March – April 2011

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MONTH YEAR: Lead Article: 1 ¾ pages [2nd page about 45 lines]
Lead Article Title: Ode to the Trust – 1st SonataSummary: So here’s a topic almost as exciting as watching paint dry — how you operate your trusts. You know so much about seed gifts, guarantees, and grantor trust status, that you’ve become the fav guest on the cocktail party circuit. But will your fans go for something more basic? The fun part is planning and signing your trust, but then the mundane but essential part begins – having your trust – be a trust. What does that take? Paying attention to lots of mundane details. To have a shot at your trust getting the respect that eluded Rodney Dangerfield, an annual meeting of the fiduciaries and advisers (CPA, investment manager, attorney, etc.), is a must. What about the Congressional tax cacophony? While we only know what the estate tax looks likes for 2 years, most of the tunes that follow are classics that you’ll have to hum for many seasons regardless of the Congressional tax winds, oldies but goodies.

♪ Type of Trust: Understand the nature or type of trust involved. This will help you identify many other issues you will have to address to properly operate your trust: tax filing requirements (grantor trust, split-dollar loan statement, gift tax return, etc.). The tune of your trust can be classified in a myriad of ways: ♫ Revocable versus irrevocable (can’t change); ♫ Grantor (person establishing the trust is taxed on the trust) versus non-grantor (trust pays its tax, subject to the complex “DNI” rules on when distributions carry income out to beneficiaries); ♫ Testamentary (formed at death) or inter-vivos (formed while you’re alive); etc. ♫ The type of assets held by a trust can have a significant impact on the terms of the trust and required operational steps: life insurance, S corporation stock, etc. ♫Each note has importance to operational steps: ♫ Life Insurance Trust: In most instances, Irrevocable Life Insurance Trusts (“ILITs”) are grantor trusts. This means that income (which is usually negligible) is taxed to the grantor/insured. It also can have benefits to minimizing tax rules when transferring or selling policies. ILITs are typically set up to assure that the proceeds are excluded from the grantor/insured’s estate and not reachable by creditors or ex-spouses. These latter benefits will remain vital whatever the tax finale Congress sings. There are many variations on this type of planning and the types of trusts that might own insurance. Evaluate transferring new policies to the ILIT in light of the large $5M exemption, or unwinding split dollar loans. ♫ Dynasty/GST Trusts: These perpetual trusts are typically (2010 remains an oddity) intended to continue for a loooong time, often in perpetuity, without triggering estate or GST tax at generational levels. This may require an allocation of GST exemption on a gift tax return unless it is confirmed that the GST automatic allocation rules apply. Plan now, the Obama budget has proposed limitations on these trusts. ♫Child’s Trust: Confirm whether Crummey powers are used, whether the trust fulfills a parent’s obligation to support income may be reported to the parent. Alternatively, the trust may have intentionally been structured as a grantor trust so that the parent/grantor’s payment of income tax leverages greater asset growth in the child’s trust.

♪ Payments to Be Made: ♫ Many trusts require exacting payment schedules. ♫Are they monthly, quarterly or annually? What date are they due? The anniversary date of the funding of the trust or year end? ♫Charitable Remainder Trusts (“CRTs”), Grantor Retained Annuity Trusts (“GRATs”) require payments be made to you as grantor. If not made as required the trust will hit a flat note for tax purposes. Identify the amount and timing of the required payment and set up procedures to assure they’re sung in tune. ♫If there is a unitrust payment, or inflation adjustment, be certain the calculations follow the trust terms. ♫If an appraisal is necessary to calculate a payment, get the process going far enough in advance so that the trustee can make a timely payment. ♫ Have your CPA set up a chart of all payments and collect proof of payments now, so you’re ready when Uncle comes knockin’.

