practitioners should guide clients to reasonably and flexibly implement planning strategies as quickly as

feasible in order to endeavor to complete planning before the possible date of enactment.

CITE AS:

LISI Estate Planning Newsletter #2876 (April 5, 2021) at www.leimbergservices.com Copyright 2021 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

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SLATs

SHOULD YOUR CLIENT

GIFT THEIR VACATION

HOME TO SLATS TO

HELP USE TEMPORARY

EXEMPTION?

A dynastic trust can retain property,as well as other assets needed toprovide cash f low to covermaintenance and carrying costs, etc.,in trust for as long as state law willpermit.

PATRICK GORDON, ESQ.,COURTNEY DOLAWAY,ESQ., DAVID NEUFELD,

ESQ., BRIAN BOAK,BRONWYN L. MARTIN,

and MARTIN M.SHENKMAN, ESQ.

PATRICK GORDON, ESQ.[ P L A C E H O L D E R T E X T ]COURTNEY DOLAWAY, ESQ. isa shareholder and member of FlasterGreenberg’s Trusts & Estates, Taxa-tion, and Business & Corporate De-partments. She concentrates herpractice on complex estate planning,estate administration, business suc-cession, and general corporate mat-ters. She also serves as chair of thefirm’s Women’s Initiative Commit-tee. Ms. Dolaway can be reached at2 1 5 . 2 7 9 . 9 3 7 7 o [email protected] NEUFELD, ESQ. is ashareholder and member of FlasterGreenberg’s Trusts & Estates, Taxa-tion, and Business & Corporate De-partments. Having practiced law for

more than 35 years, he advises indi-viduals and businesses around theglobe on sophisticated federal in-come and estate tax planning, statetax residency planning and audits,asset protection, and insurance andinvestment planning. Mr. Neufeldcan be reached at 856.382.2257 [email protected] BOAK, AEP, CPRIA,CLU, LUTCF, has been advis-ing clients for over thirty years. Forthe last twenty years, he has workedwith family offices and advisors ofhighly successful families providingrisk management for the personalproperty, liability and lifestyle expo-sures of their clients. Brian is on theBoard of the Estate Planning Coun-cil of NYC and the Past-Presidentof The Estate Planning Council ofRockland County. He can bereached at [email protected] L. MARTIN, PhD,MBA, ChFC, CLU, CLTCCRPC, CFS, CMFC, AEP,LACP, AIF has been in the finan-cial planning industry for over 20years and has an office in both PAand MD. She is a member of theNAEPC Board and a member of theexecutive board of the ChesterCounty Estate Planning Council.MARTIN M. SHENKMAN, CPA,MBA, PFS, AEP (distinguished),JD, is an attorney in private practicein Fort Lee, New Jersey and NewYork City, New York. His practiceconcentrates on estate planning. Au-thor of 44 books and more than1,200 articles. Editorial BoardMember of Trusts & Estates Maga-zine, CCH (Wolter’s Kluwer) Co-Chair of Professional AdvisoryBoard, CPA Journal, and the Matri-monial Strategist. Active in manycharitable and community causesand o rgan iza t ions . FoundedChronicIllnessPlanning.org whicheducates professional advisers on

planning for clients with chronic ill-ness and disability and which hasbeen the subject of more than ascore of articles. American BrainFoundation Board, Strategic Plan-ning Committee, and InvestmentCommittee. Bachelor of Science de-gree from Wharton School, concen-tration in accounting and econom-ics; MBA from the University ofMichigan, concentration in tax andfinance; Law degree from FordhamU n i v e r s i t y S c h o o l o f L a w .www.shenkmanlaw.com.

7.4 million Americans own a sec-ond home.1 Planning for these as-sets is important to the estate plan-n i n g p r o c e s s . T h e c u r r e n tenvironment of lower interest ratesand property values, high temporaryexemptions, and a growing concernamongst the wealthy that estatetaxes will be made harsher to payfor the coronavirus bailouts, suggestthat planning for this popular assethas become even more important.Wealthy clients can use vacationhomes as gift assets to use some oftheir current high temporary exemp-tions. This can be particular advan-tageous now as many clients will bereluctant to gift away investment as-sets given market declines, as theymay want to preserve those dimin-ished assets to cover future livingcosts. Many wealthy families wish-ing to pass on vacation homes to fu-ture generations should take stepsbefore the current high temporaryexemptions decline.

Using exemption and passing ona vacation home, with a myriad ofpersonal issues, require planning.That planning often is best servedwith a long-term dynastic trust.

Trust

One approach to eventually be-queath a vacation home to heirs

1 http://eyeonhousing.org/2018/12/nations-stock-of-second-homes/.

1

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may be for one spouse to gift thevacation home to an irrevocable dy-nastic trust. A dynastic trust can re-tain the desired property, as well asother assets needed to provide cashflow to cover maintenance and car-rying costs, etc., in trust for as longas state law will permit. This canfacilitate passing the vacation hometo future generations without estatetax concerns and future appreciationof the vacation home is removedfrom the donor client’s estate. Whenthe donor client’s spouse is namedas beneficiary of the trust, perhapsalong with descendants (or withtrusts for their descendants beingthe remainder beneficiaries), thetrust is often referred to as aSpousal Lifetime Access Trust(SLAT). If the client is not marriedand wishes access a domestic assetprotection trust (DAPT) might beused, or some other variation oftrust.

Some of the provisions or charac-teristics of such a trust might in-clude:

• Whether a draftsperson createsa SLAT or simply a trust for de-scendants, the trust instrumentshould have an express provision topermit the trustee to hold personaluse property.

• The trust might include lan-guage permitting the beneficiaries touse that property rent-free. How-ever, that may not always be opti-mal. If an existing vacation home istransferred into the trust some prac-titioners might recommend that thespouse/donor pay rent to the trust toreduce the risk of estate inclusion(although that may not be necessaryin some instances). Also, if the trustis a grantor trust paying rent mayhave no income tax consequences,but may permit the clients to makegift-tax free transfers of funds eachyear that could be used to offsetcarrying costs for the property.

• Inquiry, if the trust is going touse an institutional trustee (see be-low), should be made at the draftingstage as to whether the trusteewould have any issues holding per-sonal use property such as the vaca-tion home. If so, the trust might bestructured as a directed trust with aperson named to be in charge oftrust investment decisions (e.g. asinvestment director), including hold-ing the personal use residence.Draftspersons should be careful toconfirm which fiduciary will be re-sponsible for the decision to holdthe personal use property. It maynot be certain whether a vacationhome would be viewed as an invest-ment decision within the purview ofthe investment director, or instead adistribution decision within the pur-view of the distribution director orthe general trustee who may, de-pending on the terms of the gov-erning instrument, be responsiblefor distribution decisions. The man-ner in which some trusts are draftedmight make the general or adminis-trative trustee responsible for deci-sions to hold personal use property.If an institutional trustee is to benamed, it may be easier to have anindividual trust investment directorinstead responsible for personal useproperty investment decisions. Itmay also be worthwhile to considerproviding the investment directorwith the right to create rules or reg-ulations for the use of the property(but see below).

When creating a SLAT considerusing as a jurisdiction for the situsof the trust one of the 19 jurisdic-tions that permit self-settled domes-tic asset protection trusts (if thetrust is structured as a DAPT, thatwould be required). That way, ifthere is a challenge to the trust bythe IRS or creditors that the settlor/donor retained the use of trust prop-erty, the donor client can argue that

the trust qualifies as a self-settledtrust and should still be respected. Ifthe clients do not live in a state thatpermits such trusts, then an institu-tional trustee will have to be namedto obtain situs in one of those per-mitted states.

In most instances it will be ad-vantageous for the client to use sucha trust plan for more than just safe-guarding a vacation home, e.g. touse exemption generally before thelaws change.

Using an LLC to Hold Title tothe Vacation Property

A limited liability company (LLC)is often beneficial, and in some in-stances essential, to the vacationhome plan for several reasons:

1 An LLC can provide assetprotection insulating the trust fromliabilities associated with the owner-ship of the vacation home property.

2 The LLC operating agree-ment can contain rules and regula-tions about the use of the property.For example, which beneficiaryfamily can use the vacation homeon key holidays? For a beach house,July 4th weekend may be highly de-sirable. For a mountain home,Christmas week may be the hotticket. A rotational use systemmight be provided for. Other issuesmight include who is responsible forrepairs and who can make decisionsas to decorating or improvements.

3 If the property is located in adifferent jurisdiction then the trustjurisdiction where the trust has situs,the trust should not own propertyoutside of its home jurisdiction.Thus, the LLC effectively trans-mutes a real property interest intoan intangible asset the trust can holdregardless of where the real estate islocated.

Consider whether the LLC shouldbe a manger managed LLC. Sincethe trust may be the sole member, it

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can be advantageous to have a man-ager named who has authority toexecute documents, pay bills, etc.,on behalf of the LLC. That maymake the LLC easier to administer.

Does the LLC Need a BusinessPurpose?

As a matter of state law it seemsthat, subject to any particular statelaw or ruling otherwise, a businesspurpose generally is not a prerequi-site for forming and using an LLC.Many LLC’s are formed with a bus-iness purpose. Owning a vacationhome exclusively for personal use(as opposed to holding it primarilyto rent out with limited personaluse) is not on its face a businesspurpose. In most states this is not animpediment. Most states do not re-quire the LLC to specify a businesspurpose to be formed. For instance,section 108(b) of the current versionof the Uniform Limited LiabilityCompany Act2 provides that informing an LLC it “may have anylawful purpose, regardless ofwhether for profit.” The commentexplains that “[a]lthough some LLCstatutes continue to require a busi-ness purpose, this act follows thecurrent trend and takes a more ex-pansive approach.” Thus, a purposestatement permitting the LLC “toengage in any lawful activity forwhich the LLC may be organize inthis state” or a similar statementshould suffice.

While in the context of an operat-ing business the income tax law re-quires a valid and bona fide busi-ness for several reasons, includingtax free organizations and reorgani-zations,3 issues relating to deduc-tions and issues relating to income

shifting,4 and others.5 But in a purepersonal asset scenario these incometax rules typically do not come intoplay, and so the existence of busi-ness may likewise be irrelevant as amatter of income tax.

Even where the IRS might have avalid argument attacking the entityunder the income tax rules based onbusiness purpose the courts have re-jected the IRS’s position that theentity itself should be disregardedfor transfer tax purposes.6

Having said that the LLC servesnumerous economic purposes inde-pendent of tax savings. It:

1 Provides control and man-agement.

2 Provides for succession ofmanagement.

3 Permits a trust to hold own-ership of real estate.

4 Supplies an additional layerof asset protection.

The lack of any business purposefrom the ownership and operation ofthe vacation home seems to be irrel-evant.

Operating Agreement Considera-tions

When an LLC is used an operatingagreement may be useful to prepareeven though it is a single memberdisregarded (for income tax pur-poses) LLC. While many practition-ers might not bother with an operat-ing agreement, failure to use anoperating agreement defaults to therules imbedded in that state’s LLCstatute which may or may not re-flect the needs of the family. Thereare a number of provisions that canbe added that might be beneficial.As noted above, it may be advanta-

geous to name a manager, and ex-pressly provide provisions for acts amanager may be required to per-form with third parties (e.g. expressauthority to acquire and finance aresidence), name a successor man-ager, rules and regulations on theuse of the property, and more. Forexample, personal and religiouspreferences of the family could beconsidered, such as requiring thatthe kitchen adhere to particular faithreligious dietary restrictions: aHindu family might wants thekitchen to remain vegetarian, or aMuslim or Jewish family might re-quire the kitchen to be used only inaccordance with Halal or Kosher di-etary rules. Or perhaps a restrictionon pets may be mandated. LatterDay Saints might prohibit smoking,gambling, or alcoholic beverages onthe premises.

Occupancy Agreement

An occupancy agreement could beembodied in an operating agreementor could be a separate document.Overlapping personal and financialinterests raise challenging situationsoften; toss in family dynamics andthe situation could be quite volatile.If good fences make good neigh-bors, good written agreements go along way in keeping peace within afamily sharing a vacation home.This is true whether the home is ina trust or otherwise. But the veryact of transferring it to the trustgives the family advisor the perfectopportunity to address the need toanticipate problems before they be-come insurmountable. In some in-stances, an occupancy agreementbetween the trust and the occupantmay be used to memorialize the re-

2 Uniform Limited Liability Company Act(2006) (Last Amended 2013), adopted in 21states thus far.

3 Section 355(a) and (b).4 Reg. section 1.704-1(e).5 Section 708(b)(1).

6 See, e.g., Estate of Bosch, 387 U.S. 456(1967). This has been true even in the con-text of the discount wars. Estate of Strangi,115 T.C. 478 (2000), aff’d in part, rev’d inpart and rem’d in part, 293 F.3d 279 (5th

Cir. 2002); Church, 2000-1 USTC 369 ¶ 60(W.D. Tex. 2000), aff’d, 268 F.3d 1063 (5thCir. 2001) (unpublished table decision). Butsee Holman, 601 F.3d 763 (8th Cir. 2010).See Section 2703(b)(1).

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spective rights and obligations ofthe occupant and trust regarding theuse, maintenance, improvement, andrepair of the vacation home. It couldaddress which party will be respon-sible for the payment of which ex-penses relating to maintenance, util-ities, ordinary repairs, and so forth.Integrating these rules will go along way to making sure house re-lated spats stay out of ThanksgivingDinner arguments.

What if the Client has No Ex-emption Left?

If a client has little or no exemptionleft, the client can sell the vacationhome, or any other asset, to a trustto shift any appreciation on thehome out of the client’s estate. Thiscan be a sale for a promissory note;if so the trust will need seed money,traditionally in the amount equal to10% of the value of the home. Ifthe client has sufficient exemptionremaining (even the yearly increaseto the federal exemption can be suf-ficient), the client can form a newtrust and gift the trust the seedmoney. If the client has no exemp-tion remaining, the client can lookto a previously funded trust.

Once a trust with sufficient seedmoney is identified, the client canthen sell the home to the trust in ex-change for the promissory note.This is also beneficial for clientsthat desire an income stream. Thepromissory note must have an inter-est rate, that may be as low as theapplicable federal rate (AFR). ForDecember 2020 the long-term rateis only 1.30% (more than 9 years).With the AFR is at a historic lowthis a powerful strategy to transferappreciating assets out of one’s es-tate. The magic is in the arbitragebetween the rate on the note (as lowas the AFR) and any appreciation tothe gifted property above the AFR

rate. Although the note is repaidwith interest this is considered atransfer tax win because substantialappreciation after the date of thesale is liberated from the client’staxable estate when the client dies.

Estate Tax Considerations

When a person transfers an assetout of his or her estate, the IRS mayconsider that asset still part of theperson’s estate upon the person’sdeath if the person retains an inter-est or power over that asset. It is thepresence of “strings” which drawthe property back into the person’sestate at his or her death for estatetax purposes that creates the prob-lem that needs attention. What con-stitutes strings for estate taxation isaddressed in Section 2036 (transferswith retained life estate), Section2037 (transfers taking effect atdeath), and Section 2038 (revocabletransfers). For purposes of this arti-cle, the focus will be on Section2036.

Section 2036 provides that a de-cedent’s gross estate includes any

transfer (except in case of a bonafide sale for an adequate and fullconsiderat ion in money ormoney’s worth), by trust or other-wise, under which he has retainedfor his life or for any period notascertainable without reference tohis death or for any period whichdoes not in fact end before hisdeath (1) the possession or enjoy-ment of, or the right to the in-come from, the property, or (2)the right, either alone or in con-junction with any person, to des-ignate the persons who shall pos-sess or enjoy the property of theincome therefrom.

In Estate of Reichert,7 the TaxCourt considered whether assets thedecedent transferred to a partnershipwere included in his gross estate

under Section 2036(a). Decedenttransferred his residence to a revo-cable trust, which was the generalpartner of a partnership, but contin-ued to live in the residence aftertransfer without paying rent. TheTax Court held that the decedenthad retained actual control over theproperty despite the change in legaltitle.

Is the holding in Estate of Reich-ert a problem if the donor uses thegifted vacation home after it isgifted to a SLAT for the benefit ofthe donor’s spouse if the SLAT pro-vides that family members (whichincludes the spouse) of the benefici-ary can use the vacation home? Thishas not been resolved by the Ser-vice or the courts; below are a fewthoughts that might stave off poten-tial Section 2036 challenges:

• The Donor Client Can Pay Rentto Use the Vacation Home - Havethe donor client execute a rentalagreement with the trustee of thetrust to allow the donor client to usethe vacation home by paying fairmarket rent. As with rentals afterthe occupancy term of QPRTs, thisis not considered a retained interestunder Section 2036.

• Bona Fide Sale - In Estate ofNancy H. Powell,8 the Tax Courtheld for the first time that assets ofa limited partnership could betreated as a retained interest underSection 2036(a)(2) where the dece-dent only held a limited partnershipinterest. Keeping in mind that Sec-tion 2036(a) turns on the retainedpossession or enjoyment of theproperty (or the income therefrom)or the right to determine alone orwith others who can have posses-sion or enjoyment of the property(or the income therefrom) and thatpossession can be inferred evenwithout legal control, The solutionmight lay in avoiding Estate of

7 114 T.C. 144 (2000). 8 148 T.C. No. 18 (2017).

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Powell altogether by invoking thebona fide sale exception.

Section 2036 does not apply toany transfer that was “a bona fidesale for adequate consideration inmoney or money’s worth.” A saleof the vacation home to the trust forfull and fair consideration shouldtherefore negate the Section 2036issue. But that sale of the propertymust serve a significant nontax pur-pose. If a valid nontax purpose ex-ists, such as consistent managementand investment strategy of a fam-ily’s assets, Estate of Powell shouldnot pose a problem.

There may be another line of rea-soning to address Section 2036 is-sues. In Estate of Allen D. Gutch-ess, a family residence transferredby husband to wife about 11 yearsbefore his death was not included inthe husband’s estate under Section2036, even though he continued tooccupy the residence with his wifeuntil his death. There was no writ-ten or oral express retention of rightof occupancy by the husband andno agreement for right of occupancywill be implied from the fact that helived there with his wife until hedied.9

Income Tax Considerations

If the SLAT is a grantor trust thereshould be no income tax conse-quences and any income earned onthe property, through rentals, willshift additional value to the SLATwithout gift tax consequences.

There is a tension between the es-tate tax and the capital gains tax;planning that removes an appreci-ated asset from the estate leaves in-tact the potential capital gains thatexisted on the date of the gift. Yetplanning that leaves the appreciatedproperty in the estate gets to avoidthe capital gains tax that would oth-

erwise be triggered on the apprecia-tion through the date of death at thepossible cost of an estate tax de-pending on the size of the estate rel-ative to available exemption.

If the vacation home is trans-ferred to the trust through a gift, thetrust will receive carry-over basis. Ifthe trust sells the vacation home, thetrust will have the same basis as thedonor and pay capital gains on thedifference. Likewise, if the vacationhome is sold to the trust, the trustwill still have carryover basis. Typi-cally when a property is sold, thebasis in the house is stepped up tothe sale price. However, if the trustis a grantor trust, the trust’s exis-tence is disregarded for income taxpurposes and the donor is viewed asstill owning the vacation home forincome tax purposes. If the vacationhome has significant appreciationover time it might make sense, ifthe option is available, to trigger es-tate inclusion and obtain the basisstep-up.

Insurance Considerations

A common topic within estate plan-ning is the issue of a vacation homeand sometimes a primary residence,which is owned by an LLC that isowned by a trust. For example, inan irrevocable trust that a family setup for child, and that child wants tobuy a home. Some feel the prefera-ble approach is not to give themoney from the trust to the childfor the down payment, but rather tohave the trust purchase the house. Ifthe trust is in one jurisdiction (Dela-ware, for example, which is a legaland tax favored jurisdiction), andthe house is in a state like NewYork, the house would need to beheld in an LLC to avoid an out ofstate trust owning a property in an-other state.

This scenario is often not ad-dressed adequately. Questions ariseabout handling insurance for ahouse owned by a trust or LLC,which is different from coverage ofpersonal property. Who/what shouldbe listed as insureds and additionalinsureds need to be examined, tomaximize protection in the event ofa claim. Many agents are not usedto dealing with this type of clienteleand do not ask the correct questions.Clients also often are unclear anddo not understand that simply beinginsured may not be sufficient.

If a lawyer or advisor is imple-menting a plan, this is somethingthey need to address. Unless a bankis involved, due to a mortgage, add-ing the trust or LLC to the policycould be missed. If the home isbought for cash and nobody men-tions to the insurance broker that atrust or LLC is buying the home, itwill not be added. The lawyer oradvisor must proactively follow up.This aspect of estate planning, ifhandled poorly, could cost the clientunrecoverable millions of dollars.

For lawyers drafting the docu-ment, part of their procedure couldbe to suggest to the client to ensurethat change is made to the homeand liability insurance. Some attor-neys opt to request to see a copy ofthe document showing that this trustor LLC is listed on the home and li-ability policy to confirm. Manytimes, the disconnect occurs becausea client does not want to incur theadded fees for attorney follow-up.They may need to be convinced ofthe benefit.

At minimum, advisors might putthe recommendation in writing. Ad-vise and encourage the client aboutthis type of follow up. This is agood item for all the different advi-sors on the team to have on their re-spective checklists. Clients need to

9 Estate Of Allen D. Gutchess. Docket No.4926-63. 1966-08-9. Acknowledgement to

Jonathan Blattmachr, Esq. for pointing outthis case.

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understand the possibility of multi-million-dollar loss if it is not in-sured properly.

In a structure where the house isowned by a trust or LLC in a differ-ent state, depending how it’s struc-tured, the client might have to namethe LLC and the trust both to avoidissues. The client would inform theinsurance broker that the home isowned by 123 Main Street LLCwhich in turn is owned by theSmith Family Trust. Spelling outthe structure so the insurance com-pany can use the appropriate word-ing. Advisers might consider docu-menting that this is done includingrequiring a response from your bro-ker to be then followed up for thefinal documents from the insurancecompany showing all insured par-ties.

While a revocable trust, arguably,may not always need to be listed, anirrevocable trust or LLC alwaysneeds to be listed. Since putting the

trust/LLC on the home and liabilitypolicy costs nothing, the authors al-ways recommend it.

Consider the following illustra-tion. A house burns down andsomebody is injured. If the house isowned by a trust/LLC, the insurancecompany may not pay to rebuild thehouse if the trust/LLC is not namedon the policy. They may pay for thecontents because those are ownedby the individual named on the pol-icy. If there is any art transferredinto the trust/LLC, it may not becovered. Regarding the claim on lia-bility, the insurance company willpay to defend the individual andpay their share of the judgement (upto the policy limit). The insurancecompany will not pay to defend thetrust/LLC or pay any judgement as-sessed against it.

When a client has personal usevacation homes owned by a trust orLLC, advisers should remind theclient to be certain that they have

addressed the insurance coverageproperly.

Conclusion

Vacation homes are a common assetand often can benefit from more ro-bust and comprehensive planning. Itmay be useful in appropriate cir-cumstances to fund a plan to use aclient’s gift and GST exemption.That plan can also carry out impor-tant goals of passing to future gen-erations a family vacation propertyas a legacy.

If an existing vacation home is trans-ferred into the trust some practition-ers might recommend that thespouse/donor pay rent to the trust toreduce the risk of estate inclusion.

If good fences make good neigh-bors, good written agreements go along way in keeping peace within afamily sharing a vacation home.

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LISI Estate Planning Newsletter

Joy Matak, Steven B. Gorin, & Martin M. Shenkman: 2020 Planning Means A Busy 2021 Gift Tax Return Season

“Gift tax returns are often incredibly complicated with layers of issues, technical decisions, and disclosure requirements. 2020 created additional and sometimes novel gift tax reporting considerations. This discussion underscores the imperative for collaboration among the estate planning practitioner and the tax preparer. Disclosures should be carefully constructed in order to bolster the client’s position against a challenge by the IRS as to the operation of the valuation adjustment clause.

The gift tax return preparer should seek counsel’s review and comment prior to finalizing the gift tax return for filing with the IRS. This will likely increase the costs of preparing and filing the gift tax return, but it will be well worth it.

Gift tax return preparation practice should be viewed by practitioners as the danger that it is. If a client will not permit you to handle a Form 709 filing in the manner you as a professional believe necessary, pass on accepting the work. Familiarize yourself with gift tax guidelines and rules carefully to ensure nothing is overlooked.”

Joy Matak, Steven B. Gorin, and Martin M. Shenkman provide members with timely commentary that should be of help to practitioners who are tasked with reporting 2020 gift tax transactions. Members who wish to learn more about this topic should consider watching their exclusive LISI Webinar titled: “2020 Gift Tax Returns: Practical Tips How to Report Common 2020 Transactions” that will be held on this Friday, February 5th from 3:00PM ET - 4:30PM ET. For more information click this link: Joy/Steve/Marty

Joy Matak, JD, LLM is a Partner at Sax and Head of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. Joy provides clients with wealth transfer strategy planning to accomplish estate and business

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https://new.leimbergservices.com/wdev/register.cfm?id=957&s=v



succession goals. She also performs tax compliance including gift tax, estate tax, and income tax returns for trusts and estates as well as consulting services related to generation skipping including transfer tax planning, asset protection, life insurance structuring, and post-mortem planning. Joy presents at numerous events on topics relevant to wealth transfer strategists including engagements for the ABA Real Property, Trust and Estate Law Section; Wealth Management Magazine; the Estate Planning Council of Northern New Jersey; and the Society of Financial Service Professionals. Joy has authored and co-authored articles for the Tax Management Estates, Gifts and Trusts (BNA) Journal; Leimberg Information Services, Inc. (LISI); and Estate Planning Review The CCH Journal, among others, on a variety of topics including wealth transfer strategies, income taxation of trusts and estates, and business succession planning. Joy recently co-authored a book on the new tax reform law.

Steve Gorin is a partner in Thompson Coburn LLP, a law firm headquartered in St. Louis, with offices in Chicago, Los Angeles, and Washington, D.C. Steve is a nationally recognized practitioner in the areas of estate planning and the structuring of privately held businesses. Lawyers, accountants and business owners regularly look to Steve for fresh, highly knowledgeable insights into the best possible tax and estate planning approaches to their transactions. Steve crafts estate plans for individuals, keeping in mind their financial security and desire to save income and estate tax. His quarterly newsletter, “Business Succession Solutions” is considered essential reading for hundreds of CPAs, attorneys, and technically-oriented financial advisers and trust officers. LISI members may email Steve at [email protected] to obtain a free copy of over 2,300 pages of technical materials and to subscribe to his free quarterly newsletter that provides the most recent version (subscriptions require complete contact information). For information not necessarily technically oriented, visit Steve’s blog at http://www.thompsoncoburn.com/insights/blogs/business-successionsolutions/about. For more information about Steve, see http://www.thompsoncoburn.com/people/steve-gorin.

Martin M. Shenkman, CPA, MBA, PFS, AEP, JD is an attorney in private practice in Fort Lee, New Jersey and New York City who concentrates on estate and closely held business planning, tax planning, and estate administration. He is the author of 42 books and more than 1,200 articles. He is a member of the NAEPC Board of Directors (Emeritus), on the Board

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of the American Brain Foundation, the American Cancer Society’s National Professional Advisor Network and Weill Cornell Medicine Professional Advisory Council.

Here is their commentary:

EXECUTIVE SUMMARY: Gift tax returns are often incredibly complicated with layers of issues, technical decisions, and disclosure requirements. 2020 created additional and sometimes novel gift tax reporting considerations.

This discussion underscores the imperative for collaboration among the estate planning practitioner and the tax preparer. Disclosures should be carefully constructed in order to bolster the client’s position against a challenge by the IRS as to the operation of the valuation adjustment clause. The gift tax return preparer should seek counsel’s review and comment prior to finalizing the gift tax return for filing with the IRS. This will likely increase the costs of preparing and filing the gift tax return, but it will be well worth it.

Gift tax return preparation practice should be viewed by practitioners as the danger that it is. If a client will not permit you to handle a Form 709 filing in the manner you as a professional believe necessary, pass on accepting the work. Familiarize yourself with gift tax guidelines and rules carefully to ensure nothing is overlooked.

COMMENT: Throughout 2020, estate planning practitioners encouraged their clients to pursue estate and asset protection planning aggressively as the tax world anticipated the impact of harsh transfer tax changes to be enacted by Democrats if they gained control in the November national elections. This was all amidst a once-in-a-lifetime pandemic that affected every aspect of daily life. As COVID cases rose throughout the country, tax experts and pundits noted that the volatile economy and rising deficit could force federal and state governments to consider additional tax legislation as early as the beginning of 2021. Practitioners were cautioned to forewarn clients how

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economic and political uncertainties might create more chaos for them, their finances and their estate plans. Tax advisers cautioned clients to act before the end of 2020 before the effective date of any changes should there be a Democrat victory. In particular, advisers voiced the concern that tax legislation enacted in 2021 after the election could be made retroactive to January 1, 2021. Practitioners also pointed to the perfect storm that made 2020 the year to plan: exceptionally high lifetime exemption from gift and estate taxes ($11.58 million per taxpayer), historically low interest rates, and artificially depressed asset values. On this advice, many practitioners advised their client to accomplish significant wealth transfers throughout 2020. Anecdotally, it appeared that the latter portion of 2020 may have been the most intense period in estate planning history in terms of the volume of planning and inter-vivos transfers. This tidal wave of estate planning will all need to be disclosed on timely filed gift tax returns in 2021. The objective of this article is to provide practitioners with practical guidance on preparing 2020 gift tax returns. In particular, attention will be given to some of the specific transaction types the authors believe received particular attention in 2020 and how to disclose them.

Gift Tax Returns General 2020 Cautions

Gift tax returns appear to be seductively simple. It's not a long return, the tax return template does not seem particularly complex to complete, so how hard can it be? Preparing a gift tax return correctly is not an easy task, and professionals who don’t prepare them regularly and with care can easily make a myriad of mistakes. There are so many areas of uncertainty, layers, and nuances that it's virtually impossible for anyone preparing a gift tax return who does not have considerable experience to miss important issues. Reporting 2020 transfers, especially those involving transfers in trust, should not be treated lightly. This is a particular concern for 2020 since so many taxpayers who made transfers may rely on their general practice attorney or CPA who may not specialize in trust and estate matters, to prepare their gift tax return. This newsletter, however, will not focus on gift tax return basics, but rather on reporting common 2020 transactions.

It will be unusual for 2020 transfers for clients to have made gifts that intentionally generate gift tax. The 2020 environment, perhaps with the

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exception of elderly or ill clients, was not one in which taxable gifts would prove generally advantageous. Also, few taxpayers are willing to intentionally incur a gift tax. In some instances, 2020 planning may have intentionally incurred gift tax. For example, a terminally ill client in 2020 may have believed that paying a gift tax at the 2020 rate of 40% and having that gift tax paid excluded from their estate if they survive three years, and in anticipation of a possible significant increase in the rates in the future, may have been thought to be advantageous. Those returns, however, will likely be few in number.

When no gift tax is due, tax returns may seem somehow less urgent. Nothing could be farther from the truth. Failure to file a gift tax return and disclose transactions “in such return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item” can delay the tolling of the statute of limitations,i and regulations impose specific requirements for “adequate disclosure.” In other words, gifts not adequately disclosed may be subject to challenge indefinitely. Additionally, a proper gift tax return filing may include elections that protect the client’s future planning objectives such as Generation Skipping Transfer tax exemption allocations, gift splitting, etc. For the most part, elections must be made correctly and timely or else the opportunity is lost.

Nuances of 2020 Gift Tax Compliance

In many ways, planning in 2020 looked different from that which was done in prior years. Many clients were reluctant to engage in significant wealth transfers without safety valves and flexibility that would protect their interests in the event that the stock market plunged. Some clients had already used their high exemptions and needed to consider other wealth transfer strategies to reduce their families’ overall tax exposure. In some cases, plans had to be pieced together quickly in the last weeks between the November election and New Year’s Eve, most often without a final valuation of the assets being transferred. The unique challenges of 2020, especially the time compression of later 2020 planning, forced practitioners to become creative in crafting plans to address their clients’ concerns. The challenge for 2021 is to ensure that the specifics of each transaction are disclosed adequately on timely filed gift tax returns so that the statute of limitations might run. Often this work will be done by CPAs who may not have been part of the original planning

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discussions. That could be particularly problematic if the CPA was excluded from planning and the attorney handling it believes that a gift tax return is not necessary, when in fact it might be, or perhaps when the CPA views the filing of a return to report a non-gift transaction differently than the attorney may. Consider the language in the instructions to Form 709: “The gift tax applies not only to the free transfer of any kind of property, but also to sales or exchanges, not made in the ordinary course of business, where value of the money (or property) received is less than the value of what is sold or exchanged.” While different views are not unusual, it is important that the client be informed of all perspectives. Assume one adviser recommends against reporting a non-gift transaction, such as a note sale transaction, and another adviser recommends filing to toll the statute of limitations. The client should be informed of the pros and cons of each position and make the ultimate decision.

Following are explanations of 2020 planning techniques with suggestions and recommendations for how a gift tax return preparer might disclose those transactions in order to satisfy adequate disclosure regulations.ii

2020 Valuations 2020 was marked with substantial market volatility and economic uncertainty. At the time of this writing, some stock market indices have reached all-time highs. Other stock prices remain low and have not fully recovered from the impact of COVID-19. The impact of COVID-19 on valuations is incredibly unequal. Businesses that have benefited from sheltering in place, increased concerns over disinfecting, etc. have burgeoned in value. Other businesses have dropped in value, and many have simply closed their doors. For many businesses, real estate investments and other assets, uncertainty as to their economic future was significant when 2020 transfers were made. This uncertainty presented the opportunity for clients to transfer temporarily depressed assets out of their estates using less gift tax exemption (or forgive part or all of note balances if a note sale transfer had been used in prior years, etc.) than what the asset would have been estimated to be worth once the Covid-induced uncertainties have resolved. By transferring noncontrolling, unmarketable interests in businesses, clients may have

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made transfers at values much less than if all of the business were sold to one buyer. Each of these points raises specific issues to gift tax return disclosures. Specific recommendations for gift tax return preparer:

• Asset values must be disclosed in a way that satisfies the adequate disclosure regulations.iii

• If a valuation is provided to support the value of the assets, the preparer should review the valuation to confirm that it meets Rev. Rul. 59-60.

