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Probate and Estate Planning  Articles

INTRODUCTION
If you pass away leaving a substantial estate, a significant portion of your Las Vegas property may pass to the government in the form of estate taxes, rather than to the beneficiaries, of your choosing. However, it is often possible to reduce or even eliminate estate taxes with proper planning. While it is almost never too late, early planning is generally the key to maximizing the benefits of certain estate planning techniques. For example, where an asset is removed from your state today, all appreciation occurring between now and the date of your passing will also be removed from your taxable estate.

The techniques discussed below are not appropriate for every estate plan. Indeed, if you anticipate that your assets will not be subject to estate taxes upon your passing, it may not be necessary to employ these techniques in order to maximize the amount that ultimately passes to your beneficiaries. For this reason, we will carefully analyze your particular circumstances and explore the specific techniques that are right for you. Indeed, we pride ourselves on tailoring each estate plan to the unique needs of each individual client.

Please be aware that the advanced planning techniques discussed below are usually implemented only after a basic estate plan has been created. Typically, a basic estate plan will include a living trust, a pour over will, an advanced healthcare directive, and a power of attorney. This basic estate plan will provide the foundation upon which an advanced estate plan is built. While proper planning takes time and energy, the benefits can be substantial. Discussed below are several techniques that you may wish to consider: Grantor Retained Annuity Trusts, and Intentionally Defective Grantor Trusts. Additional techniques, such as irrevocable life insurance trusts, certain specially structured charitable donations, and qualified personal residence trusts, are discussed in other articles on the website.

GRANTOR RETAINED ANNUITY TRUSTS
A Grantor Retained Annuity Trust (GRAT) allows a donor to transfer property to a trust, retaining for a period of time the right to receive an income stream (an annuity) from the property. After all of the required annuity payments have been made to the grantor, the assets remaining in the trust (referred to as the remainder) pass to the beneficiaries chosen by the grantor when the trust was created. The benefit of this technique is that, although the entire property goes to the donor’s beneficiaries at the end of the term, the gift tax on the transfer is computed on the remainder interest at the time of the gift. This can permit a transfer of property at a fraction of its actual value.

The transfer of the assets to a GRAT is potentially subject to gift of taxes. The advantage of using a GRAT, however, is that the value of the gift is discounted for the income interest retained by the grantor. In other words, the fair market value of the gift is not the entire value of the assets transferred because the grantor is retaining an income interest for a period of time. Rather, the gift is only the value of the remainder interest. The gift tax is calculated on this remainder interest. If a taxpayer’s gift tax credit has not been completely used, there may be no gift tax to be paid. Moreover, in certain instances, it may be possible to reduce the value of the gift to almost nothing, and therefore minimize any erosion of the grantor’s gift tax credit. This is true because, in apportioning the value of the respective interests in the GRAT, the government uses an assumed rate of return called the applicable federal rate (AFR). The amount by which the assets held by the GRAT exceed this assumed rate of return in not subjected to gift tax.

For example, suppose that the grantor creates a GRAT with stock valued at $1,000,000. If the GRAT is obligated to pay the grantor $230,900 per year for five years, and the AFR (the government’s assumed rate of return) is five percent, the value of the interest transferred to the remainder beneficiaries for gift tax purposes will be $318.45. In other words, using its assumed rate of return, the government is willing to bet that almost nothing will be left for the remainder beneficiaries after all the required payments are made to the grantor. Under this scenario, the taxpayer can only win the bet.

If the assets remaining in the GRAT have increased to $5,000,000 at the end of the five year annuity period, assets with a value of $5,000,000 will have been transferred to the remainder beneficiaries for a gift tax value of only $318.45. In other words, the gift will have been made with almost no exposure to gift taxes. On the other hand, if the assets perform at a rate that is less than the AFR, the taxpayer has lost nothing except for the cost of creating the GRAT. For example, if the stock held by the GRAT were to decline in value, such that the remainder beneficiaries receive nothing (I.E. the government wins the bet), the grantor has potentially been exposed to gift taxes upon a gift of only $318.45. In other words, the donor will have almost no gift tax exposure. This technique is commonly referred to as a “zero GRAT” because the assumed value transferred to the remainder beneficiaries is almost zero.