♪ Trust Permanent File: Every fiduciary and adviser should have a file of critical trust documents. Once this file is set up in an organized fashion, tailored to the specific trust involved, operating your trust becomes as simple as playing Choptstix. Consider: ♫Trust agreement. This is the key to all operational decisions from investments to distributions. Be certain you have the entire trust and all ancillary documents, including: schedules listing assets transferred, amendments (if not irrevocable), etc. ♫ Fiduciary actions. The fiduciaries (trustees, investment advisors, distribution committee, someone holding a power to designate a charitable beneficiary, etc.) of a trust may have the authority to take certain actions that affect the trust. You need to maintain copies of all these actions. Sometimes it is essential to confirm that anyone holding a power has not exercised that power (e.g., if someone has a power to substitute assets whether or not they have done so is essential to confirming the assets of the trust). Periodic confirmations of actions not taken can be as important as copies o factual written actions taken. ♫ Beneficiaries. Current data on trust beneficiaries should be maintained: addresses, Social Security numbers, residency/domicile which may affect how the trust is taxed as well the marginal state/federal income tax rate to be considered in planning investments, etc. ♫ Crummey Powers: If gifts to the trust require notices of annual demand powers be issue to qualify for the annual gift tax exclusion records confirming that these notices were properly issued must be maintained in order to support favorable gift tax treatment. The trust CPA should consider whether a gift tax return can be filed reporting all gifts to toll the statute of limitations on an IRS audit. Too often, years after a trust has been established, notices are lost, not sent, or wind up being handled in a manner contrary to either the terms of the trust or the law. Even if you are sure that estate taxes will never matter (the exemption is still scheduled to plummet to $1M in 2013) failing to adhere to the terms of an irrevocable trust may still create liability for the trustee, demonstrate to a court that you have ignored the formalities of the trust in the event of a future suit or claim, etc. The trust permanent file should include copies of all Crummey notices since inception, and demonstrate that they were properly prepared and acknowledged. ♫ Trust assets. Understanding trust assets is essential to a host of planning issues. Are the assets properly insured with the trustee properly covered? Too many people have residential real estate that is owned by a trust but insured as if owned by them personally. Will that suffice to protect the asset and trustee in the event of a casualty or suit? The assets may determine which fiduciary (e.g., investment advisers) has responsibility. Assets can impact state tax filing requirements. Assets should be consistent with the trust Investment Policy Statement (IPS). Should assets be supplemented by additional gifts be made to existing trusts to capture the new $5M gift exemption? The Obama budget proposal calls for a reduction to a $1M gift exemption.

♪ Ancillary Transactions: Ancillary transactions affect the necessary legal documentation, trust income tax return, and more. ♫ Split-dollar insurance. A split-dollar arrangement may have been used to pay for a portion of life insurance premiums. Split-dollar loans require a statement to be filed with the trust and premium payor’s tax returns. If the trust involved is not an insurance trust, it might be the party advancing premiums for the policy owned by an insurance trust or family business. Split-dollar arrangements all need to be reassessed, and many unwound using the new $5M gift exemption. ♫ Guarantee. If the family engaged in any intra-family sales (e.g. a note sale to a grantor trust) a trust other than the purchasing trust may have guaranteed a portion of the payments. Are guarantee fees advisable? Were they in fact paid and reported appropriately? The $5M gift exemption gives leeway to make gifts to reduce or eliminate the need for guarantees. ♫ Loan Arrangements. With historically low interest rates many family entities have engaged in intra-family loans. Proper documentation, payment and reporting of interest, etc. is essential. Post tax season be certain you have all relevant documents that the interest rate charged is adequate, and that other formalities are adhered to. ♫ Personal use assets. If a trust purchases a house for a beneficiary, be certain that property tax and mortgage interest deductions are being properly handled both for the trust and those using the property. Clients often seek to deduct property taxes for a personal property that may be owned by a trust (e.g., the surviving spouse resides in the marital residence now owned by a bypass trust).

Checklist: Second Article 2 lines less than One Page [about 54 lines]:
Checklist Article Title: 2010-11 Tax Plan

Summary: Lots of tax uncertainty and change. But there is one certainty, doing nothing won’t help you, and may prove the worst “strategy” of all. “Wait and see,” may well become “wait and pay.” Most importantly, the $5M gift exemption enacted at the end of 2011 presents for some the greatest tax, estate and asset protection planning opportunity in many decades, and that opportunity may not be around for long.