• The preparer should be sure to check the box at the top of page 2 of the Form 709, answering YES to the question: “Does the value of any item listed on Schedule A reflect any valuation discount?” when that is applicable. A question of note as to 2020 transfers is whether “valuation discount” encompasses a valuation impact of Covid. The instructions to Form 709 provide: “If the value of any gift you report in either Part 1, Part 2, or Part 3 of Schedule A includes a discount for lack of marketability, a minority interest, a fractional interest in real estate, blockage, market absorption, or for any other reason, answer “Yes” to the question at the top of Schedule A. Also attach an explanation giving the basis for the claimed discounts and showing the amount of the discounts taken [highlight added].” Some may suggest that a reduction in value to reflect the uncertainty of Covid on the business might require checking the box, not merely the lack of control and other more traditional discounts, but others may suggest that uncertainty included in management estimates of future earnings is not really a “discount.” The box for discounts has always been a dicey topic for operating businesses, the value of which tends to be based on a multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA). The EBITDA multiplier (a form of a price-to-earnings ratio) tends to be derived from results of publicly-traded companies, which have discounts for lack of control baked into them instead of being separately stated.

• The preparer should also attach an explanation giving the basis upon which discounts were taken in the description of the gift and also showing the amount of the discounts taken. The following language might be helpful:

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The Fair Market Value of [the asset conveyed] was determined in good faith based on the valuation report proffered by [valuation professional], a third party valuation professional, in accordance with Revenue Ruling 59-60 and other regulations and rulings where appropriate (the “valuation report”) as of [the date of the gift]. The valuation report uses the [valuation methodology], applying discounts of XX% for Lack of Control and YY% for Lack of Marketability, for a combined blended discount rate of XY%. In addition, the appraisal reflects a discount to reflect the uncertainty of Covid-19 in the form of an increase in the discount rate from z% to zz% [modify as appropriate].

Valuation Adjustment Clauses Some practitioners have increased the use of valuation adjustment clauses to minimize the potential gift tax risk of a large transactions. This was particularly true towards the end of 2020 when so much planning was occurring that valuation professionals were unable to complete valuation reports in time for the transfers. This was more likely to be the case for transfers completed close to the end of 2020. In those situations, planners may have had to use estimates of value to get the transactions completed before year-end. This raised somewhat unique issues in 2020 valuation adjustment mechanisms. Another unique aspect of valuation adjustment mechanisms used in 2020 planning was that there was a concern in 2020 amongst many practitioners that major estate tax legislation could be enacted in 2021 that could include the elimination of valuation discounts, tax transfers to grantor trusts in the settlor’s estate, etc. Those concerns raised issues with one of the favored valuation adjustment mechanisms, a Wandry clause. While the Tax Court in Wandry upheld the defined value mechanism based on the specific wording of the clause in the assignment documents, the IRS issued a statement that the commissioner did not acquiesce to the Court’s conclusion. Although nonacquiescence signals strong disagreement, the IRS apparently did not have the confidence to appeal the case, presumably because of a prior taxpayer-favorable related precedent in the court to which the case would been appealed. The Wandry approach results in only the intended dollar amount of the assets being transferred with any excess

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above that amount remaining in the transferor’s estate. However, those remaining interests could be subjected to harsh restrictions if the most stringent of the Democrat proposals are enacted. As a result, variations of the Wandry mechanism were sometimes used. Practitioners preparing gift tax returns need to be alert to these variants and the impact on Form 709 reporting. Some transactions may have been structured using some application of one of the notable defined value cases.iv These types of mechanisms are based on the entirety of the intended value being transferred away from the transferor. However, if there is an excess value over what the buyer in the transaction is paying as a result of an IRS audit adjustment, that excess value is poured into a non-taxable receptacle. This non-taxable receptacle could be a charity, a grantor retained annuity trust (“GRAT”), marital trust, or an incomplete gift trust. Words matter in valuation adjustment clauses. In a recent case, Nelson, the taxpayer’s valuation adjustment mechanism failed because it did not use the requisite language of referring to “gift tax value as finally determined” and instead had a reference to an appraised value.v The preparer should, as a professional courtesy, notify the drafting attorney if the language required in the Nelson case does not appear to have been used. Then, it may also be advisable to notify the client of the issue. If the language is wrong, counsel might consider whether the provision can be amended, but it is not certain that a correction in problematic language after the fact would be effective. If the phrase “gift tax value as finally determined” had been used in the underlying transfer documents, the gift tax return preparer may wish to quote that language in the disclosure. If not, the practitioner would be well advised to attach the transfer documents without highlighting the potential issue; after all, the client does believe that the appraisal was correct. A gift tax return preparer is confronted with a valuation adjustment clause must exercise additional caution in disclosing the contours of the transaction. Specific suggestions for gift tax return preparer:

• Review the valuation adjustment clauses carefully. Consider the Nelson issue identified above. But that is not the only consideration.

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Which receptacle was used in the governing documents for the spillover, if a spillover was used? What might be appropriate to disclose as to that spillover receptacle? If the spillover is to an incomplete gift trust, that trust might be contained in the same trust instrument that is the primary donee or purchaser. However, if the spillover is to a GRAT the gift tax return should disclose all relevant information as to the GRAT and attach the GRAT document. In all situations, consider attaching the instrument incorporating the defined value mechanism. The Form 709 instructions provide: “If the gift was made by means of a trust, attach a certified or verified copy of the trust instrument to the return on which you report your first transfer to the trust. However, to report subsequent transfers to the trust, you may attach a brief description of the terms of the trust or a copy of the trust instrument.” It is strongly recommended that preparers of gift tax returns attach a complete copy of the trust document to every gift tax return it relates to, even if the trust document had been attached to a prior return. It is not worth the risk of attaching a description that may prove inaccurate or incomplete, when it is easier and more complete to attach a copy of the actual trust instrument.

• Be certain to identify follow up steps and key dates that might pertain to the valuation adjustment mechanism and be confirm whether the client and which advisers will monitor those items. While this may not be pertinent to the direct filing of the gift tax return, it may be essential to the success of the plan. For example, if there is a spillover to a charity, what should be reported on the donor’s income tax return and when should a potential refund claim be filed? If there is a spillover to a GRAT but the required GRAT payments are not made, the GRAT will fail. Some practitioners fund a GRAT used in a spillover with other assets so that the GRAT operates from inception like a GRAT. In such instances it may be prudent to confirm that someone is assuming responsibility for that administration. Someone, perhaps the CPA who is preparing the gift tax return, should calendar the date at which the gift tax statute of limitations tolls as that may be the trigger in the governing transfer documents for the final determination of the allocation of the interest in the asset transferred.

• Defined value mechanisms may leave open the determination of which party will own which interests in the transferred asset. Practitioners should inquire as to who is preparing those income tax

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returns and whether they have the knowledge of the transaction so that the reporting is consistent with the defined value mechanism. For example, if the client gifted LLC interests subject to a Wandry clause to an irrevocable trust, the K-1s issued to each of the trust and the donor should reflect, perhaps on an attached statement, that the percentage interests on Form K-1 are estimates subject to a defined value mechanism. Perhaps the document creating that mechanism should be specifically referenced. In addition, the donor’s income tax return should also reflect similar language. Finally, to complete the circle, - trust records should reflect similar language.

• Collaborate closely with the planning practitioner to ensure a complete understanding of how the valuation adjustment will work. The preparer should be certain that all documents pertaining to the transaction have been provided. This is not only necessary to the preparation of the exhibits to the gift tax return to meet adequate disclosure requirements, but also as the preparer may wish to hold certain documents in a permanent file supporting the gift tax return even if those documents are not included with the return.

• Make specific disclosures on the gift tax return showing all of the related transactions in the event that the valuation adjustment is invoked.

Disclosing the Two-Tiered Valuation Adjustment Provision

For many clients, planning in 2020 was a rush to divest themselves of all the equity in closely held businesses, whether to use up some or all of their lifetime exemptions, or to shift value (e.g., by a note sale) out of their estate while valuation discounts and other benefits may be achieved prior to a change in the law. On these occasions, some estate planners took an extra step to avoid a Wandry clause resulting in some part of the equity being returned to the transferor.

One such approach is to use what one of the authors has dubbed a “two-tiered Wandry” arrangement. This could consist of a traditional Wandry transfer followed by the simultaneous sale of any shares (or other assets) left by the Wandry adjustment clause if the clause is triggered. In other words, the transferor makes a gift of a specified value of the shares of the entity, believing that all of the transferor’s interest in the entity is equal to the value being transferred. In the event that the shares are re-valued on

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audit (such that the value that the transferor sought to transfer does not cover all of the shares), the transferor will have sold shares that exceed the intended gift value. The second tier of the double Wandry arrangement could consist of a second sale of any shares, effective as of the same date as the primary Wandry sale, that remain by operation of the Wandry arrangement in the selling taxpayer or trust’s hands. The price for this second sale, if any, could be for a price equal to the gift tax value as finally determined. The sale would be supported by a note upon which interest accrues from closing and is required to be made current within a specified time period, e.g., 90-days of the final determination. Apropos to 2020 transfers, the concern over dramatic estate tax changes may have well encouraged many practitionersvi to utilize the two-tier Wandry clause as future transfers might not qualify for discounts, etc. if the law changes. Further, using a two-tier Wandry transfer may both protect against an unintended gift tax and simultaneously avoid a Powell challenge for estate inclusion. In Powell, the taxpayer “in conjunction with others” retained control over the FLP interests transferred resulting in estate inclusion. With a traditional application of a Wandry clause interests in an entity could remain in the transferor’s control resulting in a Powell challenge. Using the two-tier Wandry may avoid that problem, and do so at a time in the law before discounts might be restricted or eliminated by a Biden Administration.

For the most part, these types of arrangements would rely on grantor trusts, so that, in the event that the Wandry clause is triggered, the transferor could avoid an income tax – and possibly income tax interest and penalties – for a sale transaction deemed to have occurred on the date when the original gift was made.

The following is an example of how a gift tax return preparer might disclose a transaction that includes a valuation adjustment with a sales provision: Example: On August 1, 2020, Jack transfers shares in his closely held business, Entity, with an aggregate fair market value of $1 million to the Jack Family Trust. Jack believes that he has transferred a 25% interest in the closely held business, but if it turns out that the aggregate value of a 25% interest was worth more than $1 million, Jack will be deemed to have sold the excess shares to the Jill Trust, which is a grantor trust.

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In this case, the gift tax return preparer should be to make the following disclosures:

1. The gift of $1 million worth of shares in his closely held business to the Jack Family Trust.

o Include a copy of the Assignment document, trust agreement, and the qualified valuation report.

o Report the gift on the appropriate section of Schedule A and show a $1 million gift value. Be sure to include the basis of the interests believed to have been conveyed (in this case, estimated at 25% of the entity).

o Use careful language to describe the transaction. Following is an example:

Jack estimated that the value of a 25% undivided membership interest in the Entity was worth $1 million, based upon the taxpayer's good faith reliance on the valuation report. This preliminary allocation of a 25% interest in the Entity to the Jack Trust, based upon the valuation performed by [third party valuation professional], a third party valuation professional, in accordance with Revenue Ruling 59-60 and other regulations and rulings where appropriate, is for administrative convenience only with respect to the value, until the fair market value of the Entity interests is finally determined for federal gift tax purposes.

The estimate of the percentage of gifted percentage interests in the Entity shall be revised accordingly so that the percentage of Entity interests gifted to the Jack Trust equals the corresponding dollar amount of $1,000,000, to the extent that values are finally determined for gift tax purposes.

2. If an escrow agent was used in the transaction, e.g. to hold title documents impartially on behalf of the Jack Trust and the Jill Trust until either the gift tax statute of limitation passes, or the gift tax valuation is finally determined. If an escrow arrangement is used that

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should be disclosed as that may be a positive factor to demonstrate that the adjustment will in fact be made should one occur.

3. The sale of an undetermined value of shares in his closely held business to the Jill Trust.

o Reference the Assignment Document and qualified valuation report.

o Include a copy of the Jill Trust and sales documents: promissory note, sales agreement, etc.

o Report the sale on the appropriate section of Schedule A and show a $0 gift value. Since Jack has estimated in good faith that the fair market value of the interests sold is $0, Jack should report the basis of the interests conveyed by sale as $0.

o Use careful language to describe the sale to the Jill Trust. Following is an example of what was sold:

That percentage of interests in the Entity deemed to have been sold by operation of that certain [Assignment Instrument] executed on [original date of the transaction], between, and among Jack and the trustees of the Jack Trust and the Jill Trust, as may be adjusted upon a final determination for federal gift tax purposes of the fair market value of the interests in the Entity as of [original date of the transaction].

The preliminary allocation of 0% interest in the Entity to the Jill Trust based upon the valuation performed by [third party valuation professional], a third party valuation professional, in accordance with Revenue Ruling 59-60 and other regulations and rulings where appropriate, is for administrative convenience only with respect to the value and percentage of the Entity interests until the fair market value of the Entity interests is finally determined for federal gift tax purposes.

Consideration should also be given to how the transfers are reported on the income tax returns for the Entity and the trusts. Perhaps the income tax

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return preparer should include a footnote on each return to reflect the effect of the valuation adjustment clause. Another factor to consider, and perhaps calendar for follow up, is what adjustments may need to be made for income tax purposes and cash flow, to reflect an adjustment. If the Jill Trust is determined on audit to have received from inception 10% of the interests in the transferred Entity then 10% of all distributions and other economic attributes should be paid by the Jack Trust to the Jill Trust with interest. Determine what the governing documents provide for and disclose it as appropriate. If the documents are silent it may be advisable to consult with counsel as to whether adjustments are appropriate. Returning to the prior example, the income tax return preparer might consider the following:

Entity income tax return: 1. Issue Schedules K-1 as follows:

Jack as to 75% of the Entity Jack Trust: as to 25% of the Entity Jill Trust: as to 0% of the Entity

2. On each of the Schedules K-1 issued to Jack, the Jack Trust and the Jill trust, a footnote should appear as follows:

The preliminary allocation of a 75% interest owned by Jack, 25% interest in the Entity to the Jack Trust and 0% interest in the Entity to the Jill Trust was estimated in accordance with that certain [Assignment Instrument] executed on [original date of the transaction], between, and among Jack and the trustees of each and both of the Jack Trust and the Jill Trust, a copy of which is on file with the Entity as part of its business records.

This preliminary allocation is based upon Jack’s good faith reliance upon the valuation performed by [third party valuation professional], a third-party valuation professional, in accordance with Revenue Ruling 59-60

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and other regulations and rulings where appropriate. This preliminary allocation is for administrative convenience only. The preliminary allocation of percentages in the Entity will be revised to the actual allocation as necessary once the fair market value of the Entity interests is finally determined for federal gift tax purposes.

3. Each of the individual income tax return for Jack and the fiduciary income tax return for the Jack Trust and the Jill Trust should include a footnote with the language from the Schedule K-1.

Charitable and Marital Mechanisms for Valuation Adjustment Clauses

A common gift tax return oversight is the failure to report charitable gifts. This is an incredibly common oversight. For almost every gift tax return there is an intent to toll the statute of limitations by meeting the adequate disclosure rules. If any omitted charitable gifts constitute a substantial understatement of gifts, the statute of limitations may be extended from a three-year period to a six-year period.vii

This can be doubly problematic where a charity is identified as the non-taxable receptacle in a valuation adjustment clause. In such a case, failure to report charitable gifts, including the potential transfer by operation of the assignment upon final determination of the values of the assets conveyed for gift tax purposes, could result in underreporting of the total gifts made during the year. For the gift tax return, report the potential charitable gift on Schedule A Part 1, showing $0 gift tax value and $0 basis. Further, the gift tax preparer should reference the specific item number of the potential charitable gift, along with any other charitable gifts, on Schedule A Part 4, line 7. The preparer should include an explanation with reference to the Assignment instrument and valuation report about how the value of the interest conveyed to the charity will be as finally determined for gift tax purposes. This same language should be incorporated on the individual’s income tax return, Schedule A.

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Likewise, where the valuation adjustment clause requires any excess to be devised to a spouse or marital trust, the gift tax return preparer should report the potential marital gift on Schedule A Part 1, showing $0 gift tax value and $0 basis. Further, the gift tax preparer should reference the specific item number of the potential marital gift on Schedule A Part 4, line 6.

A Word about GST Exemption and Valuation Adjustment Clauses

Where multiple transactions have occurred during the tax year, a gift tax return preparer must consider how the GST (generation skipping transfer) exemptionviii might be allocated to various transfers, particularly if the valuation adjustment clause is invoked, as follows:

• The first trust that you certainly want to treat as a GST trust, to which you want to allocate GST exemption, should be elected to be treated as a GST trust. The remaining trusts should have an election not to be treated as GST trusts so that a notice of allocation can better control the manner in which GST exemption is allocated.

• Include a statement of the donor’s intention that GST exemption allocations should be done by formula which will change if values are modified on audit.

• To the extent that the donor funded multiple trusts, the gift tax return preparer may wish to specify the order of GST exemption allocation among the various trusts. This could be important as it is not otherwise clear how a limited GST exemption might be allocated. Suppose the client made 2020 transfers to a grantor trust to which a family business interest was transferred, and separately to a simple life insurance trust owning term life insurance. It has been suggested that less than 2% of term life insurance policies are ever collected. So, if there is an adjustment of GST for the overall 2020 transfers it might be preferable to first protect the trust holding the family business even if that is at the expense of the irrevocable life insurance trust (“ILIT”) holding term policies. Possible language to consider is as follows:

In the event that the value of any asset transferred by the Taxpayer to the Trusts reported on Schedule A, Part 3 as referenced below is re-determined for federal gift tax purposes,

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the formula allocation of the Taxpayer’s GST exemption should be allocated in the following order:

1. The smallest amount of the Taxpayer’s GST exemption shall be allocated to the value of the assets as finally determined for federal gift tax purposes to have been so transferred to the FIRST TRUST as may be necessary to produce an inclusion ratio for GST purposes, as defined in the Internal Revenue Code Section 2642(a), which is closest to, or if possible, equal to zero.

2. To the extent that the Taxpayer has any GST exemption then remaining after the specific allocation of GST exemption as set forth in #1 above, the Taxpayer directs that the smallest amount of the Taxpayer’s GST exemption shall be allocated to the value of the assets as finally determined for federal gift tax purposes to have been so transferred to the SECOND TRUST as may be necessary to produce an inclusion ratio for GST purposes, as defined in the Internal Revenue Code Section 2642(a), which is closest to, or if possible, equal to zero.

Another consideration might be the reference above to Schedule A Part 3. If the client made a gift to a trust in 2019, for example, that gift might be reported on Schedule A Part 3. However, a note sale to that trust in 2020 may not appear on Schedule A Part 3 but rather it may be disclosed as a non-gift transaction in exhibits attached to the return, or possibly on Part 1 of Schedule A. In such a case, the preparer might opt to modify the reference above to Schedule A Part 3 to indicate that transfers disclosed on exhibits or in other parts of Schedule A would also be covered. That way, if a portion of the sale is recharacterized as a part gift, then any GST exemption remaining could be allocated to it. When reporting a gift to a grantor retained income trust (GRIT) or other trust includible in the grantor’s estate, you may allocate GST exemption. However, the inclusion ratio is not calculated until the estate tax inclusion period (ETIP) closes. When the ETIP closes, that is, at the moment when the trust would no longer be includible in the donor’s estate if the donor died at that time, the taxpayer may allocate GST exemption to the value of the remainder interest as if the gift had been made on the day the ETIP closes (taking into account any prior allocations).

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Reporting 2020 Planning for Married Taxpayers

Throughout 2020, planning professionals considered the importance in crafting plans that emphasized maximum flexibility for their clients as a hedge against the uncertainty of the time. As a result, many married taxpayers engaged in planning that may have differed in 2020 from the type of planning that had been done in years past.

Perhaps One (Not Both) Spouse Made 2020 Gifts Commentators noted that having only one spouse make irrevocable transfers might avoid the so-called “buyer’s remorse” that affected many 2012 last minute estate planning transactions. In the 2020 trust planning environment, assuring access to assets can prove much more difficult than in the 2012 environment for two reasons. First, in 2012, any transfer of more than $1 million preserved exemption. In 2020, transfers might need to be quite substantial before benefit of the temporary exemption is preserved. The reason is that, if (and when) the exemption drops to $5 million (adjusted for inflation) in 2026, the prior use of the exemption may not allow the new (lower) exemption to be used. For example, for a client who made a taxable gift in 2020 of $3.5 million and dies after a reduction in the exemption to $3.5 million, no benefit from the perspective of purely using exemption may have been gained from the 2020 gift. However, growth in the value of the $3.5 million may provide incremental benefit. Further, if GST exemption is allocated to the trust, and/or if the trust is a grantor trust, there may be substantial advantage to having consummated the planning if the trust is grandfathered from changes under discussion that could tax dynasty trusts every 50 or 90 years, or from changes causing inclusion of grantor trust assets in the settlor’s estate. Another benefit to this strategy is that the couple is able to preserve one of their lifetime exemptions for subsequent gifting.

The planner should specifically alert the gift tax return preparer about this strategy in order to avoid any mistakes in filing. The gift tax return preparer should confirm that gifts were made from assets that were held by the donor and not jointly by the married couple. No election to split gifts should be made on the gift tax return.

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Gift Tax Return Reporting Relinquishment of Interests in Joint Property.

In order to make greater use of the large temporary exemption amounts, some married clients, as discussed above, had only one spouse make gifts to an irrevocable trust. In some instances, the non-donor spouse had to make transfers to the donor spouse or jointly held property had to be divided as to one spouse to then make gifts. In community property states, a transmutation agreement may have been signed to effectuate that. The practitioner completing the gift tax return should be alert to such title changes, and consider disclosing and, possibly including, the documentation effectuating the change in title and transmutation. Evaluate possible issues of step-transaction challenges. Consider obtaining documentation, even though not disclosed on the return, that might be useful to deflect a step-transaction audit. Should the transfer from one spouse to the spouse making the transfers to an irrevocable trust be disclosed on the spouse relinquishing rights? There are pros/cons, as well as uncertainty, as to whether a return should be filed for a spousal relinquishment of interests in a joint account. It is not certain which spouse should disclose this gift on his gift tax return or that the “donor” spouse has relinquished any rights or interests in the accounts. The Form 709 instructions clearly provide that no return is required on gifts to a spouse in general. The instructions provide that a return is required on a spousal gift to make a QTIP election, or if the spouse is not a citizen. The instructions do not say that you cannot file, they merely state that the taxpayer does not have to file. Conceptually, this may not be any different than filing a gift tax return to report a non-gift transaction like a note sale. It is not clear that filing a return that is not required to be filed will toll the statute of limitations. Thus, even after the intra-spousal transfers are timely and properly disclosed, it is possible that the statute of limitations will not run, leaving the IRS an indefinite opening to challenge whether the spouse has actually relinquished ownership in an asset that was ultimately transferred by the other spouse to a trust. Obviously, one of the risks which this relinquishment of rights in joint spousal accounts raises is the IRS asserting the step transaction doctrine or that the relinquishing spouse should be treated as a co-grantor to the other spouse’s trust, possibly resulting in inclusion of the trust assets in the transferor spouse’s estate.ix Spousal Lifetime Access Trusts (SLATs)

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SLAT strategies were used throughout 2020 in order to use exemption and preserve access for a wide range of client wealth levels. Moderate wealth clients may have used SLATs to preserve some exemption, obtain asset protection planning, preserve access and to endeavor to secure GST exemption and grantor trust by grandfathering those benefits from the possible effects of future legislation. At high wealth levels, SLATs may have been used to fractionalize control positions in a family business (and thereby produce valuation discounts) and as the participants in very large note sale transactions (that is a sale to a grantor trust in exchange for an AFR note from the trust). SLATs might work as follows. Each spouse creates a trust for the other spouse, avoiding the state law creditor and tax reciprocal trust doctrines.x This occurs by making the trusts sufficiently different so the doctrines will not apply. The trusts can be created at different times, with different assets and trustees, and with very different terms (e.g. different powers of appointment, different distribution standards, etc.) In one trust, the beneficiary spouse can be entitled to have a lifetime broad special power of appointment, the power to change trustees,xi and/or receive annual income distributions or distributions limited to HEMS. In the other trust, the beneficiary spouse would have no entitlement to distributions (perhaps, is not even a current beneficiary), no power to change trustees, and no power of appointment, but could become eligible to receive a distributions only upon exercise by a trusted child with a power to add beneficiaries. Practitioners completing gift tax returns reporting SLATs, especially if they were not involved in the planning process, might indicate to the client that they did not review the trusts and plan for purposes of determining the applicability of the reciprocal trust doctrine. Practitioners might also consider whether they should obtain corroboration for their gift tax file as to the differentiation of each SLAT and the respective planning. Gift tax return reporting should dovetail the SLAT strategy:

• Spouses may wish not to elect to split gifts in a year when SLATs are funded. To the extent that a spouse’s beneficial interest is not limited sufficiently, a gift to a SLAT cannot be split.xii

• Assets conveyed should be clearly identified as those which were owned by the donor spouse individually and not joint assets if that is

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consistent with the actual facts (if not see the discussion above about prior inter-spousal transfers).

• To the extent that a donor spouse made multiple gifts to a SLAT, the gift tax return should separately identify each such gift and disclose the exact date of each transfer. The gift tax return preparer should be sure to avoid using a catchall “various” notation for the dates when gifts were made to the SLAT.

• In the case of an insurance trust that includes a marital deduction savings clause, the gift tax return preparer may wish to make specific reference to the clause in the gift tax return disclosures. A marital deduction savings clause provides that if any property is included in the grantor’s estate (because the grantor dies within three years after transferring a policy on his life to the trust thereby causing the proceeds to be included in the insured’s estate or for any other reason) some or all of the proceeds of the policy is held in a qualified terminable interest property trust or is payable to the surviving spouse outright.xiii

Additionally, the gift tax return preparer should report the potential marital gift on Schedule A, Part 1, showing $0 gift tax value and $0 basis with an explanation of how the provision in the trust agreement would work.xiv Further, the gift tax preparer should reference the specific item number of the potential marital gift on Schedule A, Part 4, line 6.

Last, Best Option for a Do-Over for the Married Client Some clients were reluctant to plan and remain so even now that 2020 is behind them. If, as 2021 wears on, the risk of a dramatic change in tax law seems to them less likely, these clients may wish to undo planning that had been completed in 2020, if at all possible. The prudence of that, now that the GA runoff election has concluded and the Democrats can have Vice President Kamala Harris cast a tie breaking vote on tax legislation, might be questionable. The gift tax return may be the last, best option for accomplishing a “do-over” for the reluctant, married client, so long as the underlying instruments were properly drafted.

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In order to allow for such a do-over, some attorneys drafted trusts in 2020 with specific language allowing the trust to qualify for an inter vivos QTIP election, as described in Code Sec. 2523(f):

1. The trust must grant to the donee spouse a qualifying income interest for life; and

2. The donor must make a QTIP election on a timely filed gift tax return. To the extent that the election is made, no gift tax will be due (and no lifetime exemption used), assuming the spouse who is the beneficiary is a US citizen. On the other hand, to the extent that the donor fails to make a timely election as to all or part of the contribution to the trust, exemption will be used and, in effect, a so-called Spousal Lifetime Access Trust (SLAT) will have been created as to that part of the trust.xv This unique opportunity in a time of great uncertainty has allowed such clients to consummate a large gift in 2020 to a “QTIP-able” (eligible for the QTIP election) trust and then evaluate throughout the better part of 2021, until the extended filing date for the 2020 gift tax return (October 15, 2021), whether or not the gift or any part of it should, in fact, use exemption. The donor might consider using a formula QTIP election which fails to make the QTIP election as to the amount of the donor’s remaining exclusion available in 2020.

The estate planning attorney should work closely with the gift tax return preparer, financial advisors, and other professionals to ensure adherence to the planning. Lack of consistency and failure to make timely elections that specifically identify the portion of the transfer subject to the QTIP can doom this type of planning.

Finally, several points should be considered with respect to the QTIP-able trust discussed above. First, it may be prudent, regardless of other factors, to be certain that the gift tax return is extended to the final due date in October 2021 to provide as much hindsight as possible to make the decision. Also, practitioners might consider sending a communication to the client/donor confirming the impact of making or not making the QTIP election as to the impact of that on possible exemption use.

Disclaimer “Undo”

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Another approach used in some 2020 trust planning was to incorporate a mechanism into the trust document permitting a beneficiary to disclaim. That mechanism may have made one particular beneficiary the primary beneficiary and further provided, in contrast to traditional disclaimer mechanisms, that if that beneficiary disclaimed all assets would revert to the donor thus unwinding the transaction. Even if the trust agreement was silent it may be possible under state law for the trustee to disclaim. Practitioners should confirm whether the transaction incorporated a disclaimer safety valve and the terms of that provision. Further, it may be advisable not to file the return until after the date the time period for the disclaimer has passed. Finally, practitioners might consider requesting confirmation in writing from the person or persons holding the disclaimer right that they have not exercised the disclaimer. Without confirmation, how can the preparer be certain that the disclaimer was not exercised?

Reporting Note Transactions

Some clients had no appetite for making substantial wealth transfers in 2020. However, they may have revisited some of their older planning and took advantage of the historically low interest rates by refinancing older intra-family loans or making new intra-family loans. Other clients used note sale transactions to lock in Covid valuation discounts and lack of marketability and control discounts before those might be restricted or eliminated by future legislation.

Substituting Higher-Interest for Lower-Interest Notes For example, assume that parent sold assets to a trust several years ago in September 2015 and the required interest rate was 2.64% and in October 2020, the long-term rate was 1.12%. If a new note at the new rate was substituted for the old note at the old rate, a substantial reduction in leakage back into the parent’s estate might be achieved. Practitioners considering the array of planning options available to clients may have engaged in planning to substitute low interest notes for higher interest notes. Practitioners preparing gift tax returns may wish to disclose these types of transaction on 2020 gift tax returns as non-gift transactions. Failing to do so might result in the statute of limitations on gift tax audit not tolling (there may be income tax issues if the borrower was a non-grantor trust that warrant consideration as well). If the practitioner completing the gift tax return becomes aware of such a note substitution transaction, in addition to

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disclosing that transaction (if that is the decision) the practitioner might consider alerting the client to some of the tax risks and issues with such a transaction if the practitioner was not involved in the actual transaction to have done so at that time. While note refinances were not completed to address the risk of future transfer tax changes, they were common in 2020 because of the historically low interest rates. Therefore, practitioner should expect to see many of these transactions.

Assume, for example, that the original note arose from a sale by a parent of family business interests to a grantor trust. This non-gift transaction could be reported on Form 709, most likely on Schedule A Part 3, with all relevant documents attached as exhibits. The following documentation and steps might be available to substantiate the note swap by reporting it on a timely filed gift tax return:

• Original Note which includes a provision allowing the debt to be

prepaid at any time without penalty. To the extent that the original note incorporated restrictions on prepayment, the gift tax return preparer should include any documentation resolving this restriction as an exhibit to the gift tax return.

• New Note. The new, fully executed promissory note should be included with the gift tax return.

• Modification of Pledge and Escrow Agreement. If the original note arose from the sale of assets by the parent to the grantor trust, the gift tax return preparer may wish to include as exhibits both the original pledge and/or escrow agreement as well as the modified pledge and/or escrow agreement (or perhaps a modification agreement that modifies all sale documentation as to the refinance of the note). Both should be fully executed by all relevant parties.

• Novation Agreement. A novation agreement could be signed by both the maker of the note as well as the lender and could confirm the agreement on cancellation of the original note. The gift tax return preparer may wish to include any such Novation Agreement as an exhibit to the gift tax return.

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• Other Documents. The gift tax return preparer should reach out to the planner to obtain copies of all other documentation that had been executed to address the nuances of the original transaction giving rise to the original note and to finalize the substitution of the promissory note between the parties.

Possible Gift Tax Disclosures for Certain Note Transactions

If a client was engaged in a loan transaction, generally consideration should be given to disclosing the loan to toll the statute of limitations on audits of the loan as a potential gift. While some practitioners are uncomfortable using a loan to fund the borrower making a gift, some clients engaged in these transactions in 2020 and practitioners may wish to be aware of some of the disclosure nuances.

In some situations, clients who have used up their exemption may be looking to help their children use theirs. In those cases where the adult children do not have sufficient resources to make gifts to use their exemptions, the older generation (G1) may have loaned assets to the younger generation (G2) so that G2 can take advantage of G2’s remaining lifetime exemption. Practitioners need to be alert to the possibility of these transactions to be certain that appropriate gift tax return compliance reporting is addressed. By making a long-term loan using an interest rate that matches the applicable federal rate (the “AFR”), G1 may be able to provide the use of money to G2 without making a taxable gift, although this transaction may not be without risk.

If G2 wanted to make gifts upon receipt of funds borrowed from G1 in order to use up G2’s lifetime exemption, the practitioner may have considered additional safeguards to avoid implication of the step transaction doctrine which holds that “a series of transactions designed and executed as parts of a unitary plan to achieve an intended result … will be viewed as a whole regardless of whether the effect of so doing is imposition of or relief from taxation.”xvi Some of these transactions, for G1s transfer to G2 to be respected as a loan may require outside guarantees, which might come from a family dynasty trust of which G2 is a beneficiary. The planner and the gift tax return preparer should discuss how best to make the necessary disclosures in order to reduce the risk that the transaction will be recharacterized as a gift from G1 to G2’s intended beneficiaries. On G1’s 2020 gift tax return, G1 should include a copy of the Note. For any Note that was secured by an existing dynasty trust guarantee that had

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been previously set up by G1 (or other family members) for the benefit of a class of beneficiaries that might include G2, the elements of this part of the transaction might be disclosed on G1’s gift tax return, with copies of the Security Agreement and Dynasty Trust instrument, and any other relevant documentation. G1 should report interest income received from G2 on a timely filed income tax return. For context, the annual interest due on a loan of $1 million with a 1.12% interest rate (the October 2020 long-term AFR) would only be $11,200. The gift tax return preparer for G2’s 2020 return should be sure to meet the adequate disclosure rules for the gifts made by G2, including all documentation to support the gift. If G2 had made gifts to trusts for the benefit of individuals who are not the natural objects of G1’s bounty in order to hedge against a step-transaction challenge, the gift tax return preparer should be sure to specify the individual beneficiaries of any such trust in the description of the gift on the G2’s gift tax return. Loans from G1 to G2 may appear simple to implement but it is important for the parties to follow loan formalities. Any such intra-family loan should be memorialized in a Promissory Note instrument. Both parties should sign it, possibly in the presence of a Notary Public, if available. Payments should be made in accordance with the note instrument and there should be economic consequences if payments are not made timely, such as a late payment penalty. All such transactions might be disclosed on timely filed gift tax returns in order to avoid government scrutiny and a possible recharacterization of the loan as a gift.