It should be noted that a GRAT will generally only be appropriate where it is anticipated that an asset will appreciate at a rate significantly greater than the government’s assumed growth rate (the AFR). Indeed, in some cases, the donor may be able to achieve a better result with outright gifting. For example, if a 55 year old grantor transfers $5,000,000 to a five year GRAT with an annuity payment of $1,167,679 when the AFR is 5.4% the relevant calculations reveal that a taxable gift has been made in the amount of $102,406. If the assets actually grow at a rate that is substantially lower than the AFR, nothing will be left for the beneficiary at the end of the five year GRAT term. Moreover, the grantor will have paid gift taxes on the transfer of $102,406, as well as having paid the expenses associated with the creation and operation of the GRAT. By contrast, if the grantor had made an outright gift of $102,406, the beneficiary could have invested the money, and ultimately would stand to receive an amount greater than a GRAT would produce.

While a “zero GRAT” is one method of avoiding this problem, this technique may not be appropriate for the circumstances of a particular case. Moreover, significant restrictions limit the amount by which the annuity payments under a GRAT can vary from year to year. For example, it is not permissible for a GRAT to pay $ 10,000 in one year and $100,000 in the next year. By contrast, other techniques may permit greater flexibility in the structuring of annuity payments.

The use of a GRAT can have significant benefits in the appropriate circumstances. In particular, a GRAT may be appropriate where it is anticipated that assets will significantly appreciate in the immediate future. However, the key to gaining the most leverage from this technique is early planning, such that appreciation will occur outside of the grantor’s taxable estate. It would be our pleasure to analyze your circumstances to determine whether early planning with a GRAT would be right for you.

INTENTIONALLY DEFECTIVE GRANTOR TRUSTS
The intentionally defective grantor trust (IDGT) is commonly used as an estate freezing device. In other words, an IDGT “locks in” the value of an asset for transfer tax purposes, and all future appreciation in the transferred assets is shifted to the donor’s beneficiaries. A transfer to a properly structured IDGT is considered a completed transfer for estate and gift tax purposes, but incomplete for income tax purposes. Therefore, an IDGT will not be included in the donor’s estate upon his or her death, even though the donor is obligated to pay the income taxes generated by the trust while alive. By paying the income taxes attributable to the trust assets, the donor is essentially making additional gifts to the trust beneficiaries that are not subject to gift tax.

Preliminarily, it should be noted that the use of the word “defective” is somewhat a misnomer. This is a reference to a violation of certain rules that would otherwise make the transfer effective for income tax purposes. However, in this context, the taxpayer is intentionally violating these rules. As a result, the trust is not “defective” in the sense that it is improperly drafted, but rather is only “defective” in the sense that it does not meet the requirements necessary to prevent the income of the trust from being attributed to the donor (which, of course, is entirely the point of an IDGT).

In any event, an IDGT generally is structured as a sale of certain assets from the donor to the IDGT. The IRS generally will respect a properly structured IDGT as a sale; however, the transaction may be deemed a taxable gift if improperly structured. For this reason, attention to detail is necessary relative to the formalities associated with the transaction.

For example, before selling assets to the IDGT, the grantor should initially contribute property having a value equal to approximately ten to twenty percent of the fair market value of the assets to be sold (depending upon the circumstances). The purpose of contributing “seed money” is to avoid having the sold assets constitute the sole source of payment for the note, such that the IRS could argue that the transaction was without substance. (If the sold assets are the source of payment, it might also be argued that the transaction is a transfer with a retained interest, which would cause the assets to be included in the grantor’s estate.) Following the contribution of seed money, the grantor then sells the assets to the IDGT in exchange for an interest bearing installment note. The installment note should be for a term of years and may be payable in installments with a balloon payment, or alternatively, an interest only note with a balloon payment on the due date.

As noted above, the IDGT technique freezes the value of the note in the grantor’s estate. In other words, any increase in value of the assets sold will not be taxed in the grantor’s estate, but rather will inure to the benefit of the trust beneficiaries. When the grantor dies, only the fair market value of the note is included in the grantor’s estate. That value generally will be less than the outstanding principal of the note. This is true because a buyer in the open market generally would not pay the full face value of the note in order to purchase it. The precise value of the note may depend upon several factors, including the payout of the note, the interest rate, the absence of security, default provisions, and other note terms.