√ Change in Venue: So your income oriented stocks were snug in your personal account where the Taxman only could tag them at a 15% rate. Bam Zap Zowie (think old Batman Shows) — the Bush 15% tax siesta for dividends may end in 2013 and dividends may be nailed at a 39.6% rate. So dividend paying stocks may morph from tax efficient to tax costly. So, just like hermit crabs who need to find a larger shell when they want to grow, your dividend paying stocks may need to slither into your IRA or other qualified plan shell to avoid a tax rate that more than doubles. Consider this possibility as you plan investments in the coming years. Asset location is as important as asset allocation to maximize your net returns.
√ Late for Supper but not for GST: So you made gifts in early 2010 to your children or trusts, but now that you know 2010 has a zero percent GST tax rate, what can you do? It might be possible through disclaimers (renouncing an interest in a gift or bequest) for grandchildren (“skip persons” in GST parlance) to become the donees or beneficiaries of certain 2010 transfers that would then be subject to a 0% GST tax rate (can’t get lower than that!). The GST rules also permit you to make a late allocation in 2011 of GST exemption to 2010 gifts. That might be a good fix. You have to act after 4/15/11. IRC Sec. 2642(g); Treas. Reg. Sec. 26.2642-2(a)(2).
√ Carryover Basis Allocation to LLCs: LLCs (and partnerships) have inside basis (LLCs’ investment in its assets that determine gain/loss if the LLC sells the asset) and outside basis (your investment in the LLC interest which determines your gain/loss if you sell). If someone died bequeathing you an interest in an LLC you might get to increase (step-up) the basis in their LLC membership interest, but that won’t cut the tax mustard unless the LLC can also give you an adjustment for the inside basis in asset it owns (otherwise if the LLC sells a building you’d still get tagged with gain). But before the executor makes an allocation to you be sure you can get the LLC manager (or partnership’s GP) to make a special tax election under Code Section 754 to adjust the inside basis. Otherwise, you might never get the benefit hoped for. If the basis adjustment for the estate is less than the gain involved confirming this in advance of filing an allocation with the IRS is key.
√ Attorney Employment: Most executors hire an attorney and CPA to represent the estate and the probate process, and tax returns are handled. In 2010 with a choice of having the estate tax or the carryover basis rules apply, each beneficiary affected really needs to hire their own counsel to represent their interests. The choice may affect how assets are distributed, not just tax issues. The receipts and releases typically signed at the end of the probate process in contrast to more typical years, for 2010 estates should include attachments clarifying how the executor selected the estate tax or carryover basis (and if the latter, how the basis adjustments were allocated). 2010 is a unique year and extra measures are warranted. Estates paying no estate tax will be perplexed by more costly professional fees when there is no tax, but alas, such is the Alice in Wonderland logic of our tax system.
√ Give it Away: Its not just your kid yelling give it away, your tax advisers will be joining the chorus in 2011. The $5M gift exemption creates sizzling tax opportunities. President Obama’s 2011 budget proposal already calls for a reduction in the gift exemption to $1M. Why is this so vital? ■ State Tax: For folks living in high tax states that don’t follow the federal estate tax rules (“decoupled”) giving it away before they check out could leave no assets in the state estate tax vice. Example: You have a $5M estate and live in NY which has only a $1M estate tax exemption. Give away $4M and there is no gift tax (unless Obama’s change goes through in which case this planning opportunity evaporates). On death if you’re under $1M there is no state estate tax either. If instead you do nothing, on death your $5M estate will trigger more than $400,000 in NY tax. Ouch. ■ Non-Married Partners: The gift tax has always been a tough impediment to non-married partners equalizing wealth. For most, the $5M gift exemption obviates the issue. Gift now before Congress turns the tax spigot off. ■ Asset Protection: Shifting assets into a protective structure had to plan around the $1M gift exemption. With $5M and $10M for a couple there might no longer be any tax impediment to shifting assets. Go for it while you can.
√ Calendar Roth Conversion Re-characterization: Many folks converted some or all of their IRAs to Roth’s in 2010 (and others will follow suit). Don’t forget to calendar October 1, 2011 to meet with your investment adviser and CPA to determine if your Roth conversion was an investment success. If not you have until October 17, 2011 (the 15th is a Saturday) to reconvert or recharacterize the Roth back to a regular IRA and avoid paying the income tax on the conversion of assets that declined in value post-conversion. You can also Roth an inherited 401(k). Notice 2008-30, IRB 2008-12, 638.