Avoid Common Form 709 Errors

Gift tax return preparers should also be wary of some of the more common mistakes/oversights that can put 2020 planning at risk by inviting additional scrutiny.

Some of the most common mistakes/oversights are:

1. Incomplete/incorrect summary of previously filed returns and exemption amounts used reported on Schedule B of the Form 709,

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United States Gift (and Generation-Skipping Transfer) Tax Return. Practitioners tackling a Form 709 should first obtain copies of all previously filed returns. Information from those returns will not only be required to be listed on the current filing, but it will be critical to ascertaining a range of positions taken and whether issues exist with past reporting. For example, if a gift to a trust was reported in a prior year, was the trust instrument appended to the return? Was sufficient information about each transaction attached to comply with the adequate disclosure regulations? Was the allocation of GST exemption handled properly? Were there front-loaded gifts to Code Sec. 529 plans that could affect current reporting?

2. Reporting gifts in the wrong section of Schedule A. Sometimes practitioners might report gifts as outright gifts when in fact there are GST implications. Each transfer must be reported in the part of the form corresponding to its category, and too often practitioners are not cautious about properly characterizing where these are reported. Gifts subject to gift tax can include any transfer by gift of real or personal property, whether tangible or intangible, made directly or indirectly, in trust, or by any other means. Gift tax applies not only to the gratuitous transfer of any kind of property, but also to sales or exchanges, not made in the ordinary course of business, where the value of the money (or property) received is less than the value of what was sold or exchanged. Gifts subject to GST tax include lifetime or inter vivos transfers that are “direct skips.” An inter vivos direct skip is a transfer made during the donor's lifetime that is subject to the gift tax and made to a skip person (e.g., a grandchild, or a trust solely for grandchildren). Many gifts, however, are not direct skips, e.g., a gift to a trust that includes children (who are not skip persons), as well as further descendants (e.g., grandchildren) who are skip persons. An outright gift or a gift to a trust with no GST potential is reported in Part 1; a gift to a skip person, whether an individual or a trust for the benefit of only skip persons is reported in Part 2; and a gift to any other trust is reported in Part 3, together with an indication of whether GST exemption is to be automatically allocated to that gift. To run the statute of limitations, sales that not intended to be gifts should be reported in an attachment with all of the elements of adequate disclosure; whether to cross-reference this on Schedule A or merely attach it is a matter of judgment depending on the circumstances.

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3. Schedule B, Gifts from Prior Periods, is commonly an incomplete summary of the prior gift tax returns filed by the client. This schedule is an important part of the gift tax return because the total of the taxable gifts from this schedule carries to page 1 of the return and is included in the gift tax computation. In addition, when a client passes away, this summary of gift tax returns filed is an important roadmap in knowing how many gift tax returns need to be included with the federal estate tax return. It is important to get copies of all prior gift tax returns filed by a client for whom a gift tax return is being prepared so that Schedule B can be correctly completed. If the client is not certain of what years they have filed, Form 4506, Request for Copy of Tax Return, can be filed with the IRS to obtain copies of gift tax returns that they have on file for the taxpayer.

4. Another reporting area in which the gift tax return preparer can cause confusion is in the reporting of transfers made to Code Sec. 529 plans when the election to treat the transfer as made ratably over a five-year period is made. The preparer must make an affirmative election on the gift tax return for the year that the transfer into the plan is made and keep in mind when reporting gifts to that child for the next four years that the client has already utilized some or all the annual exclusion amount with the previous Code Sec. 529 transfer. The ratable portion of the Code Sec. 529 gift should be shown on the future gift tax returns, until the five-year period has expired, to avoid losing track of this previously utilized amount of annual exclusion.

GST Form 709 Common Oversights

The GST tax is complicated, and many of the rules not intuitive. Further, with the growth of the estate tax exemption to $5 million inflation adjusted, and more recently to $10 million inflation adjusted ($11.58 million for 2020), many practitioners do not have much occasion to delve into GST issues. Caution is in order in addressing the many GST issues that can be reflected on what might otherwise seem to be a “simple” Form 709. Consider some of the following:

1. Incorrect/lack of GST exemption allocations. The GST exemption for

2020 was the same amount as the lifetime gift tax exemption: $11,580,000. You want to utilize this exemption for transfers that provide current or future distributions to or for the benefit of skip

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persons. The consequences of these mistakes can be severe (for example, a flat 40-percent GST tax being due on the value of a trust that was not properly covered with GST exemption) and the opportunities for remedying the mistake, if available, can also be costly.

2. A common mistake is netting out the annual exclusion amount before applying GST exemption when the annual exclusion may only apply for gift but not GST tax. The rules differ: Code § 2642(c) provides that the GST annual exclusion applies to gifts to a trust only if the trust is for only one beneficiary and is included in that beneficiary’s estate upon that beneficiary’s death.

3. Incorrect elections or acknowledgement of GST automatic allocation. Code § 2632(c)(3) allocates GST exemption automatically to an “indirect skip,” which means a transfer to a “GST trust.” The Code Sect. 2632(c)(3)(B) definition of “GST trust” can be confusing. Rather than spending any time analyzing that provision (and risking a mistake), practitioners might consider affirmatively electing under Code Sect. 2632(c)(5) to treat transfers to a particular trust as an indirect skip. That is to say, the practitioner might report the transaction as a transfer to a GST trust and then include an affirmative GST election, perhaps worded as follows:

While Taxpayer believes that John’s Dynasty Trust” is a GST Trust, in the event that such trust is not a GST Trust, the Taxpayer hereby affirmatively elects to have GST exemption allocated to the transfers to such trust….

Other practitioners might prefer instead a simpler statement that a particular trust is elected to be a GST trust and not use the precatory language suggesting that it was believed to be a GST Trust.

4. Some preparers affirmatively opt out of automatic allocation and allocate GST exemption via a notice of allocation. If a future gift tax return is late, a late allocation of GST exemption can be time-consuming. In most cases, one should consider opting to allocate GST exemption automatically and then later opting out of allocating GST exemption if that is desirable.

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5. When preparing a notice of allocation, consider whether to include language that covers the possibility of the value of the gift being changed upon audit so that the amount of GST exemption allocated fluctuates with that change in value. Even though some of these GST elections we’ve discussed (electing to be a GST trust, opting out of automatic allocation) can be made once and remain in effect going forward for that respective trust, it's helpful to list each trust to which transfers are being made and state affirmatively what GST elections have been made not just for tax reasons, but as a form of provenance and clarity for others in the future who may be working to discern and decipher the trust. Providing minimal information is counterintuitive and can breed frustration. Be clear and transparent on the steps you take/elections you make in this area.

Disclosure and Form 709 Common Oversights

When filing a gift tax return, practitioners might attach as much documentation as possible to minimize the chance of the IRS coming back with questions. You want to adequately support what is reported on the return, particularly values, or the statute of limitations for that return will not toll. Reg. § 301.6501(c)-1(e) and (f) outlines what is required to be provided for a gift to be considered adequately disclosed. Read those regulations in detail. Some tips:

• The adequate disclosure regulations require the appraisal to list the exact number of shares, units, or percentage interest transferred and value them as of the date of the transfer. Any appraisal done before the transfer date generally needs an update letter from the appraiser referring to the full appraisal and updating it for the required information.

• The adequate disclosure regulations require either a copy of the trust or a sufficient summary of the trust’s terms. Given that the IRS might argue that a summary was insufficient, attaching a copy of the trust is the most practical approach. Although the gift tax return instructions do not require a copy of the trust agreement if it was attached to a prior year gift tax return, those instructions determine merely whether the return was filed in good faith and do not purport to supersede the adequate disclosure requirements. Therefore, we recommend attaching a copy of each trust agreement each year, even if a copy was attached to a prior return.

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Lack of sufficient amount of supporting documentation included with the gift tax return to start the statute of limitations and/or avoid follow-up communications from the IRS. An approach that might be useful it to create a table of contents for all exhibits to be attached. This can be a great safety check to makes sure any important disclosure is not overlooked. It also can facilitate the collection of documents, make handling an audit easier and more efficient, and more. Before creating the table of contents, consider how it should be organized. If a client has a simpler gift tax return with just gifts to a single trust, that might be easy. If there are multiple complex note sale transactions, defined value mechanisms, GRATs and more, it might be easiest to organize exhibits by trust or donee. In other instances, the transactions themselves are so complex that organizing exhibits by transaction may be more useful. In all events organizing an exhibit list will improve the likelihood that all documents necessary for adequate disclosure have been included.

As the returns get more complicated, a year or two later, having the transactions explained and the supporting documentation included as exhibits to the return makes your process easier and removes a fair amount of guesswork in trying to remember the prior year transactions. It's not only about meeting adequate disclosure requirements so that the statute of limitation runs, but also to assure that, if an agent comes in with a “kitchen sink” audit letter, asking for everything, and the answer to 90 percent of the questions is “See exhibit A, B, or C,” it will set a different tone for the audit. Or – better yet – if the return has everything an examiner might request and demonstrates that the taxpayer was trying to comply thoroughly, the IRS may decide to accept the return as filed and leave the client – and you – alone.

Conclusion

Gift tax returns are often incredibly complicated with layers of issues, technical decisions, and disclosure requirements. 2020 created additional and sometimes novel gift tax reporting considerations.

This discussion underscores the imperative for collaboration among the estate planning practitioner and the tax preparer. Disclosures should be carefully constructed in order to bolster the client’s position against a challenge by the IRS as to the operation of the valuation adjustment clause. The gift tax return preparer should seek counsel’s review and

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comment prior to finalizing the gift tax return for filing with the IRS. This will likely increase the costs of preparing and filing the gift tax return, but it will be well worth it.

Gift tax return preparation practice should be viewed by practitioners as the danger that it is. If a client will not permit you to handle a Form 709 filing in the manner you as a professional believe necessary, pass on accepting the work. Familiarize yourself with gift tax guidelines and rules carefully to ensure nothing is overlooked.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Joy Matak

Steven B. Gorin

Martin M. Shenkman CITE AS:

LISI Estate Planning Newsletter #2858 (February 2, 2021) at http://www.leimbergservices.com Copyright 2021 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the

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http://www.leimbergservices.com/

responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITATIONS:

i IRC Sect. 6501(c)(9). ii This newsletter is not intended to be a comprehensive guide for completing gift tax returns. iii Perhaps one of the best checklists available was created by Stephanie Loomis-Price, ACTEC Fellow, and is available online at: https://www.americanbar.org/content/dam/aba/events/real_property_trust_estate/heckerling/2014/adequate_disclosure_checklist.pdf. iv McCord v. Commissioner, 461 F.3d 614 (2006), rev’g 120 T.C. 358 (2003); Estate of Petter v. Commissioner, T.C. Memo. 2009-280; Estate of Christiansen v. Commissioner, 130 T.C. 1, 13, (2008), aff’d 586 F.3d 1061 (8th Cir. 2009). For key excerpts from those cases and commentary on such issues, see Gorin, III.B.3. Defined Value Clauses in Sale or Gift Agreements or in Disclaimers, “Structuring Ownership of Privately-Owned Businesses: Tax and Estate Planning Implications,” available by emailing the author at [email protected]. v Nelson v. Commissioner, T.C. Memo 2020-81. vi Estate of Powell v. Commissioner, 148 T.C. No. 18 (May 18, 2017). vii Code section 6501(e)(2). viii “GST exemption” is a technical term defined by Code § 2631(a). ix IRC Sect. 2036(a).

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https://www.americanbar.org/content/dam/aba/events/real_property_trust_estate/heckerling/2014/adequate_disclosure_checklist.pdf

https://www.americanbar.org/content/dam/aba/events/real_property_trust_estate/heckerling/2014/adequate_disclosure_checklist.pdf

mailto:[email protected]

x Steiner and Shenkman, “Beware of the Reciprocal Trust Doctrine,” Trusts & Estates magazine (April 1, 2012). xi Within Rev. Rul. 95-58, 1995-2 CB 191 safe harbor. xii Stanley L. Wang, T.C. Memo. 1972-143; Max Kass, T.C. Memo. 1957-227; Rev. Rul. 56-439, 1956-2 Cum. Bull. 605. Whether to split gifts in a year in which gifts are made to a SLAT requires further analysis which is beyond the scope of this article. xiii Note that great flexibility will be available if a QTIP trust is used. The estate of the insured spouse would have 9-15 months to decide the extent to which the marital deduction should be claimed. xiv Blattmachr, Zeydel & Gans, “The World's Greatest Gift Tax Mystery, Solved,” 115 Tax Notes 243 (Apr. 16, 2007), expresses concern whether a QTIP election can be made on a gift tax return when the election is purely contingent. Practitioners might consider having some gift be made to the QTIP trust or to make the trust a general power of appointment marital deduction trust. xv Acknowledgement to Professor Jerome B. Hesch, Esq. and Alan S. Gassman, Esq., from Steve Leimberg's Estate Planning Email Newsletter Archive Message 28130-Aug-20, Alan S. Gassman, Jerome B. Hesch & Martin B. Shenkman, “Biden 2-Step for Wealthy Families: Why Affluent Families Should Immediately Sell Assets to Irrevocable Trusts for Promissory Notes Before Year-End and Forgive the Notes If Joe Biden Is Elected, A/K/A What You May Not Know About Valuing Promissory Notes and Using Lifetime Q-Tip Trusts.”. xvi FNMA v. Commissioner, 896 F. 2d 580, 586 (D.C. 1990), cert. denied, 499 U.S. 974 (1991) (citing Kanawha Gas & Utilities Co. v. United States, 214 F.2d 685, 691 (5th Cir. 1954).

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Subject: Joy Matak, Sandra D. Glazier & Martin M. Shenkman: An Estate Planning Six-Part Series for Late 2020, Part 1 - What Planners Should Be Doing with Their Clients NOW “What follows in this newsletter series is a discussion of a wide range of planning considerations in this challenging planning environment. In this first installment, we discuss:

1. How the current planning environment has affected valuations. 2. Opportunities to set up the plan now but wait to complete until after

the election results are known. 3. Variations on Domestic Asset Protection Trusts to preserve access. 4. An easy solution: Refinancing intra-family loans or making new low

interest intra-family loans.

We look forward to presenting you with our next installments which will explore other opportunities for planning before year-end.” Joy Matak, JD, LLM, Sandra D. Glazier, Esq. and Martin M. Shenkman, Esq. provide members with important and timely commentary in the form of a six-part series, Part 1 of which is a discussion of a wide range of planning considerations in this challenging planning environment. i

Joy Matak, JD, LLM is a Partner at Sax and Head of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. Joy provides clients with wealth transfer strategy planning to accomplish estate and business succession goals. She also performs tax compliance including gift tax, estate tax, and income tax returns for trusts and estates as well as consulting services related to generation skipping including transfer tax planning, asset protection, life insurance structuring, and post-mortem planning.

Steve Leimberg's Estate Planning Email Newsletter Archive Message #2840 Date:29-Nov-20

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Joy presents at numerous events on topics relevant to wealth transfer strategists including engagements for the ABA Real Property, Trust and Estate Law Section; Wealth Management Magazine; the Estate Planning Council of Northern New Jersey; and the Society of Financial Service Professionals. Joy has authored and co-authored articles for the Tax Management Estates, Gifts and Trusts (BNA) Journal; Leimberg Information Services, Inc. (LISI); and Estate Planning Review The CCH Journal, among others, on a variety of topics including wealth transfer strategies, income taxation of trusts and estates, and business succession planning. Joy recently co-authored a book on the new tax reform law entitled Estate Planning: Estate, Tax and Other Planning after the Tax Cuts and Jobs Act of 2017.

Sandra D. Glazier, Esq., is an equity shareholder at Lipson Neilson, P.C., in its Bloomfield Hills, MI office. She was also the 2019 recipient of Bloomberg Tax’s Estates, Gifts and Trusts Tax Contributor of the Year Award and Trusts & Estates Magazines Authors Thought Leadership Award and has been awarded an AEP designation by the National Association of Estate Planners and Councils. Sandra concentrates her practice in the areas of estate planning and administration, probate litigation and family law.

Martin M. Shenkman, CPA, MBA, PFS, AEP, JD is an attorney in private practice in Fort Lee, New Jersey and New York City who concentrates on estate and closely held business planning, tax planning, and estate administration. He is the author of 42 books and more than 1,200 articles. He is a member of the NAEPC Board of Directors (Emeritus), on the Board of the American Brain Foundation, the American Cancer Society’s National Professional Advisor Network and Weill Cornell Medicine Professional Advisory Council.


EXECUTIVE SUMMARY:

Practitioners may still wish to encourage clients to consider estate and asset protection planning aggressively before the end of 2020. While we can now expect a changing of the guard at the White House and retention by the Democrats of the House of Representatives, control of the Senate is still unclear, with two seats heading to a runoff in Georgia. Some commentators appear to believe that, regardless of which party winds up controlling the Senate, at least some adverse change in the

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nation’s tax laws may be enacted as early as the beginning of next year. It is possible for tax changes to be made retroactively effective to January 1, 2021 if the Democrats win both seats in the Georgia runoff elections. ii The level of Federal deficits caused by the COVID 19 pandemic may mean increases in taxes for many regardless of which party wins next month. Practitioners need to be alert to possible broad changes to the wealth transfer laws and factor them into any planning that might still be completed before the end of the year. By way of example, we would suggest that practitioners consider the following:

• Caution clients as to the uncertainty of the election and even after the election is known the uncertainty over what tax legislation might be enacted and the possible effective dates of such legislation. Clients could be forewarned that all the planning efforts may be for naught and might even leave them in a position that is less favorable, depending on political developments and future legislation, than had they done nothing. It is also important to discuss with clients that regardless of the outcome of the Georgia runoff election, Congressional elections will occur in 2022, another Presidential election in 2024 and the exemption is to be reduced significantly in 2026 if congress does nothing. So, especially if planning has already begun, there may be a reason to conclude it regardless of the results of the Georgia runoff elections.

• Some clients will want the ability to unravel a plan if the Georgia runoff elections are not both taken by the Democrats. This might be done by including a disclaimer provision in a trust document and making gifts to the trust.iii Another option is to make a gift to a QTIP’able trust and determining by the extended due date for a 2020 gift tax return, October 15, 2020, whether or not to elect QTIP treatment.

• Flexibility, to the extent possible and practical, may be the key to minimizing the potential for unhappy clients who transfer substantial wealth to irrevocable trusts and then regret the inflexibility the plan affords.

• Preserving access to assets transferred. There are a myriad of ways to accomplish this, some of which are discussed below.

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The potential for harsh tax increases described may create a sense of urgency for some clients, but it also suggests that the application of the techniques involved may have to be uniquely different.

COMMENT: What follows in this newsletter series is a discussion of a wide range of planning considerations in this challenging planning environment. In this first installment, we discuss:

5. How the current planning environment has affected valuations. 6. Opportunities to set up the plan now but wait to complete until after

the election results are known. 7. Variations on Domestic Asset Protection Trusts to preserve access. 8. An easy solution: Refinancing intra-family loans or making new low

interest intra-family loans.

We look forward to presenting you with our next installments which will explore other opportunities for planning before year-end.

Valuations in the Current Environment The current planning environment exhibits a number of unique characteristics which may each influence the planning mechanisms used and the application of those techniques. The intersection of historically low interest rates, artificially depressed asset values (for some assets) and very high federal estate and gift tax exclusion rates ($11.58 million per taxpayeriv) make this the perfect time to plan. In these times of great market volatility and economic uncertainty, business valuations have been impacted. At the time of this writing stock market indices have reached all-time highs. Other stock prices remain low and have not fully recovered from the impact of COVID-19 (some may never recover). The impact of COVID-19 on valuations is incredibly unequal. Businesses that have benefited from sheltering in place, increased concerns over disinfecting, etc. have burgeoned in value. Other businesses have dropped in value and many have simply closed their doors.

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Practitioners need to have an understanding as to how the current environment has impacted the particular asset in question. Generalizations as to valuation and future value may be more dangerous than ever before.

How might COVID-19 impact the valuation of closely held businesses? Valuation experts often start by assessing changes in actual and expected revenues and cash flow. For many industries and businesses, revenues and cash flows have plummeted, and there is great uncertainty about the depth and lengthy of the downturn, and, subsequently, the speed and degree of the recovery. These sudden drops in economic activity and low interest rates are likely to be relatively short-lived, allowing taxpayers to transfer assets at a lower gift tax value today than the asset may be worth in six months or a year from now. Conversely, businesses that received loans that are forgiven under the Paycheck Protection Program, may show artificially inflated income in 2020, for portions of the loan subject to forgiveness.v Other current impacts may follow essential/non-essential business classifications. Future impacts may vary if changes in behavior occur as a result of COVID.vi In many cases, blockage discounts may be greater today vs. pre- COVID on account of factors including volatility, overall market liquidity, etc. Examples of Essential vs. Non-Essential Businesses

Essential • Medical, healthcare • Telecommunications • Information technology systems • Defense • Food and agriculture • Transportation systems • Critical manufacturing • Energy and utilities • Financial services • Government facilities • Emergency services, law enforcement • Water and wastewater • Public works • Essential retail (e.g., grocery stores, pharmacies)

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Non-Essential

• Travel • Leisure • Most brick and mortar retail • Many restaurants / bars • Entertainment venues / live events • Discretionary product manufacturing • Casinos • Fitness centers • Shopping malls • Amusement parks, carnivals, water parks, and bowling alleys • Barbershops, hair salons, tattoo and piercing parlors, and certain

other personal care services All of that said, the time is now for obtaining a valuation of hard-to-value assets that will be valid for transfers made before the end of the year. Most valuation professionals are already overwhelmed with year-end planning projects and it will only get more difficult to get projections of value for closely held and other hard-to-value assets as we get closer to December 31. A Biden presidency would need a majority in Congress with an appetite to raise taxes in order to make substantial changes to the tax code. However, President Biden would not need Congressional support to re-introduce regulations that restrict valuation discounts. Any client interested in making transfers of fractional interests in closely held businesses may want to move these assets before the end of the year while discounts are still available to reduce the tax value of hard-to-value assets. Consider Teeing Up the Plan Now Some clients are still reluctant to plan even as the year is winding down. Human nature and procrastination are not going to change now. For these clients, one might consider creating and funding an irrevocable trust with a moderate amount of cash or other assets so that a GST exempt, grantor trust exists and may be grandfathered from further legislation. Clients might take the risk that any tax change won’t be retroactive so that they might add assets next year depending on the runoff results. Alternatively, a client may be able to use an older trust that had been funded in a prior year. For

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example, for clients hesitant to shift additional assets, allocating GST exemption to old irrevocable life insurance or other trusts, and perhaps decanting them into better trusts, may provide benefit without committing to additional asset transfers. If tax law changes are proposed but not retroactive perhaps those trusts can be added to next year. Documentation to complete a transfer of private equity, or an instruction letter to wire securities, can be prepared now so that the plan can be quickly implemented if and when the results of the Georgia runoff elections are known, or for worse procrastinators, when there is a change in tax law proposed. Similarly, if the transfer involves private equity, the client may consummate a note sale now, and then gift the notes at some later point with draft forms of documentation prepared, but held in abeyance and unsigned to cancel the note if later desired. These types of steps might facilitate funding the trust with some of the intended assets quickly once the results of the election are known. Arguably, a client may even be able to wait until after a more definitive tax proposal from the victors is released. From a practical perspective, with the crush of work that many practitioners may be under as this year continues to wind to a close, taking steps now may prove to be a prudent approach in order to facilitate completion of the transaction before year-end. Another approach, and both can be used, is to “bake in” the possibility of unravelling the planning done with the benefit of hindsight. There are several ways that this might be accomplished. A provision for a disclaimer, described in Code Sec. 2518, might be integrated into a trust instrument granting the trustee or a named beneficiary the right to disclaim transfers to a trust on behalf of all beneficiaries so that the assets revert back to the donor.vii If a trustee is to be provided the right to disclaim, that should be permitted under state law, the disclaimer should be expressly permitted, and the provisions should expressly permit the trustee to exercise the power without regard to the trustee’s fiduciary duties.viii Sample Clause: “Any beneficiary of any trust created hereunder, in addition to any rights conferred on him or her by the law governing the validity, construction and effect of this instrument, is authorized at any time

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within nine (9) months after the date of this instrument, and with respect to any additional property placed in trust hereunder within nine (9) months after such addition, to renounce or disclaim, in whole or in part or with reference to specific amounts, parts, fractional shares or assets, any interest, right, privilege, or power granted to that person by this instrument. Any such renunciation or disclaimer shall be made by an acknowledged, written instrument executed by that person or by his or her conservator(s), guardian(s), executor(s), administrator(s) or other personal representative, delivered to the Trustee and filed with an appropriate court or judicial office. If such renunciation or disclaimer is made by *Specified Beneficiary Name, who shall be treated as the Principal Beneficiary of the Lifetime Trust hereunder, any property disclaimed by such renunciation or disclaimer shall revert and be retransferred, reconveyed and repaid over to the person (the "donor") who made such transfer to such trust.”ix Treas. Reg. Sec. 25.2518-1(b) explains that upon execution of a qualified disclaimer, the disclaimed interest in property is treated “as if it had never been transferred to the person making the qualified disclaimer.”x The practical effect is that where a transfer is made to an irrevocable trust that provides for a reversion to the grantor, or, perhaps better, over to a trust created by the grantor, such that the transfer would then be treated as incomplete for gift tax purposes (a so-called “Incomplete Gift Trust,”) in the event of a disclaimer, no taxable gift will be deemed to have been made in the event of any such disclaimer.xi An even bolder (but potentially risky) plan might be to provide that the named minor beneficiary of the trust could make a qualified disclaimer, on behalf of the trust, pursuant to Code Sec. 2518, as the minor would have nine months from his or her 21st birthday to make the disclaimer. As another possible approach, a donor may wish to invoke the unlimited marital deduction by making a gift to a trust qualifying for an inter vivos QTIP election, as described in Code Sec. 2523(f):

1. The trust must grant to the donee spouse a qualifying income interest for life; and

2. The donor must make a timely QTIP election on a timely filed gift tax return.

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To the extent that the election is made, no gift tax will be due (and no lifetime exemption used), assuming the spouse who is the beneficiary is a US citizen. On the other hand, to the extent that the donor fails to make a timely election as to all or part of the contribution to the trust, exemption will be used and, in effect, a so-called Spousal Lifetime Access Trust (SLAT) will have been created as to that part of the trust.xii This presents a unique opportunity in this time of great uncertainty. Arguably, the client could consummate a large gift in 2020 to a “QTIP-able” trust and then evaluate throughout the better part of 2021, until the extended filing date for the 2020 gift tax return (October 15, 2021), whether or not the gift or any part of it should, in fact, use exemption. The donor might consider using a formula QTIP election which fails to make the QTIP election as to the amount of the donor’s remaining exclusion available in 2020. It's advisable for the estate planning attorney to work closely with the gift tax return preparer, financial advisors, and other professionals to ensure adherence to the planning. Lack of consistency and failure to make timely elections that specifically identify the portion of the transfer subject to the QTIP can adversely impact this type of planning. Providing Access Assuring that a client that might need access to assets transferred to a trust has reasonable access may be a critical prerequisite to the client proceeding with the planning. The following discussions review several of the ways in which practitioners might assist in providing potential access to assets transferred out of the estate. The discussion does not address using preferred interests that are not compliant with Section 2701 to secure exemption while retaining distributions on the preferred interest. Variations of Domestic Asset Protection Trusts (“DAPTs”) May Be Vital for Moderate Wealth Clients to Use Exemption in 2020 Considering the substantial amount that some clients will wish to transfer to use currently high exemption amounts, may require careful attention to preserving access to those funds. Modern trust planning techniques provide an array of options to permit a client to benefit from assets transferred to completed gift trusts that can use exemption. These include:

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DAPTs,xiii hybrid-DAPTs where someone in a non-fiduciary capacity can add the grantor as a beneficiary, special powers of appointment to direct a trustee to make a distribution to the grantor,xiv special power of appointment trusts (“SPATs”), variations of non-reciprocal SLATs, loan powers, floating spouse-clauses, etc. The number of states permitting self-settled trusts has grown steadily since Alaska enacted the first statute and now numbers 19.xv If clients have the potential to have access to the assets transferred, there may be fewer impediments for the client to proceed with planning in light of the risks posed by a change in the law relating to estate tax. However, practitioners should advise clients living in non-DAPT jurisdictions that this may come with increased risk of creditors reaching the assets in the trust or the IRS arguing for estate tax inclusion. Other than the cost of the planning, there may be less substantive downsides of planning now versus waiting and facing a potentially dramatically more limited planning regime. In fact, although effective estate tax planning always requires the client to give up certain access to assetsxvi, these strategies may nonetheless benefit him or her, as well as his or her family. The need to give up access in order to obtain tax savings may be something many moderate wealth clients have viewed quite differently with the current high exemptions; however, it might be appropriate to reexamine that perspective. The use of self-settled domestic asset protection trusts (“DAPTs”), or variations of DAPTs, to provide clients access to the large wealth that must be transferred to secure some portion, or all, of the current large exemptions may be important to 2020 planning for certain clients.xvii At the same time, there seems to be concern among some practitioners about the efficacy of this technique. Practitioners need to understand the issues to guide clients to make informed decisions about the use of DAPTs and variants, but to also give clients the comfort level to proceed with planning that could prove valuable. Self-settled DAPTs may be an important option for moderate wealth clients in the late 2020 planning environment. Access to assets to be transferred in order to use the current large exemptions may be critical for many clients other than some UHNW (ultra-high net worth) clients. Many single clients, and even many married clients, will want or insist on being able to access the assets transferred should the need arise. With historically high exemptions, very large transfers (relative to the net worth of moderate

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wealth clients - perhaps, defined as those having estates between $5 million to $40 million) are necessary to make a meaningful impact in securing as much of the large exemption as feasible before a possible tax law change (whether after the election or later). A more quantitative approach would be to evaluate the client’s budget and use financial modeling to determine how much wealth can be retained and how much can reasonably be transferred. Will assets transferred to a DAPT be excluded from the client’s estate thereby having the transfer tax planning goals for the plan succeed? A DAPT formed in a DAPT jurisdiction may afford this result.xviii Now nineteen states protect self-settled trusts from claims of the grantor’s creditors. The issue seems to be: Does this work in other non-DAPT states? It’s not certain, but perhaps if all formalities are adhered to, e.g., all persons and assets involved are in a “DAPT” state, it should succeed. The result on the continuum in between (i.e., where there are some ties to the home non-DAPT state) is less clear. If the DAPT results in creditor protection (because it is by recognized in both the state of creation and the state in which the donor resides as being excluded from the claims of creditors of the donor), then the trust should be excluded from the grantor’s gross estate if the gift to the trust is complete.xix

Consider Case Law in Formulating a DAPT Plan When evaluating the possible use of a DAPT, practitioners should consider the Wacker case.xx While some commentators concluded that DAPTs are no longer viable post-Wacker, many practitioners believe that the Wacker case was a bad facts case that does not inhibit the use of DAPTs at all, although alternative approaches and structures to lessen possible risks appear to be more commonly used. Others view the Wacker case as quite limited and that it does nothing to change the risks of the use of DAPTs even by those residing in non-DAPT jurisdictions. Rather, they view Wacker as a limited case addressing jurisdiction and another warning that no type of trust, self-settled or otherwise, can protect against a fraudulent conveyance.xxi In Wacker, both the Montana and the U.S. Bankruptcy Courts issued default judgments, including against the trust that purported to be an Alaska trust, holding that the transfers to the trust were fraudulent. The trustee brought an action in Alaska seeking to set aside the Montana and

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bankruptcy court judgments, arguing that Alaska had exclusive jurisdiction on matters involving transfers to Alaska self-settled trusts. Wacker is a narrow ruling that Alaska could not mandate that exclusive jurisdiction rests in Alaska where a fraudulent conveyance to an Alaska DAPT was found to have occurred by the courts of another jurisdiction. Wacker did not invalidate self-settled trusts created in Alaska. Indeed, although courts in other jurisdictions entered a default judgment on fraudulent transfer allegations, the viability of Alaska self-settled trusts to shield trust assets from the claims of the grantor’s creditors was not addressed. Planning Post-Wacker has evolved. Even DAPT proponents seem to suggest a wide array of variants of the traditional DAPT technique to provide more security, such as increased attention to hybrid-DAPTs and special power of appointment trusts (“SPATs”). But practitioners, even in the waning days of 2020, can take proactive steps to corroborate that the trust and transfer to it are not fraudulent conveyances, to differentiate a plan from Wacker and other bad-fact DAPT cases. These might include lien and judgment searches, other due diligence steps, having the transferor sign a solvency affidavit (whether or not state law requires it), forecasts by the client’s wealth adviser demonstrating no anticipated need to access the DAPT assets, etc. Different requirements may be warranted in late 2020 in light of the relatively large percentages of wealth some clients are transferring in order to use more of their large temporary exemptions. Additional considerations may include what life and long-term care coverage is in place pre-transfer. Should a large personal excess liability policy (umbrella) be acquired before a transfer? Should broader than traditional lien and judgment searches be obtained? In a more recent case, a bankruptcy Judge found that a pre-existing asset protection trust, formed in the Cook Islands and moved to Belize, was subject to Florida law and not protected from the creditors of a Florida resident who was the grantor and beneficiary.xxii This case might raise concern that a non-DAPT state resident’s creation of a DAPT in a DAPT jurisdiction may be tainted as governed by his or her home state laws. However, in Rensin, the facts of the debtor’s circumstances were

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egregious. In another recent case, the Tax Court appears to have respected a foreign trust.xxiii

Hybrid-DAPT To address the concern that some practitioners have over the use of DAPTs by clients in non-DAPT jurisdictions, the hybrid DAPT has received increased attention. This is a potentially-DAPT trust in which the descendants of the grantor’s grandparents (which obviously would include the grantor) can be added in as beneficiaries in the discretion of a person named to act in a non-fiduciary capacity. But when someone holds the power to add a beneficiary, the DAPT could be characterized as a grantor trust which may not be desirable in some instances. Practically, what this might mean, is a combination of various trusts (grantor and non-grantor, as well as other characteristics) tailored to the particular client’s situation. If a client is concerned that a democratic win in the Georgia runoff elections could lead to the enactment of provisions similar to those proposed by Senator Sanders, the client might now consider creating or maintaining a grantor trust that might benefit from grandfathered treatment. The power to add the grantor as a beneficiary could be made conditional by time (e.g., only after 10 years and one day (which might address issues raised by Bankruptcy Code 548(e)xxiv). Another limitation some practitioners incorporate into DAPTs is that the grantor can only be a beneficiary when not married. While married the grantor can benefit through a spouse and may have no need to be a beneficiary, and hence no need to accept whatever incremental risk a DAPT might create. While many practitioners believe that the hybrid-DAPT will succeed, there is no law specifically on point. That might itself be an indication of success from an asset protection perspective. Unfortunately, there may yet be cause for some concern. A New York case suggests that a hybrid-DAPT may not succeed if the person, such a Trust Protector, who has the power to add the grantor as a beneficiary is acting under a fiduciary duty.xxv Because a self-settled trust is one from which the trustee may or must make distributions to the grantor, some practitioners might opt to structure a hybrid-DAPT so that the person who can add the grantor is not acting under a fiduciary duty.xxvi

Special Power of Appointment Trust (“SPAT”)

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Another approach is to permit a person named in a non-fiduciary capacity to direct the trustee to make a distribution to the grantor. In this way, the trust is not self-settled (which is the touchstone for attachment in many jurisdictions). If the power holder will not be an adverse party, the trust will be a grantor trust, under Sections 676 and 677.xxvii If the trust is structured so as not to be a grantor trust, loan provisions may provide a means of access before turning on DAPT status and without triggering grantor trust status. But if the loan may be made without the requirement of adequate security or adequate interest, grantor trust status will also ensue. Indeed, loans to the grantor from a trust, regardless of the terms of the loan, may cause the trust to be taxed as a grantor trust under Section 675(3).xxviii Another consideration may be to draft limitations into the governing instrument. For example, consider including a provision that no distributions can be made to the grantor for ten years and one day after transfers are made to the trust to address the rights of a bankruptcy trustee to disavow a self-settled trust under the Bankruptcy Code.xxix Some practitioners provide that the grantor cannot be added or appointed to be a beneficiary unless there is a divorce or death of a spouse or an individual cannot be added or appointed to be a beneficiary unless they are married to the grantor at the time the power of appointment is exercised. If the trust is drafted as a third-party trust (that is, one not created by any beneficiary), and not a DAPT, but a power of appointment (“POA”) is provided to a senior family member, that POA can be exercised in favor of an appointment to a trust that includes the original trust’s settlor/grantor. That may not be characterized as a DAPT because the exercise of a POA probably will characterize the power holder, and not the initial grantor, as the transferor, especially if it is accomplished by use of a general power of appointment. The opinions of well-known practitioners vary across a wide spectrum. Some say from, on one extreme, DAPTs do not work so, therefore, they use only foreign asset protection trusts (“FAPTs”) to achieve these goals. On the other extreme, some practitioners believe that DAPTs do work and the dearth of significant cases that do not involve bad facts suggests that most DAPT challenges either do not succeed or settle favorably. Still other practitioners express considerable discomfort with using FAPTs and prefer variations of DAPTs. Even amongst DAPT naysayers, it seems that many agree that if the grantor is domiciled in a DAPT jurisdiction that the DAPT is more likely to succeed. Since the number of jurisdictions recognizing

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DAPTs has grown steadily, this creates more opportunities for use of this technique (even amongst practitioners who were historically leery of DAPTs).