There are no income tax consequences on the sale of the asset to the trust because the grantor is treated as the owner of the trust for income tax purposes. As a result, the grantor will not be required to pay capital gains tax by reason of the sale to the IDGT. Although the grantor is taxed on income generated by the trust (income the grantor does not receive), the grantor is further reducing their estate by the amount of the income tax paid.

By contrast, if an outright gift had been made to the beneficiaries, the beneficiaries, rather than the grantor, would be required to pay the income taxes associated with the assets. In other words the payment of tax by the grantor on the trust income is essentially a tax-free gift to the beneficiaries. Parenthetically, it should be noted that it is acceptable for the trust to provide the trustee with discretion to make distributions to the grantor sufficient to pay the income tax obligations generated by the trust, but that payment to the grantor can not be mandatory.

The following is an illustration of the manner in which an IDGT may be structured. The grantor starts by creating a defective grantor trust (in other words, a trust that is the effective for gift and estate tax purposes, but ineffective for income tax purposes). A number of methods can be used to achieve this result, such as providing some person other than the grantor or beneficiaries the power to name additional beneficiaries.

After creating the trust, the grantor donates “seed money” to fund the trust. Suppose that the asset to be sold to the IDGT is closely held stock with a value of 1,000,000. If the circumstances of the case required “seed money” of twenty percent, the donor would transfer $200,000 in cash to the IDGT (in other words, twenty percent of $1,000,000). Because this is a completed transfer for gift and estate tax purposes, the donor would be required to file a gift tax return (and perhaps pay gift tax) based upon this $200,000 gift.

The donor and the trustee then enter into an agreement for the IDGT to purchase the stock from the grantor in exchange for an interest only note with a balloon payment of $1,000,000 after five years. While the donor will receive interest payments, because the trust is treated as the property of the grantor for income tax purposes, the grantor is not required to pay income taxes as the result of these payments. In other words, the IRS treats the transaction as if the grantor is paying himself interest, and consequently no income taxes are due.

At the end of the five year term of the note, the grantor receives the balloon payment of 1,000,000 from the IDGT. If the stock has increased in value to$5,000,000, the beneficiaries have received a $5,000,000 asset at a transfer tax cost of $200,000 (the amount of the “seed money”). In the event that the grantor passes away during the term of the note, the unpaid principal is included in the grantor’s estate. Suppose that the grantor in this example passes away in the fourth year of the term of the note. Because no payments have been made to reduce the principal of the note, the full $1,000,000 note amount would be included in the grantor’s taxable estate. If the stock has increased in value to $4,000,000 as of the grantor’s passing, the grantor has passed $4,200,000 (4,000,000 in stock plus the 200,000 “seed money”) to the beneficiaries at a transfer tax cost of 1,200,000 (the $1,000,000 principal balance of the note plus the $200,000 “seed money”).

If the grantor owns $2,000,000 in assets other than the note in year four, the grantor’s total estate would effectively be $3,200,000 using the IDGT method (the $1,200,000 transfer tax cost of the IDGT plus the $2,000,000 of other assets). By contrast, if the grantor had not created the IDGT, the grantor’s estate would be $6,000,000 ($4,000,000 of stock plus $2,000,000 of other assets). In other words, the grantor will have effectively reduced his taxable estate by $2,800,000 by using an IDGT. Assuming that the grantor passes away in the year 2009, this would eliminate the estate tax obligation at approximately $1,150,000 In other words, approximately $1,150,000 more will pass to the grantor’s chosen beneficiaries, rather than the government.

One advantage of an IDGT over a GRAT is that an IDGT provides greater flexibility in structuring payments to the grantor. With a GRAT, significant restrictions limit the amount by which the annuity payments can vary from year to year. By contrast, the note in an IDGT is not subject to these restrictions. Indeed, the note can provide for the payment of interest only, with a balloon payment at the end of the term of the note. When this approach is used, the principal may remain in the IDGT so that income can compound for the benefit of the beneficiaries, rather than being returned to the grantor.

Another benefit of an IDGT is the flexibility in drafting the Trust. The client can structure the Trust to act as a spendthrift trust for the Trust beneficiaries. This can protect the assets of the trust from the claims of unsecured creditors. The Trust may also be structured as a generation skipping trust, which will allow the assets to pass to future generations free of estate taxes.