Recent Developments Article 1/3 Page [about 18 lines]:
■ S Corp 2nd Class of Stock: Although LLCs are the entity of choice, 2 million+ S corporations still exist. One of the many requirement to qualify and maintain tax favored S corporation status is that the corporation can only have one class of stock. Economic turmoil has forced many S corporations to restructure debt. While that could run afoul of the single class of stock rule, there is some leeway. In a recent private letter ruling the IRS held that the restructure of debt in which the lender negotiated warrants to receive Class B non-voting common stock did not constitute a disqualifying second class of stock. Reg. 1.1361-1(l)(4)(iii)(b)(1). The IRS cited 3 factors influencing the favorable result: (1) The warrants were issued to induce the lender to restructure debt; (2) The lender is regularly engaged in the business of commercial lending; and (3) The warrants were issued in connection with a commercially reasonable loan. PLR 201043015 .
■ Split Dollar Loan Filings: A loan can be made under the split-dollar life insurance loan regime but it must have interest paid or accrued at the applicable federal rate (“AFR”). Most of these loans are non-recourse to the borrower, and the lender can only look to the life insurance policy and proceeds for repayment of the loan. This makes the loan contingent with adverse tax consequences. However, this unfavorable characterization can be avoided the borrower and lender must file a written statement (representation) with their tax returns in which they state that a reasonable person would expect the loan to be repaid. In these rulings neither the employer or employees filed the required representations concerning the nonrecourse nature of the split-dollar loans with their tax returns. The IRS has recently afforded some leniency by providing an extension of time to meet these filing requirements. PLR 201041006 – 201041024.
Potpourri ½ Page:
■ “Live long and prosper” is said after a Vulcan salute, but all you Tax Trekkies knew that! But did Spock or Mrs. Spock actually first stay it? Estate planners typically represent the family so that coordinated and better results can be achieved. But if women outlive men on average by six years who should be calling the final shots? Is the female living long but not prospering because the shorter lived male pushes estate and gift planning? Perhaps dad is feeling more generous about gifts for the grandkids ‘cause dad won’t be around to need the money, but mom might be left trying to make ends meet. Six years is a long time. Just a thought.
■ Is 4% the Magic Number: Some folks test your ability to retire by estimating 3-5% of your investable assets and then comparing it to your budget. Not a bad rule of thumb for a preliminary chat before you crunch the real numbers with your CPA or financial planner. But is that budget number really right? Many magazines and financial gurus espouse that you should “need” say 75% of your pre retirement income to support your post-retirement lifestyle. But according to a recent article in Investment Advisor magazine quoting researcher Dan Ariely folks “want” a lifestyle that might require 130% of pre-retirement salary. So it’s not only teenagers who confuse “need” and “want.” But think about the implications to retirement planning! Think about the implications of estate planning, especially gifts and other wealth transfers! What numbers must remain for the female of the couple (+ 6 years) to have the lifestyle she “wants” before gifts can be made? Are estate planners pushing clients to make tax advantaged wealth transfers before reviewing stress tested numbers with the client’s wealth manager? Are advisers reasonably assuring that their client/parents have economic security first? The answer in too many cases is negative. The reluctant planning client may be the prudent client. Just a thought.
■ Trustees of Insurance Trusts: Watch your fiduciary back! If an insurance policy will be replaced have an independent insurance consultant, in addition to the broker, provide a written analysis confirming the advisability of the change. Cochran v. Keybank, 901 NE2nd 1128 (Ind. App. 2009).
■Low Interest Rates: Great for GRATs, lousy for CRATs. Charitable Remainder Annuity Trusts don’t work well when interest rates are low because the value of what the charity gets when the CRAT ends is low and the requirement that the charity get 10% of the value of the property given to the CRAT is tough to meet. A taxpayer recently missed the mark and the IRS permitted the CRAT to be rescinded and the property returned to the taxpayer. PLR 201040021. Sometimes “backsies” is allowed! But to get this result the taxpayer had to obtain the consent of the charity, the trustee and the state’s attorney general.

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