Mix n’ Match Using a combination of SLATs, DAPTs, Hybrid-DAPTs and/or SPATs may provide a more flexible approach to accomplish client goals while at the same time differentiating what might have otherwise included a more basic non-reciprocal SLAT plan. With so little time left in the 2020 planning year, having time between the creation and funding of each of the non-reciprocal trusts may not be feasible. So, if one spouse creates a DAPT and the other a SLAT, etc. the DAPT may not only enhance access to trust assets, but is arguably a significant difference from the SLAT the other spouse created.

Substitution of Lower Interest Loan for Higher Interest Older Loan There are even some planning opportunities for the most reluctant of clients who do not have any appetite for making additional wealth transfers before year-end. The current historic low interest rates have created opportunities for some clients to substitute a lower interest note in place of an older high interest note. For example, parent sold assets to a trust several years ago in September 2015 when the required interest rate was 2.64%; in October 2020, the long-term rate was 1.12%, and the December rate is a bit higher at 1.31%. If a new note at the new rate could be substituted for the old note at the old rate, a substantial reduction in leakage back into the parent’s estate could be achieved. Practitioners considering the array of planning options available to clients should evaluate the pros and cons of substituting low interest notes. The effects can be more substantial than the reduction of leakage. Assume that the parent had sold a 20% minority interest in a family business to a grantor trust in 2015 but no further sales occurred because of the concerns about cash flow from the enterprise to shareholders so that the trust could fund current note interest payments. The reduction in interest rate on the old note might also provide sufficient latitude to support a sale of further equity interests to the trust.

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Consideration should be given to the documentation advisable for such a transaction. In some instances, practitioners may merely swap a new note for an old note. If the original loan transaction were merely that of a parent advancing funds at the mandated rate to a child, that might suffice. But practitioners should evaluate the overall transaction to identify what documentation and steps might be necessary to properly effectuate a note substitution. Assume, for example, that the original note arose from a sale by a parent of family business interests to a grantor trust. The following documentation and steps might be considered:

• Existing Note. The prerequisite to substituting a lower interest note is that the existing note can be prepaid at any time without penalty. So the first step is to confirm that the note can be prepaid at any time without penalty. If the original note incorporated restrictions on prepayment those must be resolved before proceeding. A sample provision permitting prepayment might read as follows: “Optional Prepayment. This Note may be prepaid in whole or in part at any time without premium or penalty. All payments made hereunder shall be applied first to the payment of unpaid interest under this Note and, second, to the unpaid principal amount of this Note.”

• Direction Letter. If the trust involved in the initial sale has a directed trustee then the investment director should provide the directed trustee a direction letter regarding the substitution and direct the trustee to execute documents relevant to the transaction.

• New Note. A new promissory note, revised for the changes made regarding the substitution, needs to be prepared and signed as part of the substitution. There may be no changes other than the interest rate. If the maturity of the loan is shortened (see discussion below) the date would change as well.

• Modification of Pledge and Escrow Agreement. If the original note arose from the sale of assets by the parent to the grantor trust there may have been a pledge and/or escrow agreement in the original transaction securing the parent/seller’s interests in the note. If so, then consider having all parties to that agreement sign a modification agreeing to the substitution of the original note for the new note being prepared. Such a document should address whatever prerequisites to a modification of the note are contained in the original pledge and escrow agreements. If this is not properly addressed the presumed innocent substitution of a note might constitute a default under the original transaction documents. That could be problematic if the IRS

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challenged the transaction and the taxpayer themselves triggered a default and it went unnoticed.

• Novation Agreement. A novation agreement could be signed by both the maker of the note as well as the lender, and could confirm the agreement on cancellation of the original note.

• Other Documents. Be alert for other documentation or actions that might be necessary based on the nuances of the original transaction giving rise to the original note to finalize the substitution of the promissory note between the parties.

While the positive results are indisputable, there remains some uncertainty as to the tax results in some instances. The substitution of a lower interest note arguably should not have any adverse tax consequences. However, bear in mind that there is little actual law on point to support the tax-free consequences of this type of transaction. The IRS may argue that transaction triggers a gift tax on the grounds that the refinance of the original note at a lower interest rate increased the value of the trust without any economic benefit to the lender/grantor. One theory to negate such an IRS challenge is that the current higher interest note, and the new lower interest note, are both worth their face value. While the IRS might argue that the existing higher interest note should be valued at a premium, the contrary argument to that is that since the old note can be repaid at any time there can be no premium as the higher interest rate has no assurance. This argument could be advocated (but not assured to succeed) to negate a challenge by the IRS that there was a gift tax consequence to the transaction. The above position might be supported by having an independent appraisal firm value the old note at its face value on the basis that no one would pay a premium for a note that is pre-payable at any time without penalty. The commercial analogy to this is that the premium on a callable bond with a higher than market interest rate will reflect that call feature. It is not clear, however, that any taxpayer has actually gone to the lengths to obtain an appraisal for this purpose. There may, according to some views, be an advantage from the perspective of deflecting a gift tax challenge by the IRS if the lender receives something in return for agreeing to the reduction in interest rate. While this should not be necessary as long as the note permits prepayment without penalty, the argument might be that if the lender received a shorter term, additional principal payment, additional collateral, or some other

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modification of value to the lender, that such value was consideration for the lowering of the interest rate. There is no case law or other authority supporting this suggestion or the possible IRS challenge. If the borrower in the note substitution transaction is a grantor trust there should not be any income tax consequences as the transaction is with a disregarded taxpayer. Obviously, if there was a basis to challenge the grantor trust status of the trust that might negate the position of no negative income tax implication. If not, i.e., if the trust borrower is a non-grantor trust (e.g. the parent who consummated the original note sale transaction has subsequently died, or otherwise turned off grantor trust status) then consider the potential income tax consequences of the note substitution. If the transaction is with a non-grantor trust could a loss be realized on the substitution? While an argument might be advocated that the transaction might generate a loss for income tax purposes, it would seem that such a loss would, if it really occurred, be unavailable because of the related party rules.xxx

Conclusion It is prudent for practitioners to review the pros/cons of continued 2020 planning in light of the current political environment. In doing so, inform and educate clients as to the unique nuances of the current late 2020 planning environment, and the changes that may be in the offing (or not). The potential for massive tax changes is unpredictable but yet vital for many clients to consider, so that the client might consider taking proactive steps now. In this environment there are a range of planning considerations that affect how practitioners might practice, including estate tax minimization planning, income tax planning and more. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Joy Matak

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Sandra Glazier

Martin Shenkman

CITE AS:

LISI Estate Planning Newsletter #2840 (November 29, 2020) at http://www.leimbergservices.com Copyright 2020 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITATIONS:

i This newsletter is an adaption of a paper submitted to the Notre Dame Tax and Estate Planning Institute, which was an adaption of Martin M. Shenkman, Jonathan G. Blattmachr, Joy Matak, & Sandra D. Glazier, Steve Leimberg's Estate Planning Email Newsletter #2745 03-Sep-19, “Estate and Tax Planning Roadmap for 2019-2020.”

ii Pension Benefit Guaranty Corporation v. R. A. Gray & Co., 467 U. S. 717 (1984); United States v. Carlton, 512 U.S. 26 (1994).

iii Be sure to analyze the potential that a disclaimer by the trustee may constitute a breach of fiduciary duty subjecting the trustee to claims by the trust beneficiaries.

ivThe federal estate and gift and generation skipping transfer tax lifetime exemptions are currently set to increase to $11.7 million on January 1,

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http://leimbergservices.com/openfile.cfm?filename=C:/inetpub/wwwroot/all/lis_notw_2745.html&fn=lis_notw_2745

2021, if no change in the exemption amounts is effectuated through congressional action.

v See Rev. Rul. 2020-27.

vi Acknowledgements to Empire Valuations and Management Planning, Inc.

vii Acknowledgements to Interactive Legal software for the sample provision provided.

viii Caution is recommended when granting the right to disclaim to the trustee, inasmuch as the exercise of such a disclaimer may open the fiduciary to claims of breach of duty by the beneficiaries.

ix The sample provision is based on language contained in Interactive Legal drafting software and is presented with their permission. x Remember to check state disclaimer laws, as some require delivery to the probate register and/or a qualified fiduciary to be effective as a state qualified disclaimer.

xi Acknowledgements to Jonathan Blattmachr, Esq. for some of these thoughts.

xii Acknowledgement to Professor Jerome B. Hesch, Esq. and Alan S. Gassman, Esq. as noted in the above article.

xiii Self-settled trust jurisdictions now include Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. See: PLR 200944002. Under Section 6110(k), neither a private letter ruling (PLR) nor a national office technical advice memorandum may be cited or used as precedent, although they may prevent the imposition of certain tax penalties

xiv O’Connor, Gans & Blattmachr, “SPATs: A Flexible Asset Protection Alternative to DAPTs,” 46 Estate Planning 3 (Feb 2019). By definition, a SPAT is not a self-settled trust so that state statute (e.g., NY EPTL 7-3.1) that permit creditors of the trust’s grantor to access that assets in the trust and precedent (e.g., Rev Rul 2004-64, infra) which may cause such a trust to be included in the gross estate of the grantor should not apply.

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xv Self-settled trust jurisdictions now include Alaska, Connecticut, Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming.

xvi See, e.g., Rev. Rul. 2004-64, 2004-27 I.R.B. 7.

xvii For application of DAPTs to premarital planning, which has many similar concepts relevant to the discussion herein, see, Glazier, Shenkman and Gassman “DAPTs & Klabacka - At the Intersection of Estate Planning and Family Law,” LISI Asset Protection Planning Newsletter #357 (February 1, 2018).

xviii Alaska enacted AS 34.40.110 providing complete asset protection for a self-settled trust if the Grantor was not trying to defraud a known creditor (plus other requirements)

xix See Rev. Rul. 76-103, 1976-1 CB 293 and Rev. Rul. 2004-64, 2004-2 CB 7.

xx Toni 1 Trust v. Wacker, 2018 WL 1125033 (Alaska, Mar. 2, 2018).

xxi Blattmachr, Blattmachr, Shenkman & Gassman on Toni 1 Trust v. Wacker - Reports of the Death of DAPTs for Non-DAPT Residents Is Exaggerated, Steve Leimberg's Asset Protection Planning Email Newsletter #362, Mar. 18, 2018.

xxii In re Rensin, 17-11834-EPK, 2019 WL 2004000 (Bankr. S.D. Fla. May 6, 2019).

xxiii Campbell v. Commr. of Internal Revenue, 117 T.C.M. (CCH) 1018, 1 (Tax 2019).

xxiv US Bankruptcy Code Section 548(e) provides that a transfer to a self- settled trust (or similar device) may be set aside if it occurred within ten years of the filing of the petition for bankruptcy and was made “with an actual intent to hinder, delay or defraud” a creditor. Blattmachr, Blattmachr, Shenkman & Gassman on Toni 1 Trust v. Wacker - Reports of the Death of DAPTs for Non-DAPT Residents Is Exaggerated, Steve Leimberg's Asset Protection Planning Email Newsletter #362, Mar. 18, 2018.

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xxv Iannotti, 725 NYS 2d 866 (2001). Acknowledgements to Jonathan Blattmachr, Esq. for pointing out this issue and case.

xxvi This might be accomplished by providing for a lifetime limited power of appointment.

xxvii It may be feasible to create a non-grantor DAPT. Makransky v. Comm., 321 F.2d 598 (3rd Cir. 1963). See also, Lipkind, Shenkman and Blattmachr, “How ING Trusts Can Offset Adverse Effects of Tax Law: Part I,” Trusts & Estates, Sept. 2018, p. 26; “How ING Trusts Can Offset Adverse Effects of Tax Law: Part II,” Trusts & Estates, Dec 2018, p.2.

xxviii Section 675(3) provides in part, that a trust will be a grantor trust where “The grantor has directly or indirectly borrowed the corpus or income and has not completely repaid the loan, including any interest, before the beginning of the taxable year. The preceding sentence shall not apply to a loan which provides for adequate interest and adequate security, if such loan is made by a trustee other than the grantor and other than a related or subordinate trustee subservient to the grantor.” Hence, it will be appropriate to have an independent trustee make the loan and to require adequate interest and security. It is not certain what constitutes either.

xxix Section 548(e) of the United States Bankruptcy Code, which provides that assets transferred to a self-settled trust or similar device (whatever that means) are included in the bankrupt estate (for distribution to creditors) if transferred within ten years of the filing for bankruptcy if the transfer was intended to hinder, delay or defraud a creditor.

xxx IRC Sec. 267.

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Subject: Joy Matak, Sandra D. Glazier & Martin M. Shenkman: Estate Planning Six-Part Series for Late 2020, Part 2: Year-End Planning for Married Taxpayers “Time may be of the essence for married taxpayers who want to protect their assets and preserve their estates. The result of the January 5th Georgia runoff election for two hotly contested US Senate seats could severely limit opportunities for married taxpayers, regardless of the outcome. As COVID cases rise throughout the country, the plunging economy and rising deficit may force federal and state governments to consider additional tax legislation. Practitioners need to be alert to possible broad changes to the wealth transfer laws and factor them into any planning that might still be completed before the end of the year. Forewarned is forearmed. Therefore, it might be helpful for practitioners to advise clients how these uncertainties might impact them, their finances and their estate plans. The uncertainty over what, if any, regulatory actions and/or tax legislation might be enacted and the possible effective dates may also create adverse consequences. As a result, current planning efforts may be for naught and could even leave them in a position that is less favorable, depending on political developments and future regulations and legislation, than had they done nothing. Flexibility is helpful in attempting to minimize the potential for unhappy clients who transfer substantial wealth to irrevocable trusts and then regret planning that cannot be undone or modified later. In these times of economic uncertainty, permitting the possibility of access to assets transferred often is an important factor. There are a myriad of ways to accomplish flexibility and possible access, particularly for our married clients. Some of the important considerations addressed in this second installment of our six-part series, are as follows:

Steve Leimberg's Estate Planning Email Newsletter Archive Message #2841 Date:01-Dec-20

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1. The merits of having only one and not both spouses using lifetime exemptions before the end of the year;

2. Variations on spousal lifetime access trust strategies to preserve maximum flexibility for married clients;

3. Additional considerations when naming a spouse as a beneficiary; 4. Creating non-grantor trusts for the benefit of a spouse – without

tainting non-grantor trust status; and 5. Discussion about community property trusts and basis step-up

considerations.

This newsletter will be followed by the third installment in this series which will discuss other opportunities for planning before year-end.” Joy Matak, JD, LLM, Sandra D. Glazier, Esq. and Martin M. Shenkman, Esq. provide members with important and timely commentary in the form of a six-part series, Part 2 of which is a discussion of year-end planning for married taxpayers.i Joy Matak, JD, LLM is a Partner at Sax and Head of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. Joy provides clients with wealth transfer strategy planning to accomplish estate and business succession goals. She also performs tax compliance including gift tax, estate tax, and income tax returns for trusts and estates as well as consulting services related to generation skipping including transfer tax planning, asset protection, life insurance structuring, and post-mortem planning. Joy presents at numerous events on topics relevant to wealth transfer strategists including engagements for the ABA Real Property, Trust and Estate Law Section; Wealth Management Magazine; the Estate Planning Council of Northern New Jersey; and the Society of Financial Service Professionals. Joy has authored and co-authored articles for the Tax Management Estates, Gifts and Trusts (BNA) Journal; Leimberg Information Services, Inc. (LISI); and Estate Planning Review The CCH Journal, among others, on a variety of topics including wealth transfer

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strategies, income taxation of trusts and estates, and business succession planning. Joy recently co-authored a book on the new tax reform law entitled Estate Planning: Estate, Tax and Other Planning after the Tax Cuts and Jobs Act of 2017. Sandra D. Glazier, Esq., is an equity shareholder at Lipson Neilson, P.C., in its Bloomfield Hills, MI office. She was also the 2019 recipient of Bloomberg Tax’s Estates, Gifts and Trusts Tax Contributor of the Year Award and Trusts & Estates Magazines Authors Thought Leadership Award and has been awarded an AEP designation by the National Association of Estate Planners and Councils. Sandra concentrates her practice in the areas of estate planning and administration, probate litigation and family law. Martin M. Shenkman, CPA, MBA, PFS, AEP, JD is an attorney in private practice in Fort Lee, New Jersey and New York City who concentrates on estate and closely held business planning, tax planning, and estate administration. He is the author of 42 books and more than 1,200 articles. He is a member of the NAEPC Board of Directors (Emeritus), on the Board of the American Brain Foundation, the American Cancer Society’s National Professional Advisor Network and Weill Cornell Medicine Professional Advisory Council. Here is their commentary:

EXECUTIVE SUMMARY: Time may be of the essence for married taxpayers who want to protect their assets and preserve their estates. The result of the January 5th Georgia runoff election for two hotly contested US Senate seats could severely limit opportunities for married taxpayers, regardless of the outcome. As COVID cases rise throughout the country, the plunging economy and rising deficit may force federal and state governments to consider additional tax legislation. Practitioners need to be alert to possible broad changes to the wealth transfer laws and factor them into any planning that might still be completed before the end of the year.

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Forewarned is forearmed. Therefore, it might be helpful for practitioners to advise clients how these uncertainties might impact them, their finances and their estate plans. The uncertainty over what, if any, regulatory actions and/or tax legislation might be enacted and the possible effective dates may also create adverse consequences. As a result, current planning efforts may be for naught and could even leave them in a position that is less favorable, depending on political developments and future regulations and legislation, than had they done nothing. Flexibility is helpful in attempting to minimize the potential for unhappy clients who transfer substantial wealth to irrevocable trusts and then regret planning that cannot be undone or modified later. In these times of economic uncertainty, permitting the possibility of access to assets transferred often is an important factor. There are a myriad of ways to accomplish flexibility and possible access, particularly for our married clients. Some of the important considerations addressed in this second installment of our six-part series, are as follows:

1. The merits of having only one and not both spouses using lifetime exemptions before the end of the year;

2. Variations on spousal lifetime access trust strategies to preserve maximum flexibility for married clients;

3. Additional considerations when naming a spouse as a beneficiary; 4. Creating non-grantor trusts for the benefit of a spouse – without

tainting non-grantor trust status; and 5. Discussion about community property trusts and basis step-up

considerations.

This newsletter will be followed by the third installment in this series which will discuss other opportunities for planning before year-end.

COMMENT:

Contrasting 2012 versus 2020 SLATs A common planning technique, especially beginning in 2012 when taxpayers sought to use exemptions before they would purportedly decline from $5 million to $1 million, is the use of non-reciprocal spousal lifetime access trusts (“SLATs”). In this technique each spouse creates a trust for

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the other spouse and descendants. The trusts are crafted to be non-reciprocal. Therefore, they need to have sufficient differences in order to limit the ability of the IRS or a creditor “uncrossing” the trusts to undermine the planning. The benefit of the SLAT technique is that a couple can use exemptions and retain (through his or her spouse) access to assets transferred, while engaging in efforts to protect assets and reduce estate taxes. Planning in the current environment has important similarities and differences from the SLAT planning of 2012. The following highlights how planning might optimally be structured now:

• Like 2012, current wealth transfers might seek to secure the high estate and generation skipping transfer tax exemptions before they sunset or are reduced sooner by legislation.

• Like 2012, but even more pronounced, is the need for most taxpayers using current exemptions to have the possibility of access to the assets transferred. The reason access is more important is obvious, the exemptions are larger, and more wealth can be transferred.

2020 Spousal Lifetime Access Trusts (“SLATs”) SLATs are viewed by some as the “go-to” planning tool for married clients in late 2020. While clearly a valuable planning device, SLATs raise a host of issues (especially in the compressed time frame of late 2020 planning) and over-reliance on typical SLAT planning may not be optimal. SLATs can be a useful tool in late 2020 planning to use exemption and preserve possible access. This technique can be used for a wide range of client wealth levels. Moderate wealth clients can use SLATs to preserve some exemption, obtain asset protection planning and preserve possible access. At high wealth levels, SLATs can be used to fractionalize control positions in a family business (and thereby produce valuation discounts) and as the participants in very large note sale transactions (that is a sale to a grantor trust in exchange for an AFR note from the trust). All of this might be advantageous to complete before year-end in light of the many restrictions changes in the law might bring. SLATs might work as follows. Each spouse creates a trust for the other spouse, but this must be done in a way that avoids the state law creditor and tax reciprocal trust doctrines.ii This might be accomplished by making the trusts sufficiently different so the doctrines will not apply. The trusts

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should preferably be created at different times. In addition, the trusts should be funded with different assets and have different trustees and very different terms (e.g. different powers of appointment, different distribution standards, etc.). In one trust, the beneficiary spouse might be entitled to have a lifetime broad special power of appointment, the power to change trustees,iii and/or receive annual income distributions or distributions limited to HEMSiv. In the other trust, the beneficiary spouse would have no entitlement to distributions (perhaps, is not even a current beneficiary), no power to change trustees, and no power of appointment, but could become eligible to receive a distribution only upon exercise by a trusted child with a power to add beneficiaries. Sample Lifetime Power of Appointment that could be added to a SLAT for one spouse in order to differentiate it from a trust for the other spouse: “The Trustee shall distribute such income and/or principal of the trust to such one or more persons out of a class composed of the Grantor's descendants and surviving spouses of the Grantor's descendants on such terms as the Grantor's Wife may appoint, by a signed writing that, is: (i) acknowledged before a notary public or otherwise meets the execution formalities of a deed, (ii) specifically refers to this power of appointment and (iii) is delivered to the Trustee. Provided, however, that any such appointment by the Grantor's Wife shall only be effective if a trustee who is non adverse within the meaning of Reg. § 25.2511-2(e) consents to the appointment in an acknowledged written instrument. Further, in the event of Grantor’s Wife’s incapacity, this power of appointment may be exercised on the Grantor's Wife's behalf by a guardian or attorney-in-fact appointed to represent the Grantor's Wife who is expressly authorized to do so.”v Note that in the time of Covid practitioners may try to draft in a way that creates greater flexibility and ease of execution. Some documents that generally are signed with a notary (which can be electronic in many states) or two witnesses may be signed with less formality.vi

Reciprocal Trust Doctrine Checklist The following checklist provides some of the ways each SLAT might be differentiated from the other:vii

• Draft the trusts pursuant to fundamentally different plans. The planner should draft a separate memorandum or portions of a memorandum

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to describe the distinct objectives and purposes for each trust and set forth the planning relative to each such trust. Best practice would be to have the planning for each trust laid out in a separate memorandum. The plans for each trust should not be interrelated.

• Don’t put a husband and wife in the same economic position following the establishment of the two trusts. For example, the husband could create a trust for the benefit of his wife and issue, and the wife could create a trust for the benefit of her issue, in which her husband isn’t a beneficiary. Or one spouse could be a beneficiary of the trust he creates, if the trust is formed in an asset protection jurisdiction such as Alaska, Delaware, Nevada, Michigan or South Dakota, and the other spouse could create a trust in which he isn’t a beneficiary (that is, a trust that’s not a domestic asset protection trust).

• Use different distribution standards in each trust. For example, one trust could limit distributions to an ascertainable standard, while the other trust could be fully discretionary. However, limiting distributions to an ascertainable standard reduces flexibility and may prevent decanting, in some but not all states, and may expose the trust assets to a beneficiary’s creditors.

• Use different trustees or co-trustees. If each spouse is a trustee of the trust the other spouse creates, add another trustee to one or both trusts.viii If adding another trustee to each trust, consider adding a different trustee for each trust and using different institutional trustees.

• Give one spouse a noncumulative “5 and 5” power, but not the other. This power permits the holder to withdraw up to the greater of $5,000 or 5 percent of the trust principal each year. The amount the powerholder could have withdrawn at the time of death is includible in his estate. The lapse of the power, not in excess of the greater of $5,000 or 5 percent of the trust assets each calendar year, isn’t considered under Section 2514 a release of the power includible in the powerholder’s estate or a taxable gift. However, this power may expose assets of the trust to the powerholder’s creditors.ix

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• As in Levy,x give one spouse a special power of appointment, but not the other. However, the absence of a power of appointment reduces the flexibility of the trust. This might be viewed as particularly significant in light of the continued estate tax uncertainty. Note that the power might be added later by a decanting.xi

• Give one spouse the broadest possible special power of appointment and the other spouse a special power of appointment exercisable only in favor of a narrower class of permissible appointees, such as issue, or issue and their spouses and, perhaps, only with the consent of a non-adverse trustee.

• Give one spouse a power of appointment exercisable both during lifetime and by will and the other spouse a power of appointment exercisable only by will.

• In the case of insurance trusts, include a marital deduction savings clause in one trust, but not the other. A marital deduction savings clause provides that if any property is included in the grantor’s estate (because the grantor dies within three years after transferring a policy on his life to the trust thereby causing the proceeds to be included in the insured’s estate or for any other reason) some or all of the proceeds of the policy is held in a qualified terminable interest property trust or is payable to the surviving spouse outright.xii Alternatively, if each trust has a marital deduction savings clause, the provisions of the two trusts could still be different.

• Create different vesting provisions for each trust. For example, the two trusts could mandate distributions at different ages, or in a state that has repealed or allows a transferor to elect out of the rule against perpetuities; one trust could be a perpetual dynasty trust. However, mandating distributions severely reduces the flexibility of the trust, throws the trust assets into the beneficiary’s estate for estate tax purposes and exposes the assets to the beneficiary’s creditors and spouses.

• Instead of mandating distributions, give the beneficiaries control or a different degree of control, at different ages. For example, the ages at which each child can become a trustee, have the right to remove and

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replace his co-trustee, and have a special power of appointment could be different in each trust.

• Vary the beneficiaries. For example, one spouse could create a trust for the spouse and issue, and the other spouse could create a trust just for the issue. Note that if, for example, the husband creates a trust for his wife and their first child, and the wife creates a trust for her husband and their second child, the gifts could still be viewed as reciprocal.

• Create the trusts at different times. In Lueders’ Estate,xiii a husband and wife each created a trust and gave the other the power to withdraw any or all of the trust assets. Inasmuch as the trusts were created 15 months apart, the Third Circuit, in applying the Lehman doctrine,xiv held that there was no consideration or quid pro quo for the transfers. However, it should be noted that Lueders preceded Grace,xv in which, while the trusts were created two weeks apart, the Supreme Court held that the motive for creating the trusts wasn’t relevant. If the difference in time is a factor post-Grace, a short time might be sufficient in light of Holman,xvi in which a gift of partnership interests six days after the formation of the partnership wasn’t a step transaction. The closer we get to the end of 2020 and the possible reduction of the $11.58 million gift tax exemption amountxvii, the more difficult it will be to interpose any meaningful time difference between the formation of the two trusts. Practitioners should also bear in mind that if the same transaction includes funding an LLC, then in making gifts to the trusts that are to qualify for fractional interest or other discounts, they will be dealing with the challenge of two dating issues: the difference between the trusts and the maturation period of assets in the LLC prior to gift or sale.

• Contribute different assets to each trust, either as to the nature or the value of the assets. However, if the purpose is to use the full exemption for transfers to the trust, it may not be feasible to contribute assets of different value, and in any event varying the value of the trust only serves to reduce the amount to which the reciprocal trust doctrine may apply. Contributing different assets may not negate the application of the reciprocal trust doctrine, since the assets in a trust may be susceptible to change over time. However, if one trust is funded with non-liquid assets or assets subject to

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contractual restrictions on sale (e.g., operating agreement restrictions on transfer of interests in an LLC), it may be viewed as a more meaningful difference in assets that may not be susceptible to ready modification.

Perhaps, Only One (Not Both) Spouses Should Make Gifts to a SLAT The preliminary presumption in crafting a late 2020 SLAT plan might be to have each spouse create a SLAT for the other. However, apart from the reciprocal trust doctrine discussed above, it may not be ideal or even feasible for many married couples to have both spouses create SLATs. Having only one spouse make irrevocable transfers may mitigate the so-called buyer’s remorse that affected many 2012 last minute estate planning transactions. In many of those plans the transferor/donor made large wealth transfers in the rush of the December 31, 2012 anticipated deadline, and thereafter could not access those funds. While some clients might have regretted 2012 planning because the exemption did not decline to $1 million as feared, it may well have been the lack of access to assets transferred that was the primary source for complaint. In the current trust planning environment, assuring access to assets can prove much more difficult than in the 2012 environment for two reasons. First, in 2012 any transfer of more than $1 million preserved exemption. In 2020, transfers might need to be quite substantial before any benefit of the temporarily higher exemption is preserved. The reason is that, if (and when) the exemption drops to $5 million (adjusted for inflation) in 2026 (or earlier in the event of legislative action), the prior use of the exemption may not allow the new (lower) exemption to be used. For example, a client makes a taxable gift in 2020 of $5 million and dies after a reduction in the exemption to $5 million, no benefit will have been gained from the 2020 gift. They could have simply waited. Practitioners may, therefore, consider having one spouse, not both, use the exemption thereby preserving more exemption for moderate wealth clients that cannot use all their exemptions. Example: Husband and wife have a combined estate of $16 million and are willing to make a total of $10 million in transfers to irrevocable trusts to

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secure a portion of the current exemptions. If each of husband and wife transfers $5 million to a non-reciprocal spousal lifetime access trust (“SLAT”) in 2020, then, in 2026 (or earlier) when the exemption declines to $5 million, neither spouse would be left with exemption. If, instead, husband alone transferred $10 million to a trust for wife and descendants, wife would still have her entire $5 million exemption left. That step could preserve an additional $5 million of exemption for the couple going forward.