A significant drawback of using an IDGT is that there is not a single source of authority delineating the acceptable boundaries relative to the IDGT technique. Generally speaking, the IDGT is the product of a patchwork of case law, abstract reasoning, and indirect authority. By contrast, the IRS has provided clear guidelines (and even sample documents) for other techniques. As a result, the IDGT is an effective estate planning tool only where the value of the donated assets increase in value. Consequently, an IDGT is not appropriate for every case.

As is the case with a GRAT, early planning is the key to getting the most out of using an IDGT. A number of factors, some of which are beyond the scope of the above discussion, may militate either in favor or against the use of an IDGT in your estate plan. Consequently, it will be necessary to carefully analyze your unique circumstances to determine whether an IDGT is right for you.

CONCLUSION
With proper planning, it is possible to ensure that your chosen beneficiaries receive your property, rather than the government. While the techniques discussed above require intricate analysis and detailed planning, the benefits achieved are often substantial.

Charitable Giving

INTRODUCTION
For those living in Nevada or surrounding states, charitable donations can be made in a variety of forms. Depending upon your estate planning and philanthropic goals, certain planned giving techniques may be very useful. Broadly speaking “planned giving” means that donations are made in some form other than an outright gift. Alternatively, it may be possible to create a new charitable entity controlled by you and members of your family to further a charitable purpose of your choosing.

This discussion will focus on certain common techniques used to make charitable donations. Specifically, these techniques include charitable remainder trusts, charitable lead trusts, life estates, gift annuities, and private foundations. For the most part, the law in this area came into existence in 1969, when Congress created laws designed to minimize perceived abuses in the area of charitable giving.

CHARITABLE REMAINDER TRUSTS

OVERVIEW
A charitable remainder trust (CRT) is a trust which makes payments to a non-charitable beneficiary for a specified period (the “lead interest”), and at the end of that period, the assets remaining in the trust are distributed to the charitable organization designated when the CRT was created (the “remainder interest”). It is permissible for the donor or a member of the donor’s family to be appointed as trustee of a CRT.

If a CRT is funded during the lifetime of the grantor, the grantor will generally be entitled to an income tax deduction. Alternatively, if a CRT is designed to come into existence at the passing of the grantor, the grantor’s estate will generally be entitled to an estate tax deduction. The amount of the tax deduction will primarily depend upon three variables: (1) an IRS index rate known as the Applicable Federal Rate (AFR) ;( 2) the length of time that payments are to be made to the non-charitable beneficiary; and (3) the amount that is to be paid to the non-charitable beneficiary periodically during that time.

THE APPLICABLE FEDERAL RATE
Each month, the IRS publishes an index referred to as the Applicable Federal Rate (AFR). While a detailed discussion of the AFR and its consequences is beyond the scope of this discussion, the purpose of the AFR is to approximate the expected return on the assets held by the CRT.

THE LENGTH OF TIME THAT PAYMENTS WILL BE MADE TO THE NON-CHARITABLE BENEFICIARY
Generally speaking, payments to the non-charitable beneficiary may either be for a set period of time (not to exceed twenty years), or alternatively, for the lifetime of a natural person. In cases where the life of a natural person is the measure of the non-charitable interest in the CRT, tables published by the IRS are used to estimate the natural person’s life expectancy, and thus the period of time that payments will be made to the person. Depending upon the circumstances at the time that the CRT is created, such as the age of the non-charitable beneficiary and the current AFR, it is not always possible to structure the payments so that they are measured by the life of a natural person.

THE AMOUNT THAT IS TO BE PAID TO THE NON- CHARITABLE BENEFICIARY
The amount that is to be made to the non-charitable beneficiary of a CRT may be determined by one of the two methods. First, the same amount may be paid each year. For example, a CRT initially holding assets with a value of $100,000 could provide that it will pay $10,000 each year to the non-charitable beneficiary. Each year, the trustee of the CRT would distribute $10,000, regardless of the income generated by the trust or the value of its underlying assets. Because the income stream generated by this form of payment is a fixed annuity amount, a CRT with this form of payment is a fixed annuity amount; a CRT with this form of payment is referred to as a Charitable Remainder Annuity Trust (CRAT). Alternatively, a CRT can be created which will produce payments that will vary according to the value of the assets held by the trust. For example, if a CRT held $100,000 in assets and had a ten percent payout rate, the non-charitable beneficiary would receive a payout of $10,000 that year. If the value of the assets increased to $200,000 in the following year the non-charitable beneficiary would receive a $20,000 payment (ten percent of $200,000). A payment varying by reference to the value of the assets held by a trust is generally referred to as a “unitrust.” Consequently, a CRT with this form of payout is called a charitable remainder unitrust (CRUT). There are four variations on the CRUT theme:

  1. A standard unitrust pays the stated amount from the trust regardless of how much income is earned. The payout is the stated percentage of the trust assets as valued annually.
  2. A net income unitrust pays the stated amount from the trust to the extent of income earned in the trust without invading principal. The payout is the stated percentage of the trust assets as valued annually.
  3. A net income with makeup unitrust pays the stated amount from the trust to the extent of income earned in the trust without invading principal. It has the ability to makeup income in subsequent years if the income earned is less than the stated payout rate.
  4. A flip unitrust is a net income unit trust that “flips” to a standard unitrust when a specified date or event occurs such as a birth, a death, or the sale of a hard-to-market property.

PAYOUT PERCENTAGE
Once the donor has chosen between a CRAT and a CRUT, it is necessary to select a payout percentage. A higher payout percentage results in more going to the non-charitable beneficiary, and consequently less is distributed to the charitable beneficiary. As a result, a higher payout to the non-charitable beneficiary will result in a lower charitable deduction for the remainder interest. Conversely, a lower payout to the non-charitable beneficiary means that the charity receives more, and consequently increases the charitable deduction. The precise percentages that will be permissible in a particular case depend upon a number of factors, and require calculations based upon the facts of each specific case.

TAXATION OF CRTs
Charitable remainder trusts (CRT) are tax-exempt trusts and generally do not have to pay income taxes at the trust level. As a result, a CRT does not have to pay capital gain tax when it sells appreciated property. In addition, CRT’s enjoy tax-free growth on their investments. These two benefits provide donors with excellent opportunities to diversify and invest for the future in a tax efficient manner. Payouts from charitable remainder trusts (CRT) are taxable to most recipients. However, the taxable amount and the tax rate of these payouts may vary greatly from year to year, depending upon the character of the trust assets.

It should be noted that there are significant restrictions with respect to the activities that may be conducted by a CRT. A CRT will lose its tax exempt status in any year that it has unrelated business taxable income (“UBI”) or debt-financed income. This could occur, for example, if the trust borrows funds to purchase investments, operates a business, or holds mortgaged property. In addition, a CRT will lose its exempt status for a year in which it fails to timely make the required payment to the non-charitable beneficiary, or fails to make a timely payment of real property taxes or assessments, resulting in a lien on trust property.

CONCLUSION
A CRT is often an effective tool to provide an income stream to a non-charitable beneficiary while benefiting charitable causes. Additionally, the use of CRT’s can produce significant tax benefits for the donor.

CHARITABLE LEAD TRUSTS

INTRODUCTION
A charitable lead trust (“CLT”) is very similar to a CRT, except that the interests of the charitable and non-charitable beneficiaries are reversed. Recall that with a CRT,

a certain amount is paid to a non-charitable beneficiary for a certain period, and at the end of that period, the assets remaining in the trust are distributed to a charitable organization. With a CLT, the charity receives payments for a certain period, and the assets remaining in the trust at the end of that period are distributed to the non-charitable beneficiary. In other words, where a CLT is used, the charity receives the lead interest and the non-charitable beneficiary receives whatever is left in the trust after the charity has received its payments.

Just as with a CRT, the payment to the lead interest in a CLT must be either a fixed dollar amount (an annuity) or a percentage of the value of the assets held by the trust (a unitrust). A CRT that pays the amount to the charity each year is called a “charitable lead annuity trust” (“CLAT”) and a charitable lead trust that pays a percentage of the value of the assets held by the trust is called a “charitable lead unitrust” (“CLUT”). Generally speaking, the CLAT is the more useful of the two possible forms of CLTs. As is the case with a CRT, the donor or a member of the donor’s family may act as a trustee of a CLT.