Using a Floating Spouse Clause in an Irrevocable Trust May Provide More Access One way to provide flexibility for possible access may be to include a “floating spouse” provision. In that way, if the current spouse divorces or dies, the new spouse can be a beneficiary, thereby permitting the grantor access indirectly through that new spouse.xviii Sample Floating Spouse Provision: “Definition of ‘My Wife.’ For purposes of this Agreement, any reference to my Wife shall mean Jane Doe, or, if she dies before I die, or she and I become divorced, or our marriage is annulled, the person to whom I am married at any given time.”

Divorce Considerations of Naming a Spouse as Beneficiary to Gain Access A floating spouse clause provides that whoever is married to the grantor at any particular point in time shall be a beneficiary. So, if the client is married at the time an irrevocable trust is created, that spouse would be a beneficiary. If there is a later death or divorce that spouse would no longer be a beneficiary. If the client thereafter remarries, the new spouse would become a beneficiary. This could permit the client to indirectly benefit from the irrevocable trust through each successive spouse. Practitioners may also consider the impact of the repeal of Code Section 682 and the potential for the trust to remain a grantor trust even in the event of a later divorce. If the spouse was a beneficiary at the time of the creation of such power or interest, the later death or divorce of that spouse does not impact the result that the settlor-spouse who created the trust will still be treated as the grantor for income tax purposes. This may suggest considering a provision that would provide the trustee or a trust protector with the authority to eliminate the spouse as a beneficiary of the trust in the

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event of separation or divorce or, alternatively, provide that, in the case of separation or divorce, distributions to the beneficiary spouse may be made only with the consent of an adverse party as that will foreclose grantor trust status by reason of Section 676 or 677. It may be prudent to draft the trust with other provisions that would cause grantor trust status (e.g., a power to substitute property of equivalent value described in Section 675(4)(C)) should another provision causing grantor trust status otherwise become inoperative.

Loan Provision Can Provide Not Only Grantor Trust Status but another Means to Access Trust Assets Another way to provide access may be to include a loan provision. While this has traditionally been done to cause the trust to be treated as a grantor trust pursuant to Code Sec. 675 for income tax purposes, the right to receive a loan without adequate security may provide important additional access to the trust. Sample Loan Provision: “I appoint Mary Doe as the Loan Director. During my lifetime, the Loan Director shall have the power, exercisable at any time and from time to time in a non-fiduciary capacity (within the meaning of Code Sec. 675) without the approval or consent of any person in a fiduciary capacity within the meaning of that section, to compel the Trustee to loan some or all of the trust property to me without adequate security within the meaning of Code Sec. 675(2) although with adequate interest within the meaning of that section. I direct that this power is not assignable. In the event that Mary Doe dies before I die, the successor Loan Director shall be such individual (other than me, any person acting as a Trustee under this instrument or anyone who is an adverse party within the meaning of Code Sec. 672) whom Mary Doe shall have designated by instrument in writing. Any person other than Mary Doe acting as a Loan Director hereunder shall also have the power to name a successor Loan Director by an instrument in writing. In the event that no one else is acting as a Loan Director hereunder, the oldest individual acting as a Trustee hereunder (or if none, the corporation or other entity acting as Trustee hereunder) shall be the Loan Director but acting only in a non-fiduciary capacity.”xix

Non-Grantor Trust Considerations

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Non-Grantor Trusts with Spousal Access Without Tainting Non-Grantor Status SLATs are often structured as grantor trusts. A grantor trust could be structured to permit the spouse to have access, without the approval mechanism required of a non-grantor trust. Also, the grantor could be permitted to borrow trust funds without adequate security, which would trigger grantor trust status pursuant to Section 675. That cannot be permitted in a non-grantor trust. While often irrevocable trusts created to hold gifts and other transfers are structured as grantor trusts (that is, a trust where the income generated by assets of the trust is attributed under Section 671 to the grantor), a non-grantor trust might warrant consideration. In the current 2020 planning environment, it may be advantageous to structure some trusts receiving gifts as non-grantor trusts (although the potential benefit of having more than one such trust may be curbed on account of the multiple trust rule under Section 672(f), under which two or more trusts may be treated as one for income tax purposes). his may require more complex planning to achieve goals that may be contradictory. In some instances a trust may be structured as non-grantor trust to potentially garner a number of different tax benefits (even considering §199A, but that may be restricted under a Biden administration). Use of a non-grantor trust for one of two SLATs is perhaps a material differentiation of the two SLATs for purposes of the non-reciprocal trust doctrine. Threading the tax and trust “needle” to meet the differing objectives may require a different type of trust, and different planning and drafting than has been historically common. A new variant of a spousal trust may be advisable. One such trust has been referred to as a “SALTy-SLAT” by virtue of the non-grantor SLAT being able to facilitate planning to salvage some of the state and local tax (“SALT”) deductions. Others have referred to it as a Spousal Lifetime Access Non-Grantor Trust (“SLANT”). Drafting non-grantor, completed gift, trusts that may be accessible, is a technique to consider for some clients in the current planning environment. If the trust is properly structured (no grantor powers to the grantor spouse) and the beneficiary spouse can only receive distributions with the consent of an adverse party, the trust may achieve all objectives: completed gift to

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use the current high temporary exemptions that may be lowered in a Biden administration, non-grantor trust for any or all of the planning benefits of non-grantor trust, and the potential for access.

Community Property Trusts for Basis Step-up on First Death – Impact of Possible Law Changes Planning to use community property rules to obtain a full basis step-up on the death of the first spouse to die (subject to the normal exceptions, such as for income in respect of a decedent) has grown in popularity in recent years. It remains to be seen what will become of this technique. However, clients should be cautioned that if a Biden administration succeeds in eliminating a basis step-up on death this planning technique will be of limited or no benefit. If the Democrats gain control of the Senate, Biden has proposed eliminating the step-up in income tax basis on death. Should that occur the use of community property trusts to gain a basis step-up will no longer be relevant. Practitioners might then have to evaluate what to do with existing community property trusts that were set up before a law change unless they are grandfathered. While there are 11 states with community property laws, three of the states provide elective community property laws that anyone can avail themselves of: Alaska, Tennessee and South Dakota, with others contemplating adding such provisions to their statutes.xx Some commentators have different views as to the effectiveness of these statutes for non-residents of those states, but that discussion is beyond the scope of this newsletter. Residents of non-community property states, for example, might create a community property trust in Alaska in an attempt to obtain a full basis step-up on the first spouse’s death on all assets held in that community property trust. In reality, it is not a step-up but more akin to a mark to market regime as basis can be stepped down as well. This technique can be valuable for many client situations. In addition, later estate tax minimization planning might proceed without being hindered by low basis issues on those assets. If a highly appreciated rental property or business interest is transferred to an Alaska community property trust by a domiciliary of a non-community property state, e.g. New York, on the death of the

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first spouse the entirety of that asset might then benefit from a basis step-up.

For a non-resident of Alaska to create an Alaska community property trust as discussed in the above illustration, a requirement to benefit from the Alaskan law is to name a qualified trustee as an administrative trustee (e.g. an Alaskan trust company).

Conclusion Practitioners can add value to their client representations by informing and educating clients regarding the unique nuances of the current late 2020 planning environment, and the changes that may be in the offing (or not). The potential for massive tax changes is unpredictable but yet vital for many clients to consider, and perhaps take proactive steps now. In this environment there are a range of planning considerations that might affect estate tax minimization planning, income tax planning and more. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Joy Matak

Sandra Glazier

Martin Shenkman

CITE AS:

LISI Estate Planning Newsletter #2841 (December 1, 2020) at http://www.leimbergservices.com Copyright 2020 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any

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Person Prohibited Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITATIONS:

i This newsletter is an adaption of a portion of a paper submitted to the Notre Dame Tax and Estate Planning Institute, which was an adaption of Martin M. Shenkman, Jonathan G. Blattmachr, Joy Matak, & Sandra D. Glazier, Steve Leimberg's Estate Planning Email Newsletter #2745, 03-Sep-19, “Estate and Tax Planning Roadmap for 2019-2020.”

ii Steiner and Shenkman, “Beware of the Reciprocal Trust Doctrine,” Trusts & Estates Magazine, April 2012.

iii Within Rev. Rul. 95-58, 1995-2 CB 191 safe harbor.

iv HEMS is considered an ascertainable standard under the Internal Revenue Code which permits a trustee to make distributions in order to address a beneficiary’s health, education, maintenance and support without creating estate tax inclusion in the trustee or powerholder’s estate. See § 2041(b)(1)(A).

v Provision provided by Interactive Legal.

vi Martin Shenkman, Jonathan Blattmachr, Andrew Wolfe & Thomas Tietz: ”Different Approaches to Signing/Executing Estate Planning Documents,” Steve Leimberg's Estate Planning Email Newsletter #2803, 01-Jul-20.

vii Steiner and Shenkman, “Beware of the Reciprocal Trust Doctrine,” Trusts & Estates Magazine, April 2012, pg. 14.

viii Preferably at least one trustee should be an independent trustee and considered a resident or authorized to act as a trustee in the state of the DAPT’s creation.

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ix The existence of a 5 and 5 power may have income tax consequences to the beneficiary. A discussion of these potential consequences is, however, beyond the scope of this newsletter.

x Estate of Herbert Levy, TC Memo 1983-453. In Levy, Isle Levy had the power to appoint the income and corpus of the Herbert Levy Trust whereas Herbert Levy had no such power. As a result, the court concluded that the decedent and his wife had “markedly different interests in, and control over, the trusts created by each other.”

xi See, generally, Zeydel & Blattmachr, “Tax Effects of Decanting - Obtaining and Preserving the Benefits," Journal of Taxation, Vol. 111, p. 288 (November 2009).

xii Note that great flexibility will be available if a QTIP trust is used. The estate of the insured spouse would have up to fifteen months to decide the extent to which the marital deduction should be claimed.

xiii In re Lueders’ Estate, City Bank Farmers Trust Co., et al. v. Commission of Internal Revenue, 164 F.2d 128 (1947).

xiv The so-called Lehman doctrine applies “where the decedent by paying a quid pro quo has caused another to make a transfer of property with enjoyment subject to change by exercise of such power by the decedent." Lehman v. Commissioner, 109 F.2d 99, 100 cert. denied (1940).

xv See U.S. v. Grace, 395 U.S. 316 (1969).

xvi See Holman v. Commissioner, 130 T.C. 170 (2008).

xvii The exemption amount is presently scheduled to increase to $11.7 effective January 1, 2021 barring a legislative change in 2021, which could be made retroactively effective to January 1, 2021.

xviii Use of a “floating spouse” provision will require the practitioner to consider and evaluate his or her ethical duties when a joint estate planning engagement exists. Those considerations are beyond the scope of this newsletter. Moreover, if a spouse will continue to have rights following divorce, the income tax implications of such a provision should be discussed with the grantor in light of the 2017 Tax Act and the resulting provisions of Internal Revenue Code §677(a)(1), because it is the spouse’s

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status at the time the trust is created that will determine grantor trust status for income tax purposes.

xix Provision provided by Interactive Legal.

xx In Alaska, Tennessee, and South Dakota, an individual need not be a resident of the state in order to avail herself of the benefits of a community property laws in such state.

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Subject: Joy Matak, Sandra D. Glazier & Martin M. Shenkman - Estate Planning Six-Part Series for Late 2020, Part 3: Transfers for Taxpayers with Limited Exemption Remaining; Upstream and Downstream Planning “At this point in 2020, all we know for sure is that nothing is certain. Practitioners would do well to forewarn clients how these uncertainties might create more chaos for them, their finances and their estate plans. Even after the results of the runoff races in Georgia are known what, if any, tax legislation might be enacted and the possible effective dates of such legislation, will remain an uncertainty. It’s advisable to caution clients that all the tax planning efforts may be for naught and could even leave them in a position that is less favorable, depending on political developments and future legislation, than had they done nothing. Nonetheless, planning that incorporates asset protection benefits, succession planning, etc. may be worthwhile regardless of uncertainty tax changes. Despite all of this uncertainty, opportunities abound to accomplish significant wealth transfers before year end – even for those taxpayers who have already used up most (or all) of their lifetime exemptions of $11.58 million. Some opportunities discussed in this third installment of this six-part series, are as follows:

1. Consider ‘Downstream’ Planning

2. Be Wary of – and Consider Revisiting – ‘Upstream’ Planning

3. Insurance Trusts

4. Grantor Retained Annuity Trusts (‘GRATs’) in the Current 2020

Environment

The next installments of this series will explore other opportunities for planning before year-end.” Joy Matak, JD, LLM, Sandra D. Glazier, Esq. and Martin M. Shenkman, Esq. provide members with important and timely commentary in the form of


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a six-part series, Part 3 of which is a discussion of transfers for taxpayers with limited exemption remaining, including upstream and downstream planning.i Joy Matak, JD, LLM is a Partner at Sax and Head of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. Joy provides clients with wealth transfer strategy planning to accomplish estate and business succession goals. She also performs tax compliance including gift tax, estate tax, and income tax returns for trusts and estates as well as consulting services related to generation skipping including transfer tax planning, asset protection, life insurance structuring, and post-mortem planning. Joy presents at numerous events on topics relevant to wealth transfer strategists including engagements for the ABA Real Property, Trust and Estate Law Section; Wealth Management Magazine; the Estate Planning Council of Northern New Jersey; and the Society of Financial Service Professionals. Joy has authored and co-authored articles for the Tax Management Estates, Gifts and Trusts (BNA) Journal; Leimberg Information Services, Inc. (LISI); and Estate Planning Review The CCH Journal, among others, on a variety of topics including wealth transfer strategies, income taxation of trusts and estates, and business succession planning. Joy recently co-authored a book on the new tax reform law entitled Estate Planning: Estate, Tax and Other Planning after the Tax Cuts and Jobs Act of 2017. Sandra D. Glazier, Esq., is an equity shareholder at Lipson Neilson, P.C., in its Bloomfield Hills, MI office. She was also the 2019 recipient of Bloomberg Tax’s Estates, Gifts and Trusts Tax Contributor of the Year Award and Trusts & Estates Magazines Authors Thought Leadership Award and has been awarded an AEP designation by the National Association of Estate Planners and Councils. Sandra concentrates her practice in the areas of estate planning and administration, probate litigation and family law. Martin M. Shenkman, CPA, MBA, PFS, AEP, JD is an attorney in private practice in Fort Lee, New Jersey and New York City who concentrates on estate and closely held business planning, tax planning, and estate

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administration. He is the author of 42 books and more than 1,200 articles. He is a member of the NAEPC Board of Directors (Emeritus), on the Board of the American Brain Foundation, the American Cancer Society’s National Professional Advisor Network and Weill Cornell Medicine Professional Advisory Council. Here is their commentary:

EXECUTIVE SUMMARY: At this point in 2020, all we know for sure is that nothing is certain. Practitioners would do well to forewarn clients how these uncertainties might create more chaos for them, their finances and their estate plans. Even after the results of the runoff races in Georgia are known what, if any, tax legislation might be enacted and the possible effective dates of such legislation, will remain an uncertainty. It’s advisable to caution clients that all the tax planning efforts may be for naught and could even leave them in a position that is less favorable, depending on political developments and future legislation, than had they done nothing. Nonetheless, planning that incorporates asset protection benefits, succession planning, etc. may be worthwhile regardless of uncertainty tax changes. Despite all of this uncertainty, opportunities abound to accomplish significant wealth transfers before year end – even for those taxpayers who have already used up most (or all) of their lifetime exemptions of $11.58 million. Some opportunities discussed in this third installment of this six-part series, are as follows:

5. Consider “Downstream” Planning

6. Be Wary of – and Consider Revisiting – “Upstream” Planning

7. Insurance Trusts

8. Grantor Retained Annuity Trusts (“GRATs”) in the Current 2020

Environment

The next installments of this series will explore other opportunities for planning before year-end.

COMMENT:

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Consider Downstream Planning (not Upstream) for UHNW Clients

Upstream planning has received a lot of attention in recent years, but little attention has been given to downstream planning. This type of planning presents a potentially unique and valuable opportunity that may be quickly implemented in the waning days of 2020. A valuable “asset” of many ultra-high-net worth (“UHNW”) families is the unused exemption of their children. In those cases where the adult children do not have sufficient resources to make gifts to use their exemptions, the older generation (G1) may need to get assets to the younger generation (G2) so that G2 can take advantage of their remaining lifetime exemption, particularly before year-end. Consider that this is about much more than just capturing unused exemption of G2 or even G3. Creating a grantor, GST exempt, irrevocable, dynastic trust for each heir may prove valuable to their future estate planning. Further, if the laws change but those trusts created in 2020 are grandfathered, trusts created this year could prove incredibly valuable especially if those tax attributes are restricted or eliminated by future legislation. By making a long-term loan using an interest rate that matches the long-term applicable federal rate (the “AFR”), G1 may be able to transfer cash to G2 (or G3) without making a taxable gift. The December 2020 long-term AFR is 1.12% for loans with a term of ten years or more. For context, the annual interest due on a loan of $1 million with a 1.12% interest rate would only be $11,200. The rate for December 2020 is up to only 1.31%. If the intention is for G2 to make gifts upon receipt of funds borrowed from G1 to facilitate using up G2’s lifetime exemption and create GST exempt grantor trusts to benefit future generations, the practitioner might consider additional safeguards, as follows:

1. It may be important to ascertain if G2 has creditors who might try to

attach funds received before G2 is able to fund the trust or whether

such funding might be subject to attack as a fraudulent conveyance.

Also, if G2 is married, it may be prudent to ascertain potential

implications that downward planning may have in the event of

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divorce. Given the limited time before the end of the year, it may still

be feasible to have the G2 sign a solvency affidavit confirming their

belief that there are no claims that would render G2 insolvent, etc.

2. It may be important for G2 to provide a financial statement or other

documentation that demonstrates that G2 can continue to make the

payments due on the Note after any gift transfers by G2, to the extent

feasible.

3. The Note may be secured by an existing dynasty trust that had been

previously set up by G1 for the benefit of G2, this may be particularly

important if G2 does not have the resources to support the transfer as

constituting a viable loan.

4. It would be prudent for G2 to make a gift of an amount that is different

than the amount that is borrowed from G1 in order to avoid

implicating the step transaction doctrine which holds that “a series of

transactions designed and executed as parts of a unitary plan to

achieve an intended result … will be viewed as a whole regardless of

whether the effect of so doing is imposition of or relief from taxation.”ii

For example, G1 may loan G2 $10 million and G2 may gift $8 million.

Also, consider that the amounts might be much smaller. Even a

$500,000 funding of a GST exempt grantor trust, if grandfathered,

could prove to be the keystone of that family member’s future

planning.

5. G2 might want to consider making gifts that would benefit individuals

who are not the natural objects of G1’s bounty. By way of example,

G2 may use some part of the funds borrowed from G1 to fund a

spousal lifetime access trust for the benefit of G2’s spouse, using

some of the protections outlined in Newsletter #2.

Loans from G1 to G2 are relatively easy to implement quickly, but it is important for the parties to follow economic formalities in order to avoid possible re-characterization of the loan as a gift. The loan should be memorialized in a Promissory Note instrument. Both parties should sign it and adhere to any other requirements of applicable

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http://leimbergservices.com/openfile.cfm?filename=c:/inetpub/wwwroot/all/lis_notw_2841.html&fn=lis_notw_2841

state law for validity. Payments should be made in accordance with the note instrument and there should be economic consequences if payments are not made timely, such as a late payment penalty.iii

Be Wary of Risks of Upstream Planning

Upstream planning has been touted for its possible basis step-up benefits, but a reduced exemption could make such well-intended planning a tax trap depending on how the planning was formulated. Once the Tax Cuts and Jobs Act of 2017 more than doubled the federal basic exemption amount from $5.49 million in 2017 to $11.18 million in 2018, there was a marked shift in planning discussions for many clients from estate tax minimization to the income tax benefits of a basis step-up on death under Code Sec. 1014. Commentators began discussing more frequently the benefits of so-called “upstream planning” to shift values to a higher generation family member not otherwise subject to the estate tax. With fewer individual estates subject to tax on death, upstream planning became more common as practitioners incorporated general powers of appointment into trust instruments in order to cause trust assets to be included in the client’s estate or in the estate of an older generation family member whose estate is less than the exemption. This type of planning has been given considerable attention as a result of the currently large temporary exemptions. Clients who have a net worth substantially in excess of the approximately $23 million per couple exemption, might consider upstream planning if, for example, the clients’ parents have a combined net worth of well under the current exemption, e.g. only $2 million. Upstream general power of appointment (“GPOA”) planning might raise creditor issues. Confirm that the existence and exercise of the GPOA will not subject the trust assets to the claims of the creditors of the powerholder. If that is a risk, might conditioning the exercise of the power on the powerholder being solvent limit such risk? A GPOA may also subject the assets to a parent’s or other powerholder’s Medicaid claim for reimbursement.iv If there is a dramatic decline in exemption amounts before the powerholder dies, it will remain important for practitioners to now, in 2021, and in the

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future, review existing client estate plans to evaluate the need to modify or eliminate general powers of appointment that might cause estate inclusion and potentially create an unintended estate tax (e.g. if the powerholder has only a $5 million exemption instead of an $11.58 million exemptionv). Although many practitioners have touted the use of “upstream” planning to salvage otherwise unusable exemptions of clients’ elderly relatives, the planning is not assuredly beneficial. Consider the consequences of upstream planning if the lifetime exemption is substantially reduced. For example, assume that a parent had an estate of only $4 million, and the child created a trust with $7 million, granting his parent a GPOA over that trust. The intent of the plan was that the parent’s estate would include the assets of the trust and those assets would garner an estate tax free adjustment (hopefully step-up) in income tax basis on the parent’s death. If the exemption is reduced to the $3.5 million (as has been proposed by some Democrats), the plan intended to garner a basis step-up at no tax cost may instead trigger a substantial estate tax cost that was unintended. If basis step-up is eliminated (as President elect Biden has proposed) there may be no tax benefit for that estate tax cost. Practitioners should carefully review any upstream planning. For example, the elderly parent could be granted a limited power of appointment with someone given the right to convert it to a GPOA. If the exemption is reduced, the conversion would not be triggered. While some upstream plans were likely crafted to only include in the senior generation’s estate an amount that does not trigger an estate tax (e.g. using a formula inclusion), the more prudent course of action would be to confirm that any such clauses are properly drafted in order to avoid inclusion if exemptions are reduced. Clients who only recently had planning updated to address the inclusion of GPOAs to a higher generation will likely be frustrated by yo-yoing tax law changes and ongoing planning updates.

Funding Life Insurance Trusts

Another common planning tool has been for clients to make gifts to trusts from which a class of beneficiaries are allowed to withdraw a pro-rata portion of the gift made by the grantor (commonly known as a “Crummey power”), up to the annual gift exclusion amount for that beneficiary (or limited perhaps by what is commonly referred to as a 5 and 5 hanging Crummey power).vi This has facilitated the ability for clients to make large

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gifts to a trust (e.g. used to buy and hold life insurance) and not incur any gift tax cost related to the gift. A current proposal would restrict combined annual (Crummey) gifts to a maximum of $50,000 per donor. Another proposal would have restricted it to $20,000 per donorr. If these restrictions are applied to all trusts after enactment, the results could hamstring the common Irrevocable Life Insurance Trust (“ILIT”) which has been ubiquitous in estate plans. In light of such proposals clients might consider making maximum annual (Crummey) gifts, and even large gifts now (using exemption that might also disappear) of income producing assets that could have the potential to generate sufficient income to pay any premiums that become due after any change in law. This way, clients may not have to rely on annual gifts to fund their life insurance premium payments.

Example: Client has a typical ILIT with Crummey powers. Premiums are $75,000/year and are easily covered by the annual demand powers available to children and grandchildren who are beneficiaries of the trust. If tax reform is enacted and Crummey powers are prospectively eliminated (even for trusts predating the law change), the client will not be able to fund annual premiums without incurring a costly current gift tax. The client might be able to transfer a sufficient amount of marketable securities to the trust now, using current exemption, so that the future premiums might be paid from a combination of the income and principal of the gift made. If this technique is pursued, it might also be worthwhile to inquire about the availability to prepay future premiums currently in order to minimize future income tax costs to the client. Practitioners might also wish to analyze and address the effects of making a policy a so-called “modified endowment contract” as described in Code Sec. 7702A.

Alternatively, a client may consider making a large low-interest loan to an existing ILIT that could be used to pay premiums going forward. If no changes are made to the tax laws, the ILIT can use the cash borrowed to pay off the loan at some point in mid-2021. Given that the vast majority of ILITs are structured as grantor trusts, there should be no income tax consequences associated with such a payoff. As indicated earlier, it is recommended that all formalities be followed with regard to such intra-

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family loans. It’s advisable for all such transactions to be disclosed on a timely filed gift tax return.

Another Example: Since Grantor Retained Annuity Trusts (“GRATs”) may also be on the chopping block, a wealthier client who does not have adequate exemption remaining to complete a large gift (such as that discussed in the prior example to sufficiently fund future premiums) might consider creating and funding a GRAT that pours the remainder interest into the ILIT. Consider the GST implications of this before proceeding. If the ILIT is GST exempt the GRAT will not be and will pour non-GST exempt assets into the ILIT resulting in a mixed inclusion ratio.

While a more detailed discussion of GRATs follows later in this newsletter, as long as GRATs remain a viable planning option, a GRAT/ILIT plan might entail creating a two-year GRAT with the ILIT as the remainder beneficiary. Each time the annuity payment is made to the grantor, the grantor could re-GRAT it into a new GRAT for which the ILIT is designated as the remainder beneficiary. However, if both two-year GRATs and Crummey gifts are eliminated, as has been proposed, this type of GRAT/ILIT plan would have to be structured differently. Perhaps a tier of GRATs with different durations might be created now, before any new GRAT restrictions are enacted, so that the existing GRATs might be grandfathered and continue to fund insurance premiums for years to come despite proposed restrictions on Crummey powers. Practitioners may want to consider (in the current environment which some view as creating an increased risk of harsher tax legislation to pay for the current bailouts) using GRATs to “pre-fund” future life insurance premiums in ILITs. If the insurance trust is not GST exempt, a GRAT could be structured to pour into the insurance trust as its remainder beneficiary and thereby infuse capital now before restrictions are created on ILIT Crummey trust funding. If the ILIT is GST exempt, it might borrow funds at the low applicable AFR from the successful GRAT without income tax effect if each GRAT is a grantor trust as to the same grantor.

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Grantor Retained Annuity Trusts (“GRATs”) In the Current 2020 Environment

Introduction to GRATs

Grantor retained annuity trusts (“GRATs”)vii have been a popular planning tool. In the current planning environment, GRATs may be a powerful planning tool for three primary reasons:

• Suppressed asset values due to a volatile and uncertain economic

environment. Funding a GRAT when asset values are low but may

rise significantly in future years shifts all the appreciation above the

applicable Section 7520 rate outside the grantor’s gross estate for

federal estate tax purposes, unless, perhaps, the grantor dies during

the retained annuity term). For example, assuming the grantor

survives the annuity term and if the GRAT is funded with $1 million

and the taxable remainder is valued at only $1,000, any remainder

passing to the successor beneficiaries in excess of $1,000 results in

a gift tax free transfer.

• Interest rates, used to value interests in GRATS, are at historic lows

(the Section 7520 rate for April 2020 was 1.2% and has dropped to

0.4% for October 2020 and .58% for December 2020). For

comparison, in 1989, the Code Section 7520 hurdle interest rate was

at a high of nearly 12 percent. In March of 2009, it was almost 3

percent. GRATs are a technique that shines brightest when lower

interest rates are in effect, all other things being equal. Simply put:

the lower the interest rate the lower the annuity payment that has to

be made periodically back to the grantor to minimize the taxable gift

made with funding a GRAT, and hence the greater the potential for

value to be shifted outside the estate. Going back to the above

example, if the Section 7520 was 1.2%, any growth and income

above that rate passes gift tax free to the successor beneficiaries

(assuming the grantor survives the term of the GRAT).

• The federal bailouts may eventually require that taxes be raised.

While no one can forecast what tax law changes may occur, it seems

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logical that estate taxes will increase, perhaps, markedly so.

Therefore, shifting assets out of an estate using current favorable

laws, such as by using GRATs, may prove very advantageous.

However, while the current environment may be the so–called “perfect storm” for GRAT planning, practitioners need to be aware of a number of nuances to this planning. In many instances, it will not be GRAT planning as usual. This newsletter will explore some of the differences in how practitioners may choose to plan for GRATs in the current environment.

Only Use GRATs for Appropriate Situations

GRATs may not the most effective tool for clients who have remaining gift and GST exemption. The current exemption of $11.58 million is the highest in history and may well be reduced, perhaps substantially, by future legislation and is slated under current law to be halved effective 2026 (if Congress does nothing before then). Thus, clients with remaining exemption might be well served to consider gifts to GST exempt trusts, and other planning techniques that use exemption, before focusing on GRATs. GRATs are a not a technique that secures remaining GST exemption. The ETIP rules generally prevent allocation of GST exemption until after the GRAT ends (i.e., will no longer be included in the grantor’s estate). At the end of the GRAT the GRAT assets would be anticipated to have appreciated making that later allocation inefficient. Further, if the tax laws change and exemptions are reduced there may be no GST exemption remaining to allocate. viii. In an attempt to avoid ETIP limitation imposed on GST planning for GRATs, some suggest that sometime after a GRAT is funded an old and cold GST exempt trust purchase the remainder from the GRAT to thereby shift future appreciation into a GST exemption solution. However, at the present time the IRS has indicated it will not respect such a purchase of the remainder in a GRAT to provide GST exemption. Nonetheless, it remains important to consider GST planning implications when determining whether to use a GRAT in the current environment in contrast other planning techniques.

Overview of the GRAT Technique

The common application of the GRAT technique has been to structure a short-term, typically a two-year GRAT, designed to capture upside market

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volatility. The annuity paid to the grantor is generally set high enough so that the GRAT has a nominal value for gift tax purposes--a so-called “post-Walton zeroed out” GRAT. There are different perspectives on whether or not to use a zeroed out GRAT. Some practitioners think that it is perfectly acceptable while others prefer to structure the GRAT so there’s a very modest initial gift value that can appropriately be reported on a United States Gift Tax Return (Form 709).ix In any case, it may be possible to draft for a minimum gift value. The result of this traditional GRAT approach is that a substantial portion of the assets of the GRAT (principal plus the Section 7520 mandated return) would be paid back to the grantor. Market returns above the mandated federal interest rate would inure to the benefit of the grantor’s “heirs” (or a trust for their benefit). This could result in the client “re-GRAT-ing” the large annuity distributions received in each year from the GRAT to a new GRAT. In other words, if a million-dollar GRAT were created, the first one-year annuity payment (of, perhaps, $500,000+) would be paid back to the client as the grantor, who could then gift that payment into a new GRAT. This is why the technique of using repetitive short-term GRATs has been referred to as “rolling” or “cascading” GRATs. The concept of re-GRAT-ing each year’s distribution to a new GRAT has been a common part of the GRAT technique. However, it has two important implications to GRAT planning in the existing environment. As the GRAT assets are repaid to the grantor, in the form of periodic required annuity payments, he or she might continue the plan by re-GRAT-ing the assets received as the annuity payment into new GRATs. The implications to how one might choose to structure these new GRATs is discussed below and this may be different than the historical application of the GRAT technique. While the risk of a grantor not outliving the term of a GRAT exists (in which case some or all of the assets will be included in the grantor’s estate), it may be important to be mindful that certain tax proposals might eliminate the viability of the GRAT technique by requiring a minimum 10-year term for any GRATs created after enactment of such proposals. This could dramatically decrease the risk of a GRAT succeeding. There is also a proposal which would require a minimum gift amount of at least 25% of the value of the assets contributed to the trust, effectively removing the ability to have a zeroed out GRAT and likely retard the successful use of many

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GRATs. These two changes could potentially make GRATs impractical for taxpayers who have traditionally used GRATs because they no longer had gift tax exemption remaining. It would also seem to restrict the commonly used “rolling-GRATs” technique. These proposals are not new. President Obama’s Greenbooks included proposals to restrict GRATs by requiring a minimum 10-year term for GRATs that would have eliminated short term rolling GRATs. Regardless of who controls the Senate, any tax proposals may include one that restricts GRATs in this way. Thus, when structuring new GRATs, in the current environment, consider the potential implications that the elimination or severe restriction of the GRAT technique could have on the ability to roll or cascade a GRAT set up today when annuity payments are paid out in the future.

Some Thoughts on Rolling/Cascading GRATs

As mentioned above, a common GRAT technique has been the use of short-term rolling or cascading GRATs which are intended to capture upside market volatility. The historical mathematical superiority of short-term rolling GRATs over a single long-term GRAT has been documented. However, in the current environment there are a few additional points to consider:

• What is the likelihood of the next administration making the estate tax rules tougher? Might GRATs be eliminated? Or might a required minimum 10-year term and a specified 25% minimum gift value on GRAT funding be enacted? As discussed earlier, either of these restrictions would have a chilling effect on post-enactment GRAT plans and effectively undermine the assumptions of rolling GRATs for currently funded GRATs, if the successor GRATs are so fundamentally altered. If the next administration wants to raise revenues on the wealthy, or if there really is no choice in order to fund the very large bailouts during the coronavirus crisis, the availability of GRATs as an effective planning technique may disappear. Note also that restrictions on GRATs could be coupled with the elimination of discounts on related party transactions and/or elimination or restriction on so-called Crummey powers (which are used to allow

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gift tax annual exclusions for transfers to trust), etc. The result may be a substantial enhancement of estate tax revenues.

• If a rolling GRAT plan is being funded with discounted interests in a family or other closely held business, what impact might a legislative repeal or restriction on such discounts have on the plan? Short-term GRATs require high payouts to minimize or eliminate gift tax. That may mean that a significant portion of the equity in the family business may be repaid to the grantor in the form of GRAT annuity payments. If so, when the grantor wishes to re-GRAT, the assets may not, at that future date, qualify for discounts. Therefore, it may be advisable to lock in the discounts by using a longer term GRAT now (i.e., not the traditional two-year GRAT term). Query, if discounts are eliminated by future legislation might that permit the payment of annuity amounts in kind (e.g. stock in a closely held business held in the GRAT), valued without discounts even though discounts applied to the valuation of the interests when gifted to the GRAT?

• What about creating a long-term GRAT, instead of a series of short-term GRATs, on account of the possibility that Congress may restrict GRATs? Although many have demonstrated the superiority of short-term GRATs compared to longer-term GRATs, the assumption underlying those findings was that the short-term GRAT would be one in a series. Short term GRATs may not be allowed in the future.

The more granular you make the GRAT, the more likely to capture upward market swings. Creating several GRATs, each funded with one sector of the market, is more likely to result in at least one of the GRATs exceeding the annuity payment assumptions than one GRAT funded with all sectors of a market. The reason is that with one GRAT good performance in one sector will be offset by negative performance in another. But each GRAT funded with its own sector of the market can stand alone without erosion by other sectors.

GRAT Immunization

GRAT immunization refers to the process of substituting a nonvolatile asset (such as cash) for the assets inside the GRAT. So, if the GRAT holds Zoom stock which appreciates dramatically the grantor could swap in cash and swap out an equivalent value of Zoom stock. The rationale for this is

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that if the GRAT, whatever the term, realizes a significant uptick in value, the client may want to lock in that uptick by substituting less volatile assets. The application of this technique is discussed in the section that follows.

GRAT Immunization May Have to Change with 2020 Longer Term

GRATs

The preceding factors do not change the fact that use of short-term rolling GRATs is a better strategy when they work. But what happens if that strategy isn’t given a sufficient duration to succeed because the GRAT rules are changed by new legislation. Perhaps, a safer long-term strategy might be to create a series of longer-term GRATs. If the GRAT technique is repealed, GRATs that have been executed and funded might be grandfathered from these adverse changes. But with longer-term GRATs, the traditional approach of immunization using cash or Treasury bills won’t make economic sense. The reason is that swapping cash or treasuries into a two-year GRAT, and typically after some time is already run on that GRAT term, may leave significant wealth unproductive for a long period of time. By opting into, for example, a ladder of six, eight and 10-year GRATs, the GRAT arrangements will be locked in for a longer time. In case future legislation restricts or eliminates short term GRATs, immunization has to be looked at differently. If in the second year of a 10-year GRAT there is a spike is the stock market, immunization may make sense but, in contrast to a two-year GRAT that may have mere months to run, this six, eight or ten-year GRAT may have five or more years left to run. Holding assets idle in cash or treasuries for that long a period of time is not likely to be desirable. Thus, a more sophisticated investment technique may have to be implemented in order to immunize longer-term GRATs.

Example: A client establishes a series of ten $1 million ten-year term GRATs, each for a different asset class. One of the 10-year GRATs experiences a substantial gain in year one, doubling in value. Under the historical rolling GRAT paradigm, this would have been a 2-year GRAT, not a 10-year GRAT. The client likely would have been advised to substitute Treasury bills for the $2 million in the GRAT, thus locking in the large gain. This strategy will not be acceptable in a 10-year GRAT unless the client retains Treasury bills for the nine remaining years. However, a 2-year GRAT will not work either if GRATs

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are restricted next year by new legislation, or if it takes 3 or more years for that asset class to recover from the current coronavirus recession. Instead, while historically less advantageous, the 10-year (or some other term longer than the traditional 2-year) GRAT might prove the only practical effective technique. There are several approaches to consider. One might be to substitute a diversified portfolio with a nine-year time horizon for the $2 million appreciated GRAT property. Although clearly not as secure as locking in the gain with Treasury bills on a 2-year GRAT with 1 year remaining, it will be more secure for purposes of retaining that gain than, perhaps, the ten year-long term overall asset allocation of assets comprised of a heavily weighted sector. Assume that the client generally has a 20+ year investment horizon and an overall asset allocation consisting of 60 percent equities, 25 percent bonds, and 15 percent alternatives. Perhaps, the nine-year remaining GRAT might be given, as substitute property, a more conservative allocation designed to minimize downside risk of giving up the $1 million initial gain, but still consider the long 9-year time horizon and the need for growth inside the GRAT. The client’s wealth manager might recommend a 40 percent equity, 45 percent bond, and 15 percent alternative strategy. Perhaps, option techniques can be used to hedge the downside risk in the highly successful GRAT while leaving some upside potential for growth in light of the nine years remaining. Although that strategy will come at a cost that will reduce the upside, it can, perhaps, be viewed as insurance on preserving the large gain in the early years of a long term GRAT.

Long-term GRATs are not as efficient as a series of short-term GRATs can be. However, the budget deficit that the next administration will have to address, the uncertainty of whether GRATs will survive, and the unknown timing of market improvements make them worth reconsideration.

Very Long Term GRAT

A concept that has been discussed for a number of years is often called a “99 – year GRAT.” This technique is really an interest arbitrage and it is a technique whose time may have come. Many practitioners are under the misconception that if the grantor dies during the term of a GRAT the entire

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GRAT principle will be included in the taxable estate. That is not correct. Rather, to determine what portion of a GRAT’s assets are included in the grantor’s estate one must take the required annuity payment and divide it by the Section 7520 rate at the date of the grantor’s death. If the AFR interest rates are higher at the date of death less than the full value of the GRAT may be included in the grantor’s estate if he or she dies during the GRAT term. With interest rate at historic lows, it may be a reasonable bet to assume that interest rates will be higher, perhaps substantially higher at the date of death. So, for clients that have used all of their estate and gift tax exemption a bet now that asset values will grow substantially and interest rates will be much higher at the grantor’s death may make a 99-year GRAT a valuable planning tool. If the Section 7520 rate rises before the grantor dies, he or she could sell the remaining annuity payment before death and exclude a significant part of the trust’s value from his or her estate.

Conclusion Practitioners need to be alert to possible broad changes to the wealth transfer laws and factor them into any planning that might still be completed before the end of the year. The plunging economy and rising deficit may force federal and state governments to consider additional tax legislation, making it all the more possible that legislative changes imposed after the new year could reduce the efficacy of planning using so-called “freeze” techniques like zeroed-out grantor retained annuity trusts. The late 2020 planning environment and potential for massive tax changes is unpredictable but yet vital for many clients to consider, even those who have already done extensive planning and possibly used up most of their lifetime exemption amounts. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Joy Matak

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Sandra Glazier

Martin Shenkman

CITE AS:

LISI Estate Planning Newsletter #2842 (December 7, 2020) at http://www.leimbergservices.com Copyright 2020 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITATIONS:

i This newsletter is an adaption of a portion of a paper submitted to the Notre Dame Tax and Estate Planning Institute, which was an adaption of Martin M. Shenkman, Jonathan G. Blattmachr, Joy Matak, & Sandra D. Glazier, Steve Leimberg's Estate Planning Newsletter #2745 03-Sep-19, “Estate and Tax Planning Roadmap for 2019-2020.”

ii FNMA v. Commissioner, 896 F. 2d 580, 586 (D.C. 1990), cert. denied, 499 U.S. 974 (1991) (citing Kanawha Gas & Utilities Co. v. United States, 214 F.2d 685, 691 (5th Cir. 1954).

iii Some of the potential issues that might arise based upon the maker’s failure to repay the loan according to the terms of the Note or as a result of insolvency are discussed in Estate of Mary P. Bolles v. Commissioner: Loan, Gift and/or Advancement, by Sandra D. Glazier, Estate Planning Newsletter #2814 (August 11, 2020).

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iv Acknowledgement to Bernard Krooks, Esq. for this caution.

v The exemption is scheduled to increase to $11.7 million as of January 1, 2021, if congress does nothing to modify the same. Additionally, should congress do nothing between now and December 31, 2025, the exemption is set to automatically reduce to $5 Million, adjusted for inflation, on January 1, 2026.

vi Some discussion of the implications of withdrawal vs. waiver vs. lapses of such Crummey powers was address in Part 2 of this series of newsletters.

vii Adapted from “Shenkman & Blattmachr, “Using Grantor Retained Annuity Trusts In The Current Environment,” ActionLine 38 (Florida Bar Association), Summer 2020. Acknowledgements to Jonathan Blattmachr for several of the ideas discussed in this section.

viii Section 2642(f). There are some who have suggested that GST exemption might be allocable to the remainder in a GRAT by selling it to a GST exempt trust. See David A. Handler and Steven J. Oshins, The GRAT Remainder Sale, Trusts & Estates (December 2002).

ix Because these matters are uncertain, some commentators suggest word formula safeguards. See, e.g., Blattmachr & Zeydel, “Comparing GRATs and Installment Sales”, 41st Annual Heckerling Institute on Estate Planning (2007).

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http://leimbergservices.com/openfile.cfm?filename=c:/inetpub/wwwroot/all/lis_notw_2841.html&fn=lis_notw_2841

Subject: Joy Matak, Sandra D. Glazier & Martin M. Shenkman - Estate Planning Six-Part Series for Late 2020, Part 4: Enhanced Techniques for Note Sales

“2020 is grinding to a close with uncertain federal elections pending the Georgia Senate runoff races, and experts warning that a new COVID wave could cause more economic disruption for the United States in the coming months until a vaccine is widely disseminated. Regardless of the outcome of the runoff elections, rising deficits may force federal and state governments to consider additional tax legislation and ultra-high-net worth (‘UHNW’) clients may be well advised to continue to pursue active estate tax minimization planning in the current environment.

While significant attention has been given to guiding clients to use the large temporary exemptions before they may be reduced or otherwise expire, this represents only part of the tax risks present in the current environment. Democratic proposals have included a host of possible restrictions that could adversely affect planning for those UHNW clients for whom using exemption is not sufficient:

• Discounts may be reduced or eliminated.

• Assets in grantor trusts could be held to be includable in the grantor’sestate.

• A tax may be assessed periodically against dynastic trusts.

• GRATs may be so restricted as to become of limited, if any, use.

• And more.

Consequently, late 2020 planning may require much more than planning for exemption amounts. If discounts are eliminated, multi-generational planning adversely affected, the effectiveness of rolling GRAT planning impaired or other changes implemented (e.g. elimination of basis step-up), UHNW clients may be well served by completing wealth transfers in the waning days of 2020.


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Even in the midst of all of this turmoil, consider the contrast: late 2020 may be the ‘best it will ever be’ for planning clients, particularly those who want to freeze assets using a sale to an intentionally defective grantor trust; lifetime exemptions are high, discounts are permissible, grantor trusts are viable, and perhaps dynastic trusts may be grandfathered and escape a periodic assessment of GST tax. This could all be especially true if legislative changes reduce the efficacy of future planning by dropping the exemption or curtailing valuation discounts.

If one or more manner or type of note sale transactions appear warranted, practitioners may not wish to limit the discussion of available planning options so that the client can make an informed decision that appears to best suit their desires and needs. Additional installments of this series will follow and explore other opportunities for planning before year-end.”

Joy Matak, JD, LLM, Sandra D. Glazier, Esq. and Martin M. Shenkman, Esq. provide members with important and timely commentary in the form of a six-part series, Part 4 of which is a discussion of enhanced techniques for note sales.i

Joy Matak, JD, LLM is a Partner at Sax and Head of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. Joy provides clients with wealth transfer strategy planning to accomplish estate and business succession goals. She also performs tax compliance including gift tax, estate tax, and income tax returns for trusts and estates as well as consulting services related to generation skipping including transfer tax planning, asset protection, life insurance structuring, and post-mortem planning. Joy presents at numerous events on topics relevant to wealth transfer strategists including engagements for the ABA Real Property, Trust and Estate Law Section; Wealth Management Magazine; the Estate Planning Council of Northern New Jersey; and the Society of Financial Service Professionals. Joy has authored and co-authored articles for the Tax Management Estates, Gifts and Trusts (BNA) Journal; Leimberg Information Services, Inc. (LISI); and Estate Planning Review The CCH Journal, among others, on a variety of topics including wealth transfer

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strategies, income taxation of trusts and estates, and business succession planning. Joy recently co-authored a book on the new tax reform law entitled Estate Planning: Estate, Tax and Other Planning after the Tax Cuts and Jobs Act of 2017.

Sandra D. Glazier, Esq., is an equity shareholder at Lipson Neilson, P.C., in its Bloomfield Hills, MI office. She was also the 2019 recipient ofBloomberg Tax’s Estates, Gifts and Trusts Tax Contributor of the YearAward and Trusts & Estates Magazines Authors Thought LeadershipAward and has been awarded an AEP designation by the NationalAssociation of Estate Planners and Councils. Sandra concentrates herpractice in the areas of estate planning and administration, probatelitigation and family law.

Martin M. Shenkman, CPA, MBA, PFS, AEP, JD is an attorney in private practice in Fort Lee, New Jersey and New York City who concentrates on estate and closely held business planning, tax planning, and estate administration. He is the author of 42 books and more than 1,200 articles. He is a member of the NAEPC Board of Directors (Emeritus), on the Board of the American Brain Foundation, the American Cancer Society’s National Professional Advisor Network and Weill Cornell Medicine Professional Advisory Council.


COMMENT:

Note Sale Modifications Because Limited Time Exists Before Year End

Given how late it is in the year, practitioners may have to select options and steps that will facilitate completing the note sale in 2020. These might include:

1. Obtaining a figure from an appraiser for the value while waiting until2021 for the actual report.

2. It may not even be possible to obtain a figure from an appraiser intime to complete a transaction if an appraiser was not hired sometime ago. Does that mean that planning may be prevented if avaluation cannot be obtained? Perhaps, but it may be worth exploring

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with the client the possibility of using a two-tiered valuation adjustment mechanism. Example: The client had an appraisal done about 18 months ago. That value is clearly stale and there is not sufficient time before year end to have the appraiser provide an updated value. What if the equity interests were sold to a grantor trust for a King-type price adjustment note with two tiers of adjustments? The second and common adjustment in a King-type note would be to adjust the face value of the note to equal the gift tax value as finally determined. But what if a first tier of adjustment were added as well. The first tier recites that the current valuation was estimated based on an adjustment to the stale appraisal and that an independent appraiser has been hired and when that report is received the face value of the note will be adjusted retroactively to the 2020 sale date to reflect that data. Might this be a means to complete a transaction before year end?

3. The mechanism used for a valuation adjustment might have to be dictated by the limited time period remaining in 2020, with the client being informed of the potential risks. Example: The practitioner’s preferred valuation adjustment mechanism is to use a spill over to a nearly zeroed out GRAT. However, the practitioner may believe that there is insufficient time to complete and fund a GRAT and craft the spill over with a GRAT before year end. So instead a Wandry adjustment mechanism is used as it does not require the creation of a new GRAT and can be effectuated with the provisions in the assignment reflecting a fixed value of interests and not a stated number of shares, etc.

4. Entity documentation and various administrative steps may be deferred until 2021 to facilitate expediting the transaction. Example: Interests in a family FLP are to be assigned. A gift (or sale) assignment is completed. While the practitioner would normally also prepare an amended and restated limited partnership agreement, might documenting the amendment be deferred until 2021?

Can A Note Sale Transaction Be Enhanced? Practitioners might explore opportunities to refine and improve note sales transactions, with some of the considerations outlined in this fourth installment of this 2020 planning series:

1. Using Sales to Extend GST Exemption to Assets not Already Exempt.

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2. Consider “Stepped” or Deferred Interest to Facilitate a Larger Sale than Current Cash Flow May Permit.

3. Differentiate Collateral on Note Sale to Possibly Defeat IRS Challenges of a Retained Interest on a Note Sale.

4. Defined Value Mechanisms Might be Enhanced and Modified for New Planning.

5. Divide a QTIP to Possibly Contain the Risk of a 2519 Challenge before a Distribution or Sale Transaction.

Using Sales to Extend GST Exemption to Assets not Already Exempt Practitioners might consider opportunities to extend Generation Skipping Transfer Tax exemption (“GST exemption”) to trusts that are not now exempt (a “non-GST Exempt trust”). From the outset, we note that, as the lifetime exemptions from gift and estate tax rose so did the GST exemption. A taxpayer may make a late allocation up to her remaining GST exemption after all other transfers are taken into account. However, if the taxpayer’s remaining GST exemption is insufficient to cover the value of the assets in a non-GST Exempt trust, a practitioner may consider another alternative: selling those assets to an existing “old and cold” GST Exempt trust. What if such a trust does not exist? Also, what if the assets are held in the non-GST Exempt trust (e.g. a QTIP formed on the death of the first spouse who had used all GST exemption during his or her lifetime). Is there still a possible planning approach to help shift growth out of that non-GST Exempt trust into a GST Exempt trust? A family member of the client may create a new irrevocable trust that is a so-called Section 678 grantor trust as to the existing non-GST Exempt trust, funding that new trust using a portion of her current gift and GST exemptions. If the old and the new trusts are both grantor trusts, then the old non-GST Exempt trust might sell assets to the 678 trust in a note sale transaction, thereby freezing the value in the non-GST Exempt trust. Consider “Stepped” or Deferred Interest to Facilitate a Larger Sale than Current Cash Flow May Permit

Example: If Covid has temporarily depressed cash flow from a business interest being sold, perhaps this technique can facilitate completing a sale now.

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Assume a client is going to engage in a note sale (that is, an installment sale) to a grantor dynasty trust (which some call an Intentionally Defective Irrevocable Grantor Trust or “IDIGT,” although the result will be the same even if the trust is not intentionally made to be a grantor trust).ii But what if the entity whose interests are being sold has current cash flow needs for business research and development? In such a situation, distributions might be difficult and/or limited for several years. Might the purchasing trust backload (defer) the interest that accrues under the term of the note? If this were done during the first X years of the note, the purchaser might pay interest every year at a rate of say 1%. The remaining and unpaid 2% interest (assuming a 3% applicable federal rate (“AFR”)) will accrue and compound at the same 3% AFR rate until it is paid. Thus, the note will have negative amortization during the first X years of its term. After the first X years, the purchasing trust would then pay the full interest that accrues every year on a current basis (or if advisable from a cash flow perspective another “step” in rate could be used). During the remaining term of the note, the purchaser will also pay the compounded shortfalls in interest payments that arose during the first X years of the note. If the purchasing trust will not have sufficient cash flow to currently pay all the interest that would have normally accrued during the first X years of the note, it might be argued that the purchasing trust could be characterized as “thinly capitalized.” Therefore, it’s advisable for practitioners considering such a note structure to confirm and corroborate that thin capitalization does not undermine the validity of the debt itself and hence the transaction. It may be important to avoid transactions that might create an issue as to whether the note will be respected as debt or whether it could instead be characterized as equity. The issue of the trust not being “thinly capitalized” will generally depend on the balance sheet of the trust at the time of the transaction reflecting the then current appraised value of assets owned by the purchasing trust. The delayed payment during the first X years of the note of the interest that accrues generally should not by itself cause the note that the purchaser gives to the seller to be re-characterized (e.g. as an invalid indebtedness, a gift, as equity instead of debt, etc.). It does not appear that using variable interest by itself will undermine the validity of a note. If a loan requires payments of interest calculated at a rate

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of interest based in whole or in part on an objective index or combination of indices of market interest rates (e.g., a prime rate, the applicable federal rate, the average yield on government securities as reflected in the weekly Treasury bill rate, the Treasury constant maturity series, or LIBOR (London interbank offered rate)), the loan will be treated as having sufficiently stated interest if the rate fixed by the index is no lower than the applicable federal rate (1) on the date the loan is made, in the case of a term loan, and (2) for each semiannual period that the loan is outstanding, in the case of a demand loan. For term loans determining the AFR is simply arrived at by applying the interest rate that is equal to the AFR with the same compounding period for the month in which the loan is made. For sale transactions the appropriate AFR is based not on the term of the note, but on its weighted average maturity. Section 7872, which created new rules for the tax treatment of loans with below-market interest rates, went into effect on June 6, 1984. The scope of this code section and its application for gift tax purposes were addressed in Frazee.iii The Tax Court determined that the Section 7872 AFR, and not the Section 483(e) 6% interest rate, was controlling for gift tax valuation purposes. Accordingly, because the intra-family sale of real property in Frazee was not a bona fide arm's-length transaction free of donative intent, the court held that the excess of the face amount of a note bearing 7% interest over its recomputed present value, using the AFR for long-term loans, constituted a gift of interest. Section 7872 applies to any transaction that (1) is a bona fide loan, (2) is below market, (3) falls within one of four categories of below-market loans, and (4) does not qualify for one of several exceptions. The four categories are loans (1) from a donor to a donee, (2) from an employer to an employee, (3) from a corporation to a shareholder, and (4) with interest arrangements made for tax avoidance purposes.iv The below-market-rate demand loan is a two-step transaction:

• The lender is treated as having transferred on the last day of the calendar year an amount equal to the forgone interest (the prevailing federal rate of interest less the loan's actual interest rate) to the borrower; and

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• The borrower/trust is then treated as transferring that amount back to the lender as imputed interest.

What if the loan provides adequate interest so that it is not a below-market loan? There is no forgone interest to report under Section 7872. But if the note provides for the interest to accrue and is not paid, the original issue discount (“OID”) rules will apply. The OID rules do not apply merely because interest that is to be paid currently is not paid. They only apply where there is accrual/deferral by the terms of the note. The OID rules would have the taxpayer report a pro rata amount of the overall amount of the OID over the life of the loan using a constant yield method under the Regulations for Section 1272. On a sale to a grantor trust the OID complications appear to be obviated at least until grantor trust status terminates. So, while these rules should apply, they should have no income tax significance while grantor trust status is retained. Different variations may be crafted based upon the needs of the parties. Perhaps:

• Interest may be accrued rather than paid during the term of note.

• Pay interest that cannot be paid in cash by issuing a note from the borrower/trust for any unpaid interest. There does not seem to be any consistency in views as to whether this will make the note more problematic to support on audit. One view is that there is nothing prohibiting paying a note interest payment in-kind, e.g. with another note. The opposing view is that this might make the transaction appear uneconomic in contrast to “baking in” the cash flow considerations from inception, e.g. with a stepped note.

Be Mindful of Hart Scott Rodino Act Requirements It’s important to be mindful that large estate planning transactions may trigger reporting requirements under the Hart-Scott-Rodino Antitrust Improvements Act (“HSR”).v HSR imposes an obligation to file a premerger notification report form with the Premerger Notification Office of the Federal Trade Commission (“FTC”). This may all be counter-intuitive since a sale of interests in a closely-held or family business to a trust created by the family can hardly be viewed as negatively impacting competition, but, meeting the

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filing requirements, or finding an exemption, may be necessary to avoid potentially onerous penalty provisions. Acquisitions resulting from a gift, intestate succession, testamentary disposition or transfer by a grantor to an irrevocable trust may be exempt from the filing or other requirements of HSR.vi However, the conclusion may not be simple or assured and practitioners should consider consulting with an expert in these matters. There could be an impact on the HSR determination based on trustee and trust protector provisions included in the trust instrument, and, specifically, who has the ability to remove and replace trustees. Differentiate Collateral on Note Sale to Possibly Defeat IRS Challenges of a Retained Interest on a Note Sale When selling assets to an existing irrevocable trust that was created to meet prior planning goals, consider using assets other than the assets being sold in the current transaction as collateral.

Example: ABC, LLC interests were sold to a trust years ago and that transaction has been completed and any note repaid. Now, the taxpayer is contemplating selling XYZ, LLC interests to the same trust. Instead of using XYZ, LLC interests as collateral on the note the trust now gives the selling taxpayer, what if instead ABC, LLC interests are used as collateral for the note? Might that reduce the potential strings attached to the asset sold that the IRS might otherwise use to argue for estate tax inclusion?

What if a guarantee is used and the terms require that the seller/lender/donor must first proceed against the guarantor before proceeding against the collateral? While unconventional, might that create more distance from the asset sold if there is no collateral in the trust other than the original asset? How would the guarantee fee have to be adjusted to reflect this increased risk? Since the guarantor would be first “in line” before the collateral, the fee to be charged would have to be greater than in a traditional guarantee arrangement. In such instances, it might be prudent to have an independent appraiser evaluate what a fair guarantee fee might be for the transaction.

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Defined Value Mechanisms Might be Enhanced and Modified for New Planning Can the potential gift tax risk of a large transaction be minimized? While large transactions often include mechanisms to minimize current gift tax risk, there seems to be some disagreement (or perhaps just many different opinions) in the planning community about how to structure such arrangements than might be expected. For UHNW clients pursing current large dollar planning, using some variation of these mechanism may warrant consideration. Some transactions are structured using some application of one of the key defined value cases.vii These types of mechanisms are based on the entirety of an intended defined value being transferred away from the transferor. However, if there is an excess value over what the buyer in the transaction is paying as a result of an IRS audit adjustment, that excess value could be poured into a non-taxable receptacle. This non-taxable receptacle could be a charity (but, be cautious if a private foundation is used since this may not be a feasible mechanism), a grantor retained annuity trust (“GRAT”), marital trust (other than a “QTIP” which requires the election to be made on the gift tax return by the due date for the year the gift was deemed to have been made), or an incomplete gift trust. However, as with many aspects of planning, there is little agreement amongst practitioners as to which spillover or structure is best. Therefore it is important to analyze and weigh the options when evaluating UHNW transfer planning. While the law is not new in this area, there are new perspectives, and planning structures, some of which the following discussions endeavor to present. A complete discussion of already established law will not be provided. Nelsonviii Makes Clear that Words Matter in Defined Value Clauses While the Tax Court in Wandry upheld a defined value mechanism based on the specific wording of the clause in the assignment documents, the IRS appealed the decision and ultimately issued a statement that the commissioner did not acquiesce to the Court’s conclusion. The Service has made its intention to contest Wandry, especially if taxpayers deviate in any way from the specific language upheld by the Tax Court. In Nelson, the taxpayer used a defined value clause described by the Tax Court as follows:

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… [The gift was] expressed in the memorandum of gift as a ‘limited partner interest having a fair market value of TWO MILLION NINETY-SIX THOUSAND AND NO/100THS DOLLARS ($2,096,000.00) as of December 31, 2008 *** , as determined by a qualified appraiser within ninety (90) days of the effective date of this Assignment.’ Similarly, the sale [was] expressed in the memorandum of sale as a ‘limited partner interest having a fair market value of TWENTY MILLION AND NO/100THS DOLLARS ($20,000,000.00) as of January 2, 2009 *** , as determined by a qualified appraiser within one hundred eighty (180) days of the effective date of this Assignment.’ix

The Tax Court was particularly swayed by the argument that the clauses were dependent upon an appraisal within a fixed period of time rather than “as that determined for Federal estate tax purposes.”x As a result, the Court concluded that the defined value clause did not operate to allow for an adjustment of the value transferred once the IRS revalued the transferred property. Rather, the percentage limited partner interests became fixed upon receipt of the qualified appraiser’s report within the time prescribed by the relevant clause. Therefore, it’s important to take note of this recent clarification in the law of defined value mechanisms when drafting clauses in the future. Is Wandryxi King? What Type of Price Adjustment Mechanism Might You Use? The King case might provide a planning option to consider.xii King upheld the use of a price adjustment clause.

Example: Simplifying this might be as follows: “Taxpayer hereby transfers $100 worth of stock to XYZ trust for a note. If the value of the stock is finally determined for gift tax purposes to be greater than $100 the face amount of the note shall be adjusted accordingly.” Some practitioners report what they describe as favorable results on audits using this approach.

Other practitioners are less optimistic and are simply not comfortable with a King type approach. Some object to King based on the structure of the adjustment. For example, might the adjustment of the note be viewed as an impermissible condition subsequent under a Procter xiii analysis? On the

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other hand, some view King as an “outlier” not to be relied upon because it is only a 10th Circuit case. The Ward case rained a bit on the King parade according to some views.xiv A variation of a traditional King type approach might be for the note’s face value to be defined as being the gift tax value as finally determined.xv Does this negate a challenge under Procter? In any case, the federal district court distinguished King from Procter because the court found that the sale transaction was made in the ordinary course of business, at arm’s length and free from any donative intent, which under Reg. 25.2512-8 meant there was no gift. That may be a difficult business standard to sustain in some family transactions. Wandry might present another option to consider as part of the efforts to minimize gift tax.xvi In the Wandry case, the tax court upheld an approach that relied on the transfer of a fixed value of assets to a trust rather than a specified portion of equity.

Example: Simplifying this might be as follows: “Taxpayer hereby transfers $100 worth of stock to XYZ trust.” While many practitioners prefer a Wandry approach over a King approach, the IRS has non-acquiesced to the Wandry decision.xvii Thus, in a “traditional” Wandry clause the taxpayer may transfer a fixed dollar amount of shares only (that is, “I hereby transfer $100 worth of stock in XYZ”). Another variation of a Wandry approach is for the beneficiaries to execute a disclaimer of any value in excess of the specified value. The concept behind this approach is that this would make it difficult for the IRS to argue more was transferred if the recipient trust is prohibited by the disclaimer from accepting the incremental value.xviii xix

Consider a Two-Tiered Wandry Approach to Deflect a Powell Challenge If the premise for much of the late-year 2020 planning is that the laws may all change retroactively to January 1, 2021 then consummating all possible transfers in 2020 might be a goal to pursue. If that is the case, then the application of the traditional Wandry price adjustment mechanism may not suffice. That is because a successful Wandry price adjustment mechanism could result in the client having retained (never gifted or sold) the value of the asset above the gift tax value as finally determined. In late 2020 that could be more problematic than in perhaps any other year. After all, if as of January 1, 2021 discounts are eliminated, transfers to grantor trusts are

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included in the grantor’s estate, etc. it could prove very difficult to shift that retained value outside the grantor’s estate after 2020. Perhaps a two-tier Wandry approach might provide a solution to this unique 2020 planning dilemma. There are certain circumstances when a client may need to transfer all of the equity in a closely held business. By way of example, the transferor may have an income tax or contractual reason to transfer all equity. On these occasions, it may not be feasible to use a traditional Wandry clause that could result in some part of the equity being returned to the transferor. One problem with a Wandry clause is that it could leave shares in the selling taxpayer or trust’s hands, which may not be desirable for business or personal reasons. As explained above, this might be particularly undesirable in 2020. This could create uncertainty with respect to the trust’s ESBT status if all S corporation shares are sold but the operation of a Wandry clause causes shares to remain in the trust. For example, does the ESBT election end when all shares are sold? If so, what occurs when it is later determined that S corporation shares are retained in the selling trust? The solution, in some circumstances, may be a “two-tiered Wandry” arrangement which consists of a traditional Wandry transfer followed by the simultaneous sale of any shares (or other assets) left by the Wandry adjustment clause if the clause is triggered. In other words, the transferor makes a gift of a specified value of the shares of the entity, believing that all of the transferor’s interest in the entity is equal to the value being transferred. In the event that the shares are re-valued on audit (such that the value that the transferor sought to transfer does not cover all of the shares), the transferor will have sold shares that exceed the intended gift value. The second tier of the Wandry arrangement could consist of a second sale of any shares that remain by operation of the Wandry arrangement in the selling taxpayer or trust’s hands, effective as of the same date as the primary Wandry sale. The price for this second sale, if any, would be equal to the gift tax value as finally determined. The sale could be supported by a note upon which interest accrues from closing and is required to be made current within a specified time period, e.g., 90-days of the final determination. If feasible, it might be better for a transferor to use grantor trusts for these types of transactions. Otherwise, if the Wandry clause is triggered, the

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transferor could incur an income tax – and possibly interest and penalties – for a sale transaction deemed to have occurred on the date when the original gift was made. However, in some instances, if shares are held by a non-grantor trust there may be no viable option for avoiding income tax on the transaction (e.g. a non-grantor trust that is not GST exempt is the transferor). Further, to the extent that the asset being sold consists of S corporation shares, a non-grantor trust may not be a valid shareholder (absent an ESBT or QSST electionxx), which could potentially challenge the entity’s status as an S corporation.

Example: On August 1, 2020, Jack transfers shares in his S corporation with an aggregate fair market value of $1 million to the Jack Family Trust, which is a valid S corporation shareholder (it is either an ESBT, QSST, or grantor trust). Jack believes that he has transferred all of his S corporation shares but, if it turns out that the aggregate value of all of Jack’s shares were worth more than $1 million, Jack will be deemed to have sold the excess shares to the Jack and Jill Trust, which is a non-grantor trust, provided he doesn’t limit the number of share to those having a value of $1 million. The Jack and Jill Trust does not own any S corporation shares. In 2022, the IRS selects Jack’s gift tax return for audit and determines that the value of the shares transferred to the Jack Family Trust was $1.2 million (because he didn’t limit the number of shares to those having a value of $1 million). As a result, Jack is deemed to have sold $200,000 worth of shares of S corporation stock to the Jack and Jill Trust on August 1, 2020. However, the time for the Jack and Jill Trust to have made an ESBT election or otherwise qualify as a valid S corporation shareholder has long since passed. As a result, the entity itself could be deemed to have lost its S corporation status.

Incorporate an Economic Adjustments Mechanism in Your Defined Value Technique Defined value mechanisms operate to fix the dollar amount of interests in a closely held business that are sold, while leaving open the possibility that there may be an adjustment as to the number of shares or percentage interests in the business actually sold. Thus, inherent in these defined value mechanisms is the possibility that the owner of a particular asset

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(e.g., stock in a closely held business or an LLC interest) may change from the inception of the transaction. While defined value mechanisms routinely address the allocation of these equity interests, how are the economic implications of the adjustment provided for? If five years pass from the date of a transaction until the interests sold are determined definitively, how will the economic consequences of that five-year period be addressed? The consequences might include dividends or distributions that need to be repaid from the recipient to the correct party, e.g., the seller. Also, what mechanism will be used to assure that the equity interests are properly adjusted? Will merely providing for an adjustment clause alone suffice? Consider the following possible approach illustrating provisions when the valuation adjustment mechanism uses a spill-over of excess value to a GRAT.xxi There is limited guidance on this planning strategy and some commentators argue that operation of a defined value clause to fund a GRAT back to the date of the original transaction constitutes an additional contribution in violation of the regulations governing GRATs. The concern centers around the fact that the exact dollar amount that will fund the GRAT cannot be known at the time of the transaction because a well-drafted defined value clause pours over assets equal in value to the amount which exceeds a specific dollar amount. Further, those commentators posit this adjustment causes an impermissible redetermination of the annuity. Defined value clauses are intended to relate back to the date of the original transaction as though no time has passed between the date when all of the transfer instruments were originally executed and the date on which the value of the assets is finally determined for federal gift tax purposes. It is worth noting that the Service has not acquiesced to the use of formula clauses and has signaled interest in challenging defined value clauses.xxii It is prudent to warn clients of the risks attendant to the use of defined value clauses and to carefully draft such clauses in order to minimize such risks to the extent possible When this aggressive strategy is used, consider drafting an agreement between the individual transferor and the GRAT that contains the terms of the defined value mechanism. The assignment to the GRAT might also make specific reference to the mechanism and specify that what is being

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assigned is that percentage of interests (or shares of stock) in the closely held business as may be adjusted upon a final determination for federal gift tax purposes of the fair market value of the interests (or shares of stock).