LEVERAGING YOUR ASSETS WITH A CLAT
If you have an asset that you anticipate will appreciate in value, a CLAT can be a very attractive estate planning tool. For example, suppose that you own stock with a value of one million dollars, and that you select a CLAT that will pay $100,000.00 to charity each year. (Recall that with a charitable lead annuity trust, the amount that paid to the charity will be the same each year.) Assuming an AFR of 3.8 percent and a payout period of five years, the relevant calculations reveal that the charitable lead interest would have a value of $447,690. Stated somewhat differentially, in dividing up the value of the $1,000,000 in stock held by the trust, the government assumes that the annuity transferred to the charity has a value of $447,690. The donor would therefore be entitled to an immediate charitable deduction of $447,690. The remaining $552,310 is allocated to the non-charitable beneficiaries. (In other words, the $1,000,000 in total assets contributed to the trust, less the $447,690 allocated to the charitable beneficiary.) The donor has therefore potentially made a taxable gift of $552,310 to the non-charitable beneficiaries. If the donor has never made gifts in excess of the annual gift tax exclusion in past years, no gift tax will be due. This is true because there is a $1,000,000 credit for gifts made during lifetime. (In other words, you may make $1,000,000 of gifts during your lifetime before gift taxes will be imposed.)

Recall that the AFR is the rate that the government assumes that the assets will appreciate. If the assets of the trust perform at a rate that is higher than the AFR, the non-charitable remainder beneficiaries will receive greater value that was assumed for transfer tax purposes. In other words, if the government assumes that the value of the assets in the trust transferred for the benefit of the non-charitable beneficiaries had a value of $552,310 that $552,310 value is locked in for transfer tax purposes. If stock contributed to the trust has increased in value to $5,000,000 when the last payment is made to charity, the $5,000,000 in stock will be transferred to the non-charitable beneficiaries with no further transfer taxes. In other words, the donor will have transferred $5,000,000 in value for a transfer tax cost of $552,310. By contrast, if the stock becomes worthless before the charity has received all of its payments, the non-charitable beneficiaries will receive nothing. The donor will then have used up $552,310 in transfer tax credit without actually passing assets to the beneficiaries. Stated somewhat differently, the amount that the donor can gift during their life, or leave upon their passing, before taxes are imposed will be reduced by $552,310.

Depending upon the anticipated growth of the assets, it may even be possible to avoid the consumption of the lifetime gift tax exclusion. In the above scenario, if the annual payments to the charity were increased to $223,360 per year, the government’s formula values the interest transferred to charity at almost $1,000,000. Recall that in this example, the stock has a total value of $1,000,000 when the trust is allocated to the charity; almost nothing is allocated to the non-charitable beneficiaries. The remainder interest therefore has a value of almost nothing for transfer tax purposes. In other words, the government is willing to bet that the trust will have almost nothing left if it starts out with $1,000,000, and pays $223,360 per year to a charity for five years. If the remaining assets have increased in value to $100,000,000 after all required payments have been made to the charity, $100,000,000 will have been transferred to the non-charitable beneficiary, and the donor has not been required to consume a significant portion of their $1,000,000 lifetime gift tax exemption. By contrast, if the government has wagered correctly, and the trust runs out of money before any distributions are made to the non-charitable beneficiaries, nothing has been lost except for the cost of creating the CLAT.

As a general proposition, it is unlikely that stock valued at $1,000,000 will either appreciate to $5,000,000 or become completely worthless in five years as in the above examples. In most cases, the actual performance of the assets held by the CLAT fall somewhere in between these two extremes. However, these examples have been provided to illustrate the point that a CLAT makes sense only when the donor is willing to gamble that the property to be contributed will increase in value.

CLUTs
While it is possible to create a CLUT, the utility of this device is somewhat limited because it has the effect of increasing the amount transferred to the charity, without a corresponding increase in the charitable deduction, if the assets of the trust appreciate at rate that is higher than the government’s assumed rate (the AFR). Conversely, if the donor is concerned that the assets contributed to the trusty may decline in value, a CLUT may ensure that the non-charitable beneficiaries will receive at least some benefit from the trust so long as its assets do not become completely worthless. Moreover, the charitable deduction received by the donor under a CLUT is based upon the value of the assets at the time that the trust is created. Consequently, the donor may receive a higher charitable deduction by using a CLUT, rather than making an outright donation after the assets have declined in value.