Sample Economic Adjustment Clause Between Buying Trust and GRAT: A re-allocation of funds may be required as a result of any re-allocation of the Shares from the Buyer to the GRAT under the economic adjustment provisions of the Transfer Agreement following an initial adjustment (e.g., an income tax audit). A second re-allocation of funds may be required as a result of a second adjustment to the allocation of the Shares from the Buyer to the GRAT following a second and final adjustment (e.g., a gift tax audit following an initial income tax audit). It is understood that the Escrow Agent shall not release any of the Shares to the Buyer or the GRAT until the Buyer and the GRAT: (i) acknowledge in a written document acceptable to the Escrow Agent (the “Escrow Release”) that pursuant to the terms of the Transfer Agreement, the Buyer and the GRAT have determined the number of Shares to be sold to the Buyer (i.e., the “Actual Sale Shares”) and the number of Shares to be gifted to the GRAT (i.e., the Actual Gift Shares”) and (ii) set forth in such Escrow Release instructions directing the Escrow Agent as to the number of Shares that are to be released to each Party. It is understood that the CPA Report will corroborate the amount of dividends, other distributions, or other economic benefits that accrued to the Buyer prior to the Distribution Date (as defined in the Transfer Agreement), and that are properly allocable to the GRAT, if any. The Escrow Agent shall not submit the Existing Stock Certificate, the Sale Stock Power or the Gift Stock Power to the Corporation (or its transfer agent) pursuant to Section X until after the Escrow Agent receives written notice signed by the Buyer and the GRAT, in form and substance satisfactory to the Escrow Agent, that the Buyer has reimbursed the GRAT, or made adequate arrangements to reimburse the GRAT as permitted under the Transfer Agreement, for any amounts payable to the GRAT pursuant to the CPA Report.”

Consider Using a Two Tier Defined Value Adjustment on Sales to Non-Grantor Trusts The use of non-grantor trusts may have application to garner income tax benefits. A sale to a grantor trust would be essential if there is significant

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gain in the assets being sold in order to avoid recognition of gain on the occasion of the sale.xxiii Also, use of a grantor trust provides continued tax burn (that is, the grantor pays the income tax on income received by the trust), and the ability to exercise a swap or substitution power could be indispensable to basis step-up planning (by trading high basis assets the grantor owns for low basis assets in the trust, before the grantor dies).xxiv However, in some instances, use of a non-grantor trust might be advantageous to the buyer in a note sale or other transaction, particularly where the assets to be sold to the non-grantor trust were recently inherited by a surviving spouse. The basis step-up on the death of the first spouse should mitigate or possibly avoid capital gain on the sale of the assets by the survivor to the non-grantor trust. Perhaps the purchaser could be an old grantor trust that turned into a non-grantor trust by operation of its terms upon the death of the first spouse. In such a case, it is conceivable that the trust may already have substantial assets necessary to secure the transaction without any need for seed gifts or guarantees, thereby lowering any perceived risk inherent in such a sales transaction. How might a defined value mechanism be structured for such a transaction? It would appear that a two-tier defined value mechanism would be necessary to address both income tax audit results as well as gift tax audit results, since a sale to a non-grantor trust could trigger both income and gift tax audit adjustments. The income tax audit adjustment might be based on an IRS argument that the value of the asset (e.g., stock in a closely-held corporation) was understated so that the transaction is in reality a part gift/part sale with fewer shares having been sold. This adjustment could be independent from a later gift tax audit that argues the valuation was low, and hence a gift was made. Thus, in contrast to the economic adjustment clause illustrated above for a sale to a grantor trust, a two-tier adjustment might be necessary to conform the economics to the ultimate result of the transaction.

Sample Clause: “The Parties acknowledge that since the transaction is subject to income taxes and gift taxes, there is a chance that the transaction could be examined twice by the IRS. That is, the IRS could audit the transaction for both gift tax and income tax purposes, resulting in two possible economic adjustments. To the extent that two economic adjustments are required (e.g., a gift tax audit following an earlier income tax audit at which time an adjustment was made),

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the Parties further agree to take any and all reasonable additional actions, and to execute any additional documents, in order to effectuate such adjustment payments, as the Accountant determines appropriate, if any.”

An escrow agreement governing the holding of transfer documents might then address both the income and gift tax audit which would impact the release of equity as well as the holding of equity as security for the note.

Sample Clause: “Allocation of the Shares. The Shares shall be held by the Escrow Agent pending the events necessary for the Shares to be valued, which may occur in two tranches, resulting from an income tax audit and a gift tax audit. As a result of that valuation process, the Parties shall determine, pursuant to the Transfer Agreement, the number of Shares that shall be deemed sold to the Buyer effective as of the date hereof (the “Actual Sale Shares”) and the number of Shares that shall be deemed gifted to the GRAT (the “Actual Gift Shares”). All of the aforementioned steps are independent of the events associated with the repayment of the Secured Promissory Note (as defined herein).”

Since the buyer is a non-grantor trust, it may have incurred income tax as a result of distributions, dividends or other economic consequences while holding business interests it purchased pending a final determination of the gift tax value and the adjustment to reflect that result. Does this tax cost get factored into the economic adjustment clause concept discussed above? Divide a QTIP to Possibly Contain the Risk of a 2519 Challenge The transfer of the qualifying income interest of the spouse in a QTIP trust is a transfer by the spouse subject to gift tax under Section 2511.xxv More importantly, the transfer of any part (or all) of that income interest can result in a transfer of the entire amount in the QTIP trust. Therefore, if the IRS were to successfully assert a Section 2519 transfer (because the spouse lost part of the income interest in the trust), the entirety of a QTIP trust could be deemed transferred with potentially significant gift tax consequences for UHNW clients (for lesser wealth clients the current high exemptions might eliminate any tax cost to a Section 2519 deemed gift and hence make this otherwise worrisome tax challenge an affirmative planning tool).xxvi

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A successful Section 2519 challenge could impose draconian consequences to a client’s transaction. Any steps that could be taken or, even alternate planning structures that insulate or mitigate such risk might be advantageous, even if it proves difficult to evaluate the scope of the risk or to weigh the effectiveness of steps that might be taken. If a sale is to be made by a trust that is a separate trust or share of a QTIP trust, perhaps steps might be taken to insulate the remainder, or main QTIP trust. A 2014 PLR provides a suggestion as to how, in part, this Section 2519 insurance might be obtained. xxvii The concepts in the PLR might also be extended to provide insulation to different types of estate planning transactions. The PLR provided as follows:

Decedent's executor elected to treat Marital Trust as qualified terminable interest property (QTIP) under §2056(b)(7) of the Internal Revenue Code…The trustees of Marital Trust propose to divide Marital Trust into three separate trusts, Trust 1, Trust 2, and Trust 3. The terms of Trust 1 will be identical to the terms of Marital Trust. Following the division, the trustees intend to convert Trust 2 to a total return unitrust with an annual unitrust payment equal to not less than three percent or more than five percent of the fair market value of the assets of Trust 2 determined as of the first day of each taxable year. The trustees, with the consent and joinder of the trustees of Family Trust and Decedent's children, will petition Court for a court order to terminate Trust 3 and distribute the assets of Trust 3 equally to Decedent's children…the division of Marital Trust into three separate trusts each separate trust will be a QTIP trust under §2056(b)(7) and the division will not be a deemed gift or other disposition under §2519.

But the division of a marital trust might be used more proactively to insulate against a Section 2519 attack if the QTIP trust is selling an asset. Assume, for example, that an irrevocable trust that qualified as a QTIP trust (e.g., a failed GRAT structured to qualify for a marital deduction) is, pursuant to the terms of the governing instrument, to be combined or poured into the primary QTIP trust. If that first trust is to engage in a sale or transaction that might pose any Section 2519 arguments, perhaps the two QTIPs can be bifurcated to prevent a 2519 attack from reaching the second QTIP. In

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other words, one might wish to take steps to prevent the otherwise intended combination of the two QTIP trusts (e.g., the failed GRAT/QTIP merging into the primary QTIP at the end of the term of that failed GRAT). The same governing instrument might include powers to divide trusts and even not to merge trusts. Consider the following language:

Sample Clause: “Whenever two trusts created under this instrument are directed to be combined into a single trust (for example, because property of one trust is to be added to the other trust), the Trustee is authorized, in the exercise of its sole and absolute discretion, instead of combining said trusts, to administer them as two separate trusts with identical terms in accordance with the provisions that would have governed the combined trusts.”

It may be feasible for the trustees of each of the QTIP trusts to exercise these powers in advance to prevent merger and to otherwise administer the trusts as independent and separate QTIP trusts. If an institutional trustee is named in any of the QTIP trusts it may be feasible for the institution to confirm the action to prevent a merger of the separate QTIP trusts in order to provide greater independence to the transaction then if merely family members approved the transaction. This affirmative action, prior to consummating a transaction, could make it difficult for the IRS to assert a Section 2519 challenge against the separate QTIP trust that did not engage in the subject transaction. Use of an Independent Escrow Agent If a sale occurs which is subject to a defined value mechanism and/or a deferred payout supporting the note, who holds the collateral for the note? Who holds what documentation pending the resolution of the defined value mechanism? In many cases these documents are held by the estate planner crafting the transaction. Might there be a better option? The Ward court noted:

Furthermore, since there is no assurance that the petitioners will either recover the excess shares or, at the time of their deaths, possess the power to recover such shares, and since the shares are not worthless, the petitioners' estates may be reduced by the transfer of the shares.xxviii

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Might having title documents held in the hands of an independent escrow agent who assures that necessary adjustments are made, deflect this concern? Using an independent law firm, not a firm otherwise involved in the transaction, with a detailed escrow agreement specifying which documents should be held, and how they should be handled, might add additional credibility to the arrangement and negate the issue raised by the Ward court. Endeavoring to adhere to all relevant formalities could be important. In the Wandry case, the taxpayers listed percentage interests on the schedules attached to the gift tax return, not dollar figures as would have been consistent with the transfer of a fixed dollar amount. While the court did not change its conclusion because of this issue, it is certainly better to avoid such inconsistencies. Adhering to the formalities of a detailed escrow agreement, one reviewed along with all documentation by an independent agent, might also help safeguard transactions from these issues. It will be important for the tax-preparer of the closely-held business income tax returns to prepare the entity tax returns in a manner consistent with the defined value clause and it might be helpful for the preparer to include footnotes that describe that operation of the defined value clause may change the income tax return filed. As with all planning, collaboration can be key to ensuring that the plan is upheld.

Conclusion The late 2020 planning environment and potential for massive tax changes is unpredictable, making it all the more possible that legislative changes imposed after the new year might reduce the efficacy of planning using so-called “freeze” techniques like note sales transactions. Nonetheless, note sales remain a very powerful wealth transfer strategy, particularly with low interest rates and economic disturbances causing lower-than-normal valuations. It’s important to remain alert to possible broad changes to the wealth transfer laws and attempt to factor the possibility of such changes into planning considerations. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

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Joy Matak

Sandra Glazier

Martin Shenkman

CITE AS:


CITATIONS:


ii Portions based on: Shenkman and Blattmachr: “Estate Planning Updates and Planning Nuggets January - April 2019,” Estate Planning Newsletter 2728 (June 4, 2019).

iii Frazee v. Commissioner, 98 Tax Ct. 554 (1992).

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iv Section 7872(c); Section 7872(a)(1).

v See Jay D. Waxenberg and Jason A. Lederman, “The intersection of trusts and anti-trust: Why you, an estate planner, should care about Hart-Scott-Rodino,” 51 Real Property, Trust and Estate Law Journal, at 431.

vi 16 CFR Part 802.71.

vii McCord, CA-5, 2006-2 USTC ¶60,530; Petter Est., 98 TCM 534, TC Memo. 2009-280; Christiansen Est., 130 TC 1, CCH Dec. 57,301, aff'd CA-8, 2009-2 USTC ¶60,585

viii Nelson v. Commission, T.C. Memo 2020-81.

ix Nelson at *19-20.

x Id.

xi Wandry, et al. v. Comm’r, TC Memo 2012-88.

xii J. King, CA-10, 76-2 USTC ¶13,165.

xiii Comm’r v. Procter, 142 F.2d 824 (4th Cir. 1944), cert. denied, 323 U.S. 756 (1944).

xiv C. Ward, 87 TC 78, CCH Dec. 43,178.

xv This idea is attributed to Steven Gorin, Esq., Gorin, part III.B.3.a.iv. Defined Consideration Clause, “Structuring Ownership of Privately-Owned Businesses: Tax and Estate Planning Implications” (printed 7/14/2019), available by emailing the author at [email protected].

xvi Wandry et al., 103 TCM 1472, CCH Dec. 59,000(M), TC Memo. 2012-88.

xvii IRB 2012-46.

xviii This idea is attributed to Stacy Eastland.

xix However, if a trust is the recipient, the trustee will need to analyze whether and to what extent, if any, the exercise of such a disclaimer might constitute a breach of fiduciary duties owed to the beneficiaries.

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xx A sub-chapter S corporation is limited in the types of trusts that can be valid shareholders specifically: grantor trusts, ESBTs and QSSTs. IRC Sect. 1361(c)(2)(A)(v) describes the rules for a trust to qualify as an Electing Small Business Trust (ESBTs), generally limiting beneficiaries to individuals, estates, or charitable organizations. IRC Sect. 1361(d)(3)(B) defines a qualified subchapter S trust (QSST) which must distribute all of the income from the S corporation to one individual who is a citizen or resident of the U.S.

xxi Reg. 25.2702-3.

xxii Wandry v. Commissioner, T.C. Memo 2012-88, in which the Tax Court upheld a formula clause, but see Nelson v. Commissioner, T.C. Memo 2020-81, discussed later in this newsletter.

xxiii See Rev. Rul. 85-13.

xxiv Issues associated with exercise of the power of substitution, the possibility that an exercise might undermine ultimate goals of disposition, the timing and determination of equivalent value, as well as fiduciary duties triggered by such exercise, are beyond the scope of this newsletter, but merit consideration.

xxv Reg. 25.2519-1(a).

xxvi Estate of Kite v. Commr., T.C. Memo. 2013-43. Note, however, that the retention of the balance of the income interest by the spouse might trigger estate tax inclusion in the estate of that spouse not under Section 2044 (which causes a QTIP trust be included in the estate of the beneficiary spouse) but under Section 2036 because the spouse retained an income interest in the QTIP trust that the spouse was deemed to have given away under Section 2519.

xxvii See PLR 201426016 (not precedent).

xxviii The Ward Court referenced Harwood v. Commissioner, 82 T.C. at 275 n. 28. Ward v. Comm’r., 87 T.C. 78 (1986); Rev. Rul. 86-41, 1986-1 C.B. 300. Cf. King v. U.S., 545 F.2d 700 (10th Cir. 1976).

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Subject: Joy Matak, Sandra D. Glazier & Martin M. Shenkman - Estate Planning Six-Part Series for Late 2020, Part 5: Use of Non-Grantor Trusts for Planning Benefits “As we wind down the year – and this newsletter series – we are conscious of the ongoing rush to plan before year-end that has consumed so many advisers. 2020 may very well be the best opportunity to implement planning strategies to mitigate federal estate taxes and accomplish estate, asset protection and other objectives. The Biden administration is expected to seek increased COVID stimulus in order to address the widespread consequences of the pandemic. Control of the Senate hangs in the balance as two contentious Senatorial races in Georgia head towards a runoff on January 5, 2021. President-elect Biden has outlined his priorities, setting forth a wish list that will require funding to accomplish. Will Congress pass tax legislation early in the Biden presidency? Even if the Republican Party retains control of the Senate following the Georgia runoffs, President-elect Biden may be uniquely positioned by his long-standing relationships with his former Senate colleagues to pass new tax legislation. Career politicians in Washington understand that failure to deliver comprehensive measures to address the unemployment, housing, and food crises facing the nation’s populace could lead to a massive progressive wave in 2022 on a scale that could rival the 2018 elections. For these reasons, there is still so much that remains unknown about the future of taxes. Through our Roadmap series, we have aimed to provide you with practical thoughts on planning during the last few weeks of 2020. In our fifth installment, we would encourage you to reconsider opportunities to incorporate non-grantor trusts into estate plans, as discussed below in this fifth installment of our six-part series, including discussions on:

1. How vulnerable grantor trusts might be to inclusion in the grantor’s

estate on death


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2. Non-grantor trusts may support asset protection planning goals and

help differentiate SLATs as non-reciprocal

3. Structuring non-grantor trusts to maximize charitable and SALT tax

deductions, and minimize net investment income taxes

4. The merits of using beneficiary trusts and non-grantor spousal access

trusts

5. Administration of non-grantor trusts as key to ensuring the success of

an estate plan

The final newsletter in this series will review opportunities for planning before year-end that have not been addressed in preceding newsletters of this series.” Joy Matak, JD, LLM, Sandra D. Glazier, Esq. and Martin M. Shenkman, Esq. provide members with important and timely commentary in the form of a six-part series, Part 5 of which is a discussion of the use of non-grantor trusts for planning benefits.i Joy Matak, JD, LLM is a Partner at Sax and Head of the firm’s Trust and Estate Practice. She has more than 20 years of diversified experience as a wealth transfer strategist with an extensive background in recommending and implementing advantageous tax strategies for multi-generational wealth families, owners of closely-held businesses, and high-net-worth individuals including complex trust and estate planning. Joy provides clients with wealth transfer strategy planning to accomplish estate and business succession goals. She also performs tax compliance including gift tax, estate tax, and income tax returns for trusts and estates as well as consulting services related to generation skipping including transfer tax planning, asset protection, life insurance structuring, and post-mortem planning. Joy presents at numerous events on topics relevant to wealth transfer strategists including engagements for the ABA Real Property, Trust and Estate Law Section; Wealth Management Magazine; the Estate Planning Council of Northern New Jersey; and the Society of Financial Service Professionals. Joy has authored and co-authored articles for the Tax Management Estates, Gifts and Trusts (BNA) Journal; Leimberg Information Services, Inc. (LISI); and Estate Planning Review The CCH Journal, among others, on a variety of topics including wealth transfer strategies, income taxation of trusts and estates, and business succession planning. Joy recently co-authored a book on the new tax reform law

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entitled Estate Planning: Estate, Tax and Other Planning after the Tax Cuts and Jobs Act of 2017. Sandra D. Glazier, Esq., is an equity shareholder at Lipson Neilson, P.C., in its Bloomfield Hills, MI office. She was also the 2019 recipient of Bloomberg Tax’s Estates, Gifts and Trusts Tax Contributor of the Year Award and Trusts & Estates Magazines Authors Thought Leadership Award and has been awarded an AEP designation by the National Association of Estate Planners and Councils. Sandra concentrates her practice in the areas of estate planning and administration, probate litigation and family law. Martin M. Shenkman, CPA, MBA, PFS, AEP, JD is an attorney in private practice in Fort Lee, New Jersey and New York City who concentrates on estate and closely held business planning, tax planning, and estate administration. He is the author of 42 books and more than 1,200 articles. He is a member of the NAEPC Board of Directors (Emeritus), on the Board of the American Brain Foundation, the American Cancer Society’s National Professional Advisor Network and Weill Cornell Medicine Professional Advisory Council. Here is their commentary:

COMMENT: The Fate of Beloved Grantor Trusts While there has not been significant discussion among moderate Democrats, including the President-elect, to push for inclusion of grantor trusts in the taxable estates of decedents, progressives have floated the idea of including assets owned by grantor trusts in the grantor’s estate. Although many might view the possibility of inclusion of grantor trust assets as a proposal unlikely of enactment, the fact that prominent Democrats have discussed the idea creates some uncertainty about the fate of the ubiquitous grantor trust:

• Will such a proposal be included in any future legislation?

• What will be the effective date of such a change?

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• Will existing trusts be grandfathered?

Practitioners might consider two steps. First, complete grantor trust planning before year-end so that if the Democrats secure both seats in the Georgia runoff and proceed to pass such legislation, perhaps those trusts will be grandfathered. Most planning discussions have focused on use of exemptions. However, creating and funding dynastic grantor trusts that might be grandfathered could be just as important for some clients. The second step might be to consider drafting new grantor trusts, and providing that any grantor trusts that are revisited (e.g. by decanting) with mechanisms to facilitate turning off grantor trust status. This might be accomplished by incorporating provisions to permit conversion to non-grantor status by renouncing grantor powers or empowering a trust protector to switch off grantor trust status. It may be advantageous to complete such planning as soon as possible to perhaps precede any effective date of future legislation. Non-Grantor Trusts May Support Asset Protection Planning Goals and Help Differentiate SLATs as Non-Reciprocal When planning with an asset protection motive is pursued, having a significant tax motive can provide valuable support to the plan. In the current environment, the potential for a reduced exemption may well support many asset protection plans and transfers. But what about clients with smaller net worth that desire asset protection planning? Income tax benefits of non-grantor trusts (e.g. possible state income tax benefits) may provide the tax motivation for plans of more moderate wealth clients that also want asset protection.

Example: Physician and her spouse have a net worth of $6 million. Shifting assets to non-reciprocal spousal lifetime access trusts (“SLATs”), given the current high exemptions, may not permit that same couple to realize any estate tax benefit. Under what some consider the worst case scenario of a $3.5 million exemption, there still would not be any estate tax savings. Perhaps, there are insufficient other non-asset protection justifications for the plan. However, if a non-grantor trust were instead created, and state income tax (“SALT”) and perhaps other income tax savings are realized, those income tax

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savings might lend support to the viability of the asset protections provided for in the trust.

Another use of non-grantor trusts, which might be particularly useful in the waning days of 2020, is to differentiate SLATs for spouses as being non-reciprocal. There is presently insufficient time to differentiate trusts by creating them at different times and it may not be feasible to create them pursuant to otherwise sufficiently different plans. But what if one SLAT is created as a grantor trust, and the second is created as a non-grantor SLAT (some have referred to this as a spousal lifetime access non-grantor trust or “SLANT” or a “SALTy-SALT” as a SLAT structured to preserve SALT deductions restricted by the 2017 tax act)? The above are just two examples of how a non-grantor trust might provide justification for other important 2020 planning. Create a Non-Grantor Trust for Charitable Contribution Deductions for Moderate Income Client President elect Biden tax proposals have included several items that could affect the use of non-grantor trusts to secure income tax benefits. One proposal is to restore the 3% Pease limitation. This might apply if income exceeds $400,000. This could require that itemized deductions be reduced by 3% of adjusted gross income (“AGI”) over the threshold amount of up to 80% of itemized deductions. This reduction could be applied to charitable, SALT, mortgage interest, and miscellaneous itemized deductions. The use of a non-grantor trust and shifting some deductions to the non-grantor trust may preserve some of those deductions. Although legislation early in 2020 allowed for individuals to maximize charitable contributions up to 100% of their AGI, taxpayers cannot use their charitable trusts or donor advised funds without losing the income tax benefit. Further, in future years most taxpayers will not exceed the standard deduction threshold thereby losing the tax benefits of charitable giving. It is estimated that the doubling of the standard deduction to $24,000 for a married couple has lowered charitable giving by individuals $13 billion+ per yearii. Conversely, some commentators have suggested that the overall impact on charitable giving may not be significant.

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The doubling of the estate tax exemption to more than $11 million had also been estimated to lower charitable bequests by $4 billion per year.iii Bunching itemized deductions and using donor advised funds (“DAFs”) to circumvent the impact of the 2017 changes, including the doubled standard deduction, may not provide benefit for many taxpayers. With the significant restriction or elimination of so many itemized deductions, bunching may not push a taxpayer over the new standard deduction threshold. Even if the exemption threshold can be exceeded every 2nd or 3rd year via bunching, the tax benefit of donations made up to that level in any given year will still be lost. It is believed that the number of itemizers plummeted following the 2017 tax act changes. One estimate predicted that the number of taxpayers who itemized would decline from $46.5 million in 2017 to only $18 million in 2018.iv For some taxpayers, making direct charitable donations from an IRA for those over 70 ½ and donating appreciated assets (thereby avoiding tax on the appreciation), are still beneficial charitable planning strategies. For other clients, creating a simple non-grantor trust may serve to salvage charitable contribution deductions. When drafting these trusts, practitioners could include language in the instrument that directs that distributions to charity be made from gross income.v What relevance is this to late 2020 planning? If two non-reciprocal SLATs are to be created, making one non-grantor may not only provide the income tax benefits suggested above, but it could add a significant difference between the two trusts to perhaps help deflect a reciprocal trust challenge. In administering the trusts, it would be helpful for advisers to guide the client as to which expenses and distributions might be advisable to be paid from the grantor trust, and which from the non-grantor trust. Create a Non-Grantor Trust in a Trust Friendly State to Save State Income Taxes The economic disruptions of Covid may result in states increasing income taxes. Consider the possibility of enhanced income tax benefits when evaluating the use of non-grantor trusts as part of late 2020 planning. State income taxation on non-source (e.g. passive assets) may be deferred or avoided through the use of non-grantor trusts. This type of planning may become more common for two reasons. First, the state and local tax

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(“SALT”) deduction limitations make the net cost of state income taxes much higher, given the SALT limitations under the current tax laws. Therefore, many taxpayers, especially those in high tax states, may wish to pursue the use of non-grantor trusts in an attempt to avoid state income taxes that would otherwise no longer be deductible. Further, given a number of other tax savings opportunities that can be achieved through use of non-grantor trusts, taxpayers may already be creating non-grantor trusts for other tax planning purposes. It could be beneficial to evaluate whether existing trusts, paying high state income tax, might be modified or moved so that high state income tax might be avoided. An existing trust may be able to be moved to a different state that has a more favorable tax system. That may require moving assets out of the initial state, changing trustees to out-of-state trustees, and assuring no initial state source income. If source income cannot be avoided, by using powers in the instrument, decanting or non-judicial modification, it may be feasible to divide the existing trust so that one resulting trust has solely non-source income and the other resulting trust earns all source income. Only the trust containing non-source income would be moved. There may be no particular need to complete this planning in late 2020 if the purpose of such planning is to effectuate these changes alone. However, many clients are using late 2020 as a time to evaluate and improve old trusts before potential changes in the law occur. So, for example, if a client had created a trust for descendants that distributed outright to children at age 35 and to which GST was not allocated, that client may seek to improve this trust before 2021 when GST exemptions might change by decanting into a new trust that retains assets more long term (e.g. the child’s lifetime) and to which a late allocation of GST may be made. Those improvements might be enhanced by moving the trust to a no tax (or low tax) state from a high tax state, and/or modifying the trust to make it a non-grantor trust if it was not. This type of planning can raise complex issues that will need to be evaluated on a case-by-case basis. For example, the question of “what constitutes source income?” may only be answered by reference to resident state specific laws. Where a trust owns a partnership interest that has a modest amount of source income in the initial state, some states would consider even $1 of source income as sufficient to taint the trust and cause taxation on all of the income in that tax year.vi

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In moving a trust out of a high tax state to a low tax state, what if there is an investment advisor or trust protector in the initial jurisdiction? Will that taint the trust such that it remains subject to taxation in the initial state? In an attempt to break taxation nexus to the initial jurisdiction, will it suffice to create a limited liability company (“LLC”) or other entity in the new jurisdiction to house the protector, investment adviser and other positions that are residents of the initial jurisdiction? Practitioners and trustees might consider reviewing the possible benefits of converting a grantor trust to a non-grantor trust to save state income taxes. Caution is important. What if the progressive estate tax proposal of including grantor trusts in the grantor’s estate is eventually enacted?vii It might be wise to retain a grandfathered grantor trust (if that is feasible), even if that means sacrificing the current income tax benefits of having a non-grantor trust. Also, consider the implications of installment sales, negative basis, and income tax consequences on conversion. Evaluate whether grantor trust status versus possible state income tax savings is preferable. Use Non-Grantor Trusts to Save Net Investment Income Tax (“NIIT”) It may be feasible to use non-grantor trusts to save net investment income tax (“NIIT”).viii If the trustee is actively involved in a business held in a non-grantor trust the NIIT tax may not apply, whereas had the client held that interest individually it would have if the client is not actively participating in the business. Remember that the determination of what is required for a trust to actively participate to avoid the NIIT tax remains uncertain. The IRS rulings on this matter have been rather harsh.ix Several court cases, however, have taken a positive view of a trustee’s participation as characterizing a trust as active.x What if the trust involved is a directed trust and the general trustee is an institution that is not involved in management, but the investment adviser (or investment trustee) is actively involved? Is that sufficient to characterize the trust as active in order to negate application of the NIIT? Non-Grantor Trusts with Spousal Access Without Tainting Non-Grantor Status The second and fourth newsletters in this series discussed using a non-grantor trust to benefit a spouse in order to combine the benefits of using a

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non-grantor trust with the flexibility of a spousal access trust in late 2020 planning. A non-grantor trust might be a variant of a spousal trust that could be used to achieve disparate goals. These trusts have been referred to as a “SALTy-SLAT” by virtue of the non-grantor SLAT being used in an attempt to salvage some of the SALT deductions. Others have referred to it as a Spousal Lifetime Access Non-Grantor Trust (“SLANT”). Whether a new acronym is used, drafting non-grantor, completed gift, trusts that are accessible, may be a technique to consider for some clients in the current planning environment. Under IRC Section 677(a), the grantor of SLAT is treated as the owner (for income tax purposes) of any portion of a trust whose income, without the approval or consent of an adverse party, is or may be distributed to the grantor’s spouse or accumulated for future distribution to the grantor, or the grantor’s spouse, as determined in the discretion of the grantor or a non-adverse party or both. The corollary to this is that if an adverse party must approve distributions to the grantor’s spouse, a SLAT can both provide for distributions to the spouse and still be a non-grantor trust. Conversely, a SLANT might provide non-grantor status if drafted as follows:

• The “grantor-trust” rules set forth in IRC Sections 673-678 should not be triggered. This is quite the opposite of most trust planning engaged in for many years, other than ING trusts.

• To avoid grantor trust status, the grantor cannot retain a reversionary interest or the right to re-vest title in SLANT trust assets in the grantor.

• The grantor must not retain the right to direct disposition of trust income or property, the right to receive trust income, or the right to have the trust pay life insurance premiums on the grantor’s behalf.

• If the grantor’s retained power to re-vest title to trust property or receive trust distributions is exercisable only with consent of an adverse party, the trust generally will not be considered a grantor trust.

• No income or principal of the SLANT may be distributed to the grantor’s spouse without the consent of an adverse party. By way of example, the adverse party could be the eldest beneficiary of the trust

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excluding grantor’s spouse. Such individual’s beneficiary interests in the trust would be adverse to those of the grantor’s spouse. If more than one person is adverse under this definition, then the Trust Protector could be empowered to designate which of such persons shall be required to provide the adverse consent.

• No portion of the income or corpus of the SLANT may be distributed to discharge any legal obligation of the grantor or grantor’s spouse without the consent of the adverse party.

• No income of the SLANT may be used to discharge debts of the grantor or to pay gift or estate taxes on grantor’s estate.

• No income of the SLANT may be used without the consent of an adverse party to pay premiums on life insurance policies on the life of the grantor or grantor’s spouse.xi Note that it would likely be preferable to use a separate ILIT and not include life insurance on the life of the grantor or the grantor’s spouse in a trust that is intended to be a non-grantor trust.

• If the SLANT is intended to utilize the currently high temporary exemptions amounts before they might expire, it will need to be a completed gift trust. A gift is treated as complete if the donor “has so parted with dominion and control as to leave him in no power to change its disposition.”xii However, if under the terms of the SLANT instrument the grantor retains the power to consent to distributions, the gift is considered incomplete. An incomplete gift does not use up the grantor’s gift tax exemption.

Planning Considerations: Since the trust must be structured to avoid grantor trust status, the grantor cannot have a power to substitute assets, thereby necessitating that these trusts be funded carefully with high basis assets. That may all change if a Biden administration is able to enact the repeal of basis step-up. Conversion from a non-grantor trust to a grantor trust by later removing the requirement of the adverse party to approve distributions to the spouse is possible but may be expensive. It’s important to consider the forfeiture of the ability to address basis problems that may arise later when evaluating this strategy. If the trust is properly structured (with no grantor powers to the grantor spouse) and the beneficiary spouse can only receive distributions with the consent of an adverse party, the trust may achieve all objectives:

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completed gift to use exemption, non-grantor trust for any or all of the planning benefits of non-grantor trust, and spousal access. All of that said, while it is true that sophisticated clients do not mind some complexity to preserve wealth, it might be difficult for practitioners to convince a client who has spent decades building wealth to cede over to an adult child (or, step-child) the right to decide whether distributions from those assets can be made for the benefit of the client’s spouse (and, by extension, the client). While it appears that the SLANT may achieve some of the client’s intended goals, the required provisions may be just too restrictive to make the use of such a trust palatable for many clients.

Converting/Toggling from Grantor to Non-Grantor Status To convert an existing grantor trust into a non-grantor trust, the grantor (and perhaps the grantor’s spouse) may have to release all the powers in the instrument that would cause it to be treated as a grantor trust. Once the original grantor renounces all grantor trust powers, it’s advisable for the planner to confirm that Section 678 will not cause the trust to be treated as a grantor trust with respect to any beneficiary. By way of example, so-called Crummey powersxiii in the instrument can cause the trust to be deemed a grantor trust as to the Crummey power holders to the extent of their withdrawal powers if the grantor cannot be treated as a grantor for income tax purposes. Can you merge/convert/decant an existing grantor trust into a non-grantor trust? What about a non-grantor trust being converted to a grantor trust via a decanting? With changes in the law one characterization may have been preferable in the past, but a different characterization may be more advantageous now, and if the individual tax changes sunset in 2026 yet a different characterization may be more advantageous then. Practitioners might consider approaches that incorporate flexibility for this type of planning in trust instruments. For example, a power to swap assets and to lend without adequate consideration should be excluded if non-grantor trust status is desired. What if a named individual was empowered as a non-fiduciary to add these rights back into the trust, if appropriate, at a future date? If that is done, might the IRS argue that there was an understanding or implied agreement with the power holder? Also, when including a provision that might permit reimbursement of income tax consequences borne by the grantor as a result of grantor trust status, it will be important

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that no understanding or implied agreement exist between grantor and the trustee (or other power holder) with regard to such reimbursement power, if it is intended that estate tax inclusion be avoided. Converting a non-grantor trust to a grantor trust should not have any adverse income tax consequence, unless some special rule applies, by way of example, when a non-grantor trust holds the right to income in respect of a decedent, such as when a trust owns an interest in an IRA.xiv If a non-grantor trust is converted to a grantor trust then the non-grantor trust should file a final income tax return through the date of conversion reporting that all income for the year of conversion has passed to the new grantor trust. Converting from a grantor trust to a non-grantor trust also may trigger other income tax costs, e.g. if there are liabilities in excess of basis. Practitioners might contemplate possible sunset or changes in planning documents by empowering a trust protector or other person to turn on or off grantor trust status in order to convert a non-grantor trust into a grantor trust if the intended income tax benefits sunset. The IRS had held against toggling on and off grantor trust status, but the circumstances of that ruling were abusive and the same rationale may not apply to other situations, especially if the toggle is a result of a change in the law (e.g., the sunset of Act changes).xv Incorporating a decanting power to facilitate the trustee converting the trust status via decanting might also be worth consideration. Another issue might arise on conversion. Could it create a claim by a beneficiary against the trustee now that the trust or beneficiaries, not the grantor, have to bear the income tax burden? If that is envisioned and is of concern, it should be expressly authorized in the trust instrument and trustee liability waived for doing so as may be provided for in Alaska. However, in other states, the duty of undivided loyalty to the beneficiaries may not be waived – so caution is recommended.

2021 Follow up: Administration of Non-Grantor Trusts: Schedule Annual Trust Meetings - Proper Trust Operation is Vital to Achieving Intended Income Tax Status It may not be sufficient to craft the trust instrument as a non-grantor trust, or to convert a grantor to non-grantor trust properly. The trust must also be

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administered in a manner that conforms to the non-grantor trust requirements. These are all good 2021 follow up considerations for 2020 trust planning. For example, if the trustee unbeknownst to the practitioner purchases life insurance on the grantor’s life, and pays a premium, that might characterize the trust in whole or part as a grantor trust. What if a loan is made to the grantor and the interest rate or security is inadequate? Should loans be prohibited? Even if prohibited by the instrument the trustee’s authorized action of making a loan might undermine the intended non-grantor status if the loan (and the interest due thereon) aren’t paid before year-end. xvi If the instrument prohibits distributions to the grantor’s spouse without the consent of an adverse party, what if the trustee makes a distribution without such consent? This might be more likely to occur if the trustee is a non-professional individual rather than a professional or institutional trustee. What if the trustee or a protector acts in a manner that suggests an implied agreement to benefit the grantor thereby undermining non-grantor trust status. In all events, as the complexity and variety of trusts in a client’s plan expands, the importance of annual reviews with counsel and the rest of the planning team becomes more essential. It may be more difficult for clients, and even some of the client’s non-tax advisers, to differentiate grantor from non-grantor trusts, and to use the appropriate trust administration techniques for the right trust. The SEC v. Wyly case continues to serve as a reminder about the importance of proper trust operation.xvii In Wyly the trust had trust protectors for each of 17 inter-vivos trusts. None of the persons serving as trust protectors were related or subordinate. Nonetheless the trustees followed all investment recommendations made by the protectors including with regard to collectibles, etc. The conduct of the trust protectors and grantors was such that the court imputed all actions of the trust protectors to the grantors since there was a pattern of action. While the Wyly case might be a bit extreme, the concept of a pattern of conduct is problematic in so many situations (e.g., a pattern of distributions from a trust that is then attacked in a later divorce). Clients too often do not understand the need to meet annually with legal counsel to identify inadvisable patterns of distributions, payments, investments, etc. or to consult with counsel before inadvisable distributions, payments, or investments are made. Even if Wyly is viewed as an outlier, its lesson is nonetheless important. Adhering to formalities, and conducting meetings with the professional adviser team to address distributions, payments and investments remains important.

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Conclusion It remains important for clients to be informed and educated on the unique nuances of the late 2020 planning environment, and the changes that may be in the offing (or not). The potential for massive tax changes is unpredictable but yet vital for many clients to consider and thereby perhaps permit them to take proactive steps now. It might be helpful to forewarn clients that all their planning efforts may be for naught and could even leave them in a position that is less favorable, depending on political developments and future legislation, than had they done nothing. In this environment there are a range of planning considerations that might affect how practitioners handle late 2020 planning. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Joy Matak

Sandra Glazier

Martin Shenkman

CITE AS:

LISI Estate Planning Newsletter #2846 (December 15, 2020) at http://www.leimbergservices.com Copyright 2020 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited Without Express Permission. This newsletter is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that LISI is not engaged in rendering legal, accounting, or other professional advice or services. If such advice is required, the services of a competent

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professional should be sought. Statements of fact or opinion are the responsibility of the authors and do not represent an opinion on the part of the officers or staff of LISI.

CITATIONS:


iihttps://beta.washingtonpost.com/business/2019/02/26/definitely-bad-news-new-study-finds-charitable-giving-grew-sluggish-last-year/?noredirect=on .

iii https://www.councilofnonprofits.org/sites/default/files/documents/tax-bill-summary-chart.pdf .

iv Erica York, “Nearly 90 Percent of Taxpayers Are Projected to Take the TCJA’s Expanded Standard Deduction,” https://taxfoundation.org/90-percent-taxpayers-projected-tcja-expanded-standard-deduction/ , September 26, 2018

v Section 642(c).

vi Ed Morrow, Jonathan Blattmachr and Marty Shenkman, “Using Decanting and BDOT Provisions to Avoid a Peppercorn of Income Potentially Triggering State Income Tax on a Trust’s Entire Income,” Steve Leimberg's Income Tax Planning Email Newsletter Archive Message #205, 15-Sep-20.

vii “For the 99.8 Percent Act,” S. 309 116th Cong. (2019). As discussed previously, it is unlikely that this plan would be adopted in a Biden administration.

viii Section 1411.

ix TAM 200733023, and TAM 201317010. A national office technical advice memorandum (TAM) cannot be cited or used as precedent. Section 6110(k).

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https://beta.washingtonpost.com/business/2019/02/26/definitely-bad-news-new-study-finds-charitable-giving-grew-sluggish-last-year/?noredirect=on

https://beta.washingtonpost.com/business/2019/02/26/definitely-bad-news-new-study-finds-charitable-giving-grew-sluggish-last-year/?noredirect=on

https://www.councilofnonprofits.org/sites/default/files/documents/tax-bill-summary-chart.pdf

https://www.councilofnonprofits.org/sites/default/files/documents/tax-bill-summary-chart.pdf

https://taxfoundation.org/90-percent-taxpayers-projected-tcja-expanded-standard-deduction/

https://taxfoundation.org/90-percent-taxpayers-projected-tcja-expanded-standard-deduction/

x Mattie K. Carter Trust v. US, 256 F. Supp. 2d 536 (N.D. Tex. 2003); Frank Aragona Trust v. Comr., 142 T.C. No. 9 (Mar. 24, 2014). Section 642(h). See also, • When is a Trustee Not a Trustee (in the context of Real Estate Business Held in Trust for Purposes of the Net Investment Tax)? Sandra D. Glazier, BNA Tax and Accounting Center, Apr. 2014.

xi IRC Section 677(a)(3).

xii Reg. §25.2511-2(b).

xiii That is, those powers granted to a beneficiary enabling her to withdraw property from the trust generally in order to qualify all or a portion of a gift for annual gift tax exclusion.

xiv PLR 200848017, CCA 200923024 cf. I.R.S. Notice 2007-73, 2007-36 I.R.B. 545. Cf. Rev. Rul. 77-402, 1977-22 CB 222.

xv I.R.S. Notice 2007-73

xvi IRC Section 675(3). See, Burning Questions (and Even Hotter Answers) About Grantor Trusts, Samuel A. Donaldson, NAEPC Journal, Vol. 7, 2010.

xvii SEC v. Wyly et al, No. 1:2010cv05760 - Document 622 (S.D.N.Y. 2015).

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Click for Search Tips Click for Most Recent Newsletters Steve Leimberg's Estate Planning Email Newsletter - Archive Message #2848 Date: 21-Dec-20 From: Steve Leimberg's Estate Planning Newsletter

Subject: Joy Matak, Sandra D. Glazier & Martin M. Shenkman - Estate Planning Six Series for Late 2020, Part 6: Parting Thoughts on Planning and Practical Re

�2020 (the little that is left of it) may very well be the best opportunity to implement planning strategies to mitigate federal estate taxes and accomplish estate, asset protection and other objectives. As the final weeks turn into the final days of 2020, the bustle of the holidays and the promise of an effective COVID vaccine bring joy to the hearts of weary Americans, many estate planners are still crushed with last minute projects. Hopefully, some of the idea outlined in this series will have been helpful:

• Leveraging wealth out of a large estate using COVID-affected valuations

• Considering variations on Domestic Asset Protection Trusts, Spousal Lifetime Access Trusts, Life Insurance Trusts, Grantor Retained Annuity Trusts

• Refinancing intra-family loans or making new low interest intra-family loans

• Factoring in basis step-up planning through the possible use of Community Property trusts and �Upstream� planning

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• Using enhanced techniques for installment note sales to accomplish various planning objectives

• Incorporating Non-Grantor trusts into estate plans

Using the currently high temporary exemptions is at the heart of planning in late 2020 for moderate wealth clients. This planning rings similar in many ways to the crush of planning in late 2012 when there was a similar fear that the exemption might be reduced substantially in the following year.

The stakes in these last few days of 2020 could be extremely high. With a $900 billion COVID stimulus package passing Congress in the waning days of 2020, and the expectation that the incoming Biden administration will seek additional COVID stimulus in order to address the widespread consequences of the pandemic, some form of increases in taxes to meet the ever burgeoning deficit may be anticipated. Control of the Senate hangs in the balance as two contentious Senatorial races in Georgia head towards a runoff on January 5, 2021. President-elect Biden has outlined his priorities, setting forth a wish list that will require funding to accomplish. It is quite possible that the federal government will remain divided following the conclusion of the January 2021 runoff in the two Georgia races that will decide control of the Senate. If the federal government remains divided for the coming years then the prospect of making the current lifetime exemptions permanent is diminished. Any changes to the estate tax with a divided Congress may not happen. Perhaps a Biden administration will do whatever it can through regulatory means to implement its objectives. Even naysayers dismissing the possibility of massive tax legislation early in the Biden presidency, regardless of the results in the Georgia Senate runoffs, concede that there is still so much that remains unknown about the future of taxes. Career politicians in Washington understand that the failure to deliver comprehensive measures to address the unemployment, housing, and food crises facing the nation�s populace could lead to a massive progressive wave in 2022 on a scale that could rival the 2018 elections. It is quite likely that there will be some change in the nation�s tax laws to address increasing deficits resulting the pandemic and related stimulus packages. This final installment of the planning series offers some parting thoughts and practical reminders:

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1. Incorporate state income tax planning into a comprehensive estate

plan 2. Revisit credit shelter basis planning 3. Last minute GST tax planning 4. Recommendations for safer estate planning.�

Joy Matak, JD, LLM, Sandra D. Glazier, Esq. and Martin M. Shenkman, Esq. provide members with the final installment of their 6 part series, which includes parting thoughts on planning and practical reminders.[i] Members will find their commentary most helpful as it contains a number of sample drafting clauses. Here is their commentary: COMMENT: State Income Tax Planning for Clients and Trusts Planning PostCOVID State income tax planning for clients individually and for their non-grantor trusts may be evolving because of the pandemic. Even though it appears no place was safe from the spread of COVID, there appears to be a developing dynamic of clients exiting large congested urban areas for what, in a time of pandemic era, may be viewed as safer suburb and rural areas. This creates an opportunity for residency and domicile planning that may not have existed previously. Clients who may have been unwilling to entertain the thought of moving to a lower tax jurisdiction may now embrace it. As remote work environments have become common and ZOOM-time has replaced face time, clients may no longer feel tethered to their downtown office locations. In fact, many clients will be leading the change of domicile discussion for personal, not tax, reasons. Declines in state revenues due to shutdowns and the increasing costs of addressing food and housing insecurity, healthcare disparities, the effects of systemic racism, policing issues and more, may lead to an increase in taxation by some state and local jurisdictions. In addition, it is not clear how the incoming Biden administration might foster the reinstatement of state and local tax (“SALT”) federal income tax deductions or other changes. For these reasons, trust income tax planning warrants increased attention. The Supreme Court’s decision in the Kaestner caseii has already been

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discussed extensively in professional literature and this article will not delve into the specifics of the case or provide a recitation of the facts. Rather, this article seeks only to highlight the important message of the Kaestner decision. Ultimately, in the Kaestner decision, the Court failed to settle whether it is acceptable for a state to tax a non-grantor trust based on the residency of the beneficiary. Instead, the Court merely identified facts that would not allow a state to tax a trust based on the beneficiary’s residency.iii The Kaestner Court was particularly persuaded that a trust should not be taxed as a North Carolina resident trust solely on the basis of the beneficiary’s residence where the beneficiary had no control over the assets of the trust, could not demand any trust income, and did not actually receive any income from the trust during the years in question. There are important factors gleaned from Kaestner which might provide a rubric of issues to consider when structuring estate plans before the end of 2020: • Decant trusts with mandatory distributions Given the Court’s emphasis on the beneficiary’s inability to demand distributions, practitioners may consider decanting trusts, when terms of the instrument and governing law permit, to make the trust wholly discretionary. The holding in Kaestner might suggest that a state may tax a trust based on the beneficiary’s residency where the beneficiary can demand a distribution of the greater of 5% of the corpus of the trust or $5,000, as described more specifically in Section 2514(e) (commonly referred to as a “5 and 5 power”). The Kaestner decision might be construed to suggest that North Carolina, or any state with a similarly worded statute, might be able to tax any trust that requires distributions for health, education, maintenance and support (a so-called “HEMS standard”). Even a trust with an independent trustee could cause a state income tax under Kaestner because the beneficiary is eligible for distributions under a definite standard. A state may be able to tax a trust where a beneficiary is entitled to distributions on the achievement of certain ages or milestones, under the holding in Kaestner. In each of these circumstances, the safer course may be to decant

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the trust into one that only permits discretionary distributions as determined by an independent trustee and does not provide for distributions at any specified age. If a decanting is still being completed for 2020 planning, then the above factors might also warrant consideration. If there is no decanting currently in process it is unlikely that it can be initiated before year end, nonetheless these ideas may be useful for 2021 follow up projects. • Consider judicial modification without beneficiary approval The trust at issue in the Kaestner case had been previously decanted from a trust that terminated at a specified age. Consider whether effectuating a non-judicial modification to curtail beneficiary control might taint the result as evidencing beneficiary control (in contrast to a decanting effectuated by the trustee). If the beneficiary must consent (or, at least, not object) to a non-judicial modification, might a court view that as the beneficiary actively participating in or controlling the decision? In contrast, it might be possible for decanting to be effectuated by the trustee with no beneficiary involvement. When evaluating structuring a trust transaction as a non-judicial modification (in which all involved may consent or not object) versus a decanting, a decanting may be preferable to avoid an issue of beneficiary involvement. This may also be an important factor in a divorce.iv • Avoid making distributions If possible, avoid making distributions to a beneficiary who resides in a state where such a distribution would trigger an undesired state income tax. For example, assume that a state determines taxability of the trust based on the residency of the beneficiary. The terms of the trust may permit loans to the beneficiary, which may address shortterm cash needs. Any loan must carry adequate interest and be memorialized with appropriate documentation evidencing an intent on the part of the beneficiary to pay the loan back. Actual payments by the beneficiary to the trust may be needed. The loan may need to be secured by the beneficiary’s property. It is advisable the trust avoid making regular or periodic loans to the beneficiary that look more like distributions than loans. Alternatively, there may be opportunities for the trust to make payments on behalf of the beneficiary without causing taxability of the trust in the state of the beneficiary’s residence. By way of example, if the trust were to acquire a property outside the beneficiaries’ home

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state and allow the beneficiary to live in it, this would not necessarily cause the trust to be taxable under the state law at issue in Kaestner (though it may cause inclusion if the property were located within the state). Theoretically, if a person in a non-fiduciary capacity directed the trustee to transfer funds from the trust to a named person, pursuant to a power of appointment, such a payment may not be deemed a “distribution” and the recipient might not be deemed a “beneficiary” in a traditional sense because, generally, only a fiduciary can make distributions to a beneficiary. However, it is unclear how the taxability of the trust under such circumstances would be determined under the Kaestner holding. • Choose an institutional trustee in a tax-friendly jurisdiction The residence of individual trustees is a crucial factor in determining a state’s ability to tax income of a trust. In the Kaestner case, no trustee lived in North Carolina. Consider choosing an institutional general trustee based in a tax friendly jurisdiction in lieu of a friend or family trustee in the taxing jurisdiction. Doing so could be helpful in avoiding state taxation. When drafting trusts in late 2020, there can be an advantage creating such trusts with situs in trust friendly jurisdictions as opposed to the high tax home state of a client. However, given the time that it generally takes for corporate fiduciaries to review and accept appointments, it may be difficult to get an institutional trustee to accept a nomination to act as trustee before year-end. Therefore, if a client wishes to have an irrevocable trust created before the end of 2020, a family member or friend may need to be initially appointed with the goal of replacing the trustee next year with an institutional trustee located in a tax friendly situs. That approach, however, has to be implemented carefully as once a trust is formed in a particular state, it may be “stickier” to move it out than had it been initially formed in a trust friendly jurisdiction. It may prove much less costly to pay an institutional trustee to serve as trustee in a state with no tax. This may be particularly so because an institutional trustee is generally better than an individual acting as trustee in making sure a trust adheres to formalities that could bolster the trust’s defenses against a challenge by a beneficiary’s state attempting to tax the trust’s income. Even if the trust has named an institutional trustee to serve as trustee, there are still some ways to allow family members to

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participate in the administration of the trust: 1. Ensure that the family member is not a resident of a jurisdiction where such residency would be used to create a state tax which would not otherwise be owed by the trust and name that person as Trust Protector. 2. Give such person only the power to act in a non-fiduciary capacity. Though the array of positions and powers in a modern trust might still give rise to state taxation as the law in that regards develops. 3. Organize an LLC in a tax-friendly jurisdiction. Name the LLC as trust protector and outline the specific powers and responsibilities such entity would have over the trust. Identify one or more family members to serve as manager(s) of the LLC, with the power to make decisions on behalf of the LLC. Be mindful, and caution clients, that having your sister-in-law as manager of an LLC performing services in your home state may not suffice (using the LLC shield) to negate state taxation. While use of an LLC provides a layer of protection, the nature of the tasks, the involvement, the administration of the structure and other factors may all prove relevant in determining tax situs. However, using an LLC in the trust’s tax friendly jurisdiction may be an improvement. Documenting that actions are taken outside the home state may be better still. But the bottom line is that there may still be uncertainty. It would seem that taking these extra steps – and adhering to the rules established by the forum– may avoid state income taxation of the trust, or at least reduce the risk of home state taxation. • Avoid certain contacts with the taxing jurisdiction In the Kaestner case, the Court pointed out that the trust lacked several contacts with North Carolina. Though it was not entirely clear that the holding of the case hinged on the lack of these contacts, a safer course for any trust seeking to avoid state taxation would be to take note of these points: 1. In Kaestner, the trust records were physically located outside of North Carolina. It is not clear whether this inquiry will continue to be relevant in the modern digital age. In any event, Kaestner makes clear that a trustee should not store physical records in the taxing jurisdiction whose authority to

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tax is sought to be avoided. 2. Trust asset custodians were located in a state other than the taxing state in Kaestner. Might it be possible to select an office or division of a particular custodian or manager that will help strengthen the nexus (or lack of nexus) argument? 3. The trustee should try to engage investment advisors physically located outside of the taxing jurisdiction and prefer advisors which do not have locations within the jurisdiction if possible. 4. The trust should avoid renting or owning an office in the taxing state. 5. The trust should avoid owning real property or tangible personal property in the taxing state. Therefore, if the trust acquires property for the beneficial use of a beneficiary, consider dividing the trust so as to avoid tainting the entire trust corpus for taxation purposes. Alternatively, creating an LLC to own that real or tangible property may transmute the property into an intangible asset thereby reducing or even negating the issue. 6. The trust should not have any direct investments in the taxing state. Some states take the position that any active business in their state will taint the entire income of the trust as taxable. If that situation affects a trust, consideration may be given to dividing the trust. Many trust documents permit the trustee to divide the trust for a variety of reasons. If not, state law might permit division. If that is not the case, decanting may provide another possible way to cure this state tax issue. 7. The number of meetings between the trustee and beneficiary may be relevant. The Court noted: “the trustee’s contacts with Kaestner were ‘infrequent.’” Therefore, consider having beneficiary meetings in a tax neutral location. Where is a Zoom meeting based? Credit Shelter Basis Planning Risk Once high lifetime exemptions from gift and estate tax were introduced and incorporated into the estate planning rules, some practitioners may have advised clients to consider terminating credit shelter trusts or distribute appreciated assets out of a credit shelter trust in order to garner a basis

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step-up on the death of the surviving spouse. Now that the country is facing a potential drop in lifetime exemptions, terminating or distributing assets out of a credit shelter trust to gain a basis step-up might prove to be a very costly gamble if the surviving spouse dies after the exemption drops. Practitioners who worked with clients on this type of planning may wish to revisit those arrangements before the end of 2020 – and the potential decrease of the exemption from its current high of $11.58 million. A gift back to a similar trust to use exemption might be worthwhile. Maximize GST Tax Planning Before Potential Changes Another foundation of planning has been to shift value to an irrevocable trust and allocate generation skipping transfer (“GST”) tax exemption to the trust. Properly done, under the current system, the value of assets in that GST exempt trust, no matter how much those assets appreciate, should avoid future estate transfer taxation. The compounding of wealth outside the estate tax system can provide incredible wealth shifting opportunities. When this is coupled with a long-term trust (dynastic trust), wealth may (under the current tax regime) compound outside a client’s estate forever. Progressive proposals, such as that introduced by Sen. Sanders (VT) (S. 309), would appear to limit application of the GST exemption to a maximum of 50 years. Gridlock in Washington could usher in a progressive wave in 2022 and force the incoming Biden administration to the left, making it possible for this type of proposal to gain traction at some future date, even if not in 2021. Such a change would hinder GST-type planning and might result in a costly tax after 50 years of a trust’s existence. If a change along the same lines as the Sen. Sanders’ proposal is enacted, but if it “grandfathers” existing trusts (i.e., the new restrictions only apply to trusts formed after the new law), many people, even those of moderate wealth, might benefit from creating long-term irrevocable dynastic trusts now. Making a late allocation of GST exemption to trusts that were not GST exempt may still be feasible in the waning days of 2020. Even if there is inadequate time to decant an older trust into an improved trust before year end, if GST is allocated to make the trust exempt, the decanting may be

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addressed in 2021. Practice Safer Estate Planning The closer to the end of the year, and the more last minute a plan, the more cautious practitioners may need to be. If a practitioner will even undertake planning in late December for a current or new client, it may be advisable to question why such last-minute decisions are being made. Try to gain some understanding as to the client’s reasoning, what delayed the planning, and whether the client is really understanding and comfortable with rushed last minute planning. If commitments already made make it impractical or improbable for the planning objective to be met on a timely basis, perhaps the engagement should be declined. The current lifetime exemption of $11.58 million per person could very well decline to $5 million (adjusted for inflation) or lower. For many clients, making gifts in smaller amounts is insufficient to address their concerns about changes in the law that could be lurking on the horizon. For this reason, so many clients are contemplating dramatic transfers that could severely reduce their personal wealth level. Thus, the goal to practice safer may be even greater than it may have been in 2012. Before working with clients to move substantial swaths of wealth out of their taxable estates, it could be helpful to analyze whether the client will retain sufficient assets to provide for lifestyle expenses and to lower the risk of a fraudulent conveyance challenge. Further, it may be more important than ever to use structures that preserve potential access to the assets transferred (for all but the uber-wealthy clients) because of the large dollar value of many of these last minute gifts. Perhaps it is advisable to incorporate a disclaimer provision in irrevocable trusts to permit a trustee or beneficiaries to disclaim gift transfers.v Even if the practitioner has concerns with that mechanism, other mechanisms which might provide the client with an “out” have been discussed in earlier segments of this series. Malpractice risks and issues are significant. Safer practice is worth considering by all advisers, including not just attorneys and CPAs, but banks, trust companies, wealth advisers and more. Despite (or perhaps especially because of) significant pressure placed on billable hours and revenue generation (whether as hours billed or assets under management or otherwise) every one of the allied professions might wish to reassess

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practice methods and disclaimers included in memorandum, etc. Add Caveats to Letters and Memorandum Consider using caveats to caution clients about the uncertainty of 2020 planning and the uncertainty of what, if any, tax law changes might occur: • It is impossible to predict what tax law changes may occur, or not, or what the effective date (e.g. grandfathering) of any future legislation may be. • Planning done in anticipation of a certain outcome or legislative action may prove worthless, and even worse due to tax audit risk, transaction costs, and reduction or loss of access to assets, flexibility, etc. • A wealth tax, capital gains tax on death, elimination of basis step up on death, lower gift, estate and GST tax exemptions, may be enacted. GRATs may be restricted, discounts reduced or eliminated, assets in grantor trusts included in the grantor’s estate, and more. The uncertainties of future legislative changes are impossible to predict, and transactions undertaken prior to knowing such legislative changes may not achieve the intended goals. General Caveats to Consider Consider the following: • Adding cautionary language to cover letters. Sample Clause: “Estate planning is inherently complex and subject to varying interpretations. Applicable federal, state and local laws change frequently. Ongoing review and maintenance of every plan and document is essential. There is no assurance that any particular result will be realized. There are risks and negative consequences to every planning step and technique. It is impossible to enumerate all of the risks and consequences in any communication. There is a possibility that a planning strategy implemented today will be nullified by a new rule, law and/or a court case tomorrow. By proceeding with this planning, you accept these risks.” • Adding cautionary language to retainer agreements or footers on bills, or both. Sample Clauses: Risks; No Guarantees: You understand and acknowledge that the results of any plan are never guaranteed. Numerous aspects of many, if not most, estate and related plans are not

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only uncertain, but subject to a wide spectrum of different views by other advisers, the courts, the IRS, and other authorities. Most strategies have negative consequences (e.g. save estate tax, lose basis step-up). Many common strategies, techniques and transactions are subject to tax, legal, financial, and other risks and uncertainties. While we endeavor to identify some of the risks of a plan, all risks and issues with each component of a plan are not possible to identify or communicate. Creating a collaborative team may help identify more issues with your plan. Further, the fact that we communicate verbally or in writing certain risks should never be interpreted as an indication that any such listing or communication is a complete listing of every risk involved. The risks of any transaction can be further compounded by improper administration of the plan, failure to meet annually to review and update the plan, or changes in family dynamics, the tax and/or other laws may reduce (or eliminate) any projected benefits. Such risks may even result in more costly results than had no planning been pursued. The above caveat about “no guarantees” and “risks” in every transaction may have particular relevance for 2020 planning. There is simply no way any practitioner can predict what might occur. If no changes in the law occur, or if the effective dates do not provide for grandfathering, it is possible that current planning could prove worse than had no action been taken. Audit and other Risks: Any estate or transaction may be subjected to audit which creates a risk of undesired or unintended consequences. Possible challenges may emanate from risks we communicated to you, while others may not have been discussed. Challenges by the government as part of the audit process might cause inclusion of assets previously transferred out of your estate in your estate. After audit, assets that had been transferred out of the estate as part of recommended strategies may be adjusted to their date of death value, which could result in tax related liabilities such as those attendant to capital gains, depreciation recapture, and/or a negative capital account. You agree that we shall not be liable for any assessments of tax, interest, or penalties resulting from our recommendation or your decision to implement any strategy.”vi

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Adding cautionary language as a preamble to estate planning and other memorandum. Sample Clauses: Disclaimer Statements and Risks: Information Will Not Suffice to Avoid Tax Penalties or Interest Charges: The information in this memorandum, in any attachment, or cover letter (including previous and subsequent correspondence during this engagement) are not intended to be or used to: i) avoid any penalties imposed by the IRS or any state tax authority; or, ii) promote, market or recommend to any other party any tax-related matter such as an investment, product, service, advice or position. Law Changes: The suggestions, analysis, and discussions contained in this Planning Memorandum are based upon the applicable federal, state and local tax and other laws in effect as of the date of this Planning Memorandum unless otherwise noted. Such authority may change in the future, and such change may be applied retroactively. A change in state law may impact income, estate or other tax consequences. [Law Firm] assumes no responsibility to update this memorandum, or notify you in any manner, if the applicable law changes. Federal and state taxing authorities, regulatory agencies, the IRS, and the courts are not bound by the analysis herein and may take very different views or interpretations of the law, the facts or both. The analysis contained herein supersedes all prior oral and written discussions, if any, pertaining to the issues involved and may be modified by subsequent communications. Various strategies may have been recommended, but there is no assurance that the IRS or state tax authorities, other governmental agencies, regulatory bodies or courts will accept the analysis provided. While a number of associated risks have been discussed, possible challenges could be asserted which may not have been discussed or even contemplated. [Law Firm] is are not responsible or liable, to any extent, for any gift tax, income tax or estate deficiencies or assessments,

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interest, or penalties that may arise, or the results of any court holding including the piercing or disregarding of entities, trusts or transactions.vii There may now be proposed Federal, state tax or other legislation which, if enacted, could modify or eliminate the benefits of many strategies if not grandfathered. The IRS, state tax authorities, opposing counsel, and others have, and may continue to, attack various strategies and techniques that may be suggested in this Planning Memorandum. Your Responsibilities: [Law Firm] has relied upon your assertion that the information, facts and assumptions provided are true, correct, and complete. However, [Law Firm] has not independently audited or otherwise verified any of the information, facts or assumptions. A misstatement or omission of any fact or a change or amendment in any of the assumptions relied upon may require a modification of all or a part of the discussions or suggestions contained in the Planning Memorandum. In addition, the suggestions provided and discussions had were based on the facts and assumptions as asserted to [Law Firm] by you and are at best only current as of the date of this Planning Memorandum. [Law Firm] has no responsibility to update this Planning Memorandum, or otherwise notify you, for events, circumstances or changes in any of the facts or assumptions occurring after the date of this Planning Memorandum or the date of any communication to you. It is the responsibility of the client to engage [Law Firm] or another adviser to revisit these matters from time to time, especially if: there is a change in (i) your planning, (ii) the assumptions upon which these matters were based, (iii) your circumstances which impacts the discussions or suggestions contained in this Planning Memorandum; or, there is a notification via general communication from our office or through the general media which indicates a change has or may occur that could impact your plan. It is your responsibility to consider all communications [Law Firm] disseminates as well as general media coverage of events and contact [Law Firm] should any perhaps apply to you, your

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planning or this Planning Memorandum. Options; Your Decision: Although [Law Firm] has attempted to aid you in the decision-making process, and may have suggested alternative recommendations verbally or in writing to help you achieve your objectives, and assist you in understanding how well each alternative might meet your estate planning objectives, the responsibility for estate planning decisions is solely yours. These services are not designed, and should not be relied upon, as a substitute for your own judgment, nor are they meant to mitigate the necessity of ongoing review. These services are designed to supplement your own planning and analysis and aid you in achieving your objectives. Planners might provide a further caveat or add to sample language provided above, in order to reflect that for plans done late in 2020 time limitations may limit viable estate planning options as well as the time available to fully analyze, discuss and/or implement options. Finally, practitioners might consider cautioning clients as to the concerns that rushed planning may create. One such concern might relate to the valuation process. At this late date, appraisers may not be able to complete a formal report in 2020, however, some may be willing to provide values to use followed by a later report. Some may not be able to even provide a value before year-end. So, for late December planning estimates of some sort might have to be used. That introduces a new element of risk into a plan. Will a valuation mechanism be respected if based on a mere estimate and not a formal appraisal? Perhaps transfers might have been or be (for the little time remaining) consummated on estimated values. Practitioners might document to clients the increased risks that these transfers, and the mechanisms used to address them, entail. Conclusion It remains important for Practitioners still engaged in late 2020 planning to inform and educate clients as to the unique nuances of the current late 2020 planning environment, and the changes that may be in the offing (or not). The potential for massive tax changes under the incoming Biden administration and by state legislatures across the country is unpredictable but yet vital for many clients to consider when attempting to engage in

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proactive steps now. In this environment there are a range of planning considerations that affect how practitioners might practice estate tax minimization planning, income tax planning and more. Hopefully, this Roadmap series has been helpful in outlining some strategies to consider, opportunities to incorporate and options for planning safer. HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

Joy Matak

Sandra Glazier

Martin Shenkman

CITE AS:


CITATIONS:

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[i] This newsletter is an adaption of a paper submitted to the Notre Dame Tax and Estate Planning Institute and an article entitled �Estate and Tax Planning Roadmap for 2019-2020, By: Martin M. Shenkman, Esq., Jonathan G. Blattmachr, Esq., Joy Matak, Esq., and Sandra D. Glazier, Esq. published by Steve Leimberg's Estate Planning 2745 2019-09-03. Copyright © 2021 Leimberg Information Services Inc.

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http://www.leimbergservices.com/openfile.cfm?filename=d%3A%5Cinetpub%5Cwwwroot%5Call%5Clis%5Fnotw%5F2848%2Ehtml&criteria=sandra%20glazier#_ednref1