Unlike a CLAT, the assets of a CLUT can not be entirely consumed by the payments to charitable beneficiaries. For example, if the assets have a value of $1,000,000 and a payout rate of ten percent, the charity would receive a payment of $100,000, or ten percent of the value of the assets. If the assets decline in value to $100,000 the next year, the charity would only be entitled to $10,000 (again, ten percent of the value of the assets). By contrast, if the charity had been entitled to a fixed payment of $100,000 per year under a CLAT, the entire $100,000 held by the trust would be distributed to the charity, and nothing would be left for the non-charitable beneficiaries.

LIFE ESTATE AGREEMENT
Under a life estate agreement, the donor retains the right to use a personal residence or farm for their lifetime. Upon the donor’s passing, the property passes to a qualified charitable organization. A charitable trust is not part of this gift plan. Under Nevada law, the life tenant will generally be obligated to maintain the home during their life. However, a contract that clarifies the roles and responsibilities of both the donor and the charity is commonly incorporated into this type of gift plan in order to avoid any misunderstandings following the transfer. Specifically, this agreement generally requires the donor to maintain the property in its current condition, maintain property insurance, and pay the real estate taxes.

A gift of a remainder interest in a home produces a charitable income tax deduction equal to the actuarial value of the remainder interest. When computing the remainder interest in a personal residence or farm, depreciation must be taken into account if any part of the contributed property is subject to exhaustion, wear and tear, or obsolescence. In order to compute depreciation, a donor must determine the estimated useful life and salvage value of the building. For this reason, it is necessary to obtain a detailed appraisal of the property.

GIFT ANNUITIES
A charitable gift annuity is a contract between you and a charitable organization. You make a gift to a charity that is legally obligated to pay you a fixed amount of income for your lifetime. The transaction is, in reality, a bargain sale–part sale and part gift—because the value of your gift to the charity exceeds the value of the annuity promised by the charity. The annuity is backed by the general assets of the issuing charity.

A portion of the annuity payment received by the donor may be subject to income taxes; however, if the donor had sold assets, rather than donating them, the entire amount of the tax would be due in the year of sale. In other words, by exchanging assets for an annuity, the donor may defer the recognition of taxable gain. Moreover, the donor generally will be entitled to a charitable deduction in the year that the annuity is created. The net result is that the donor’s cash flow is increased and the donor’s favorite charity is benefited.

PRIVATE FOUNDATIONS
A private foundation is a charitable entity that primarily receives its support from a small group of individuals, rather than the general public. Private foundations are generally founded by an individual, a family or a group of individuals, and are organized either as a nonprofit corporation or as a charitable trust. You can appoint yourself, as well as other family members or friends, to sit on the foundation’s governing board. One common form of a private foundation is a family foundation. Families sometimes use a family foundation as a forum in which family members can work toward common goals, or as a way to instill the value of charitable giving in future generations of the family. Generally speaking, a private foundation provides the donor with greater control over the charitable purposes for which the donated property is used; however, there are some trade offs for this control.

Inasmuch as a private foundation does not depend upon the public for its funding, there is a perception that private foundations are particularly susceptible to abuse. The primary concern is that the public can not cut off the funding of the entity if it assets are used for the benefit of private individuals, rather than charitable purposes. Consequently, significant restrictions have been placed upon the activities engaged in by private foundations. It must be emphasized that self-dealing between private foundations and their substantial contributors or other disqualified persons will result in the imposition of significant penalties. As a result, great care must be exercised in the operation of a private foundation. Indeed, even some seemingly innocuous activities, such as the use of facilities owned by the foundation, may result in the imposition of penalties.

Moreover, it is necessary to exercise diligence to avoid the imposition of penalties for failure to meet distribution rules, having excess business holdings, holding speculative investments, and engaging in lobbying efforts or other non-charitable distributions. As a result, there are very detailed administrative requirements for private foundations, which can result in significant operating expenses. Additionally, donations to private foundations are subject to lower adjusted gross income requirements than donations to public charities.

There are generally three types of private foundations:

  1. Private Endowed foundations

This is the most common type of private foundation. The foundation’s financial assets create a principal—or endowment—that is invested, and income from the endowment is paid out annually to charity. Generally, the principal can increase with good investment, ensuring the foundation’s continuation and growth to meet future community needs. Private foundations are required by law to pay out annual grants and other qualifying distributions totaling a minimum of 5 percent of the fair market value of their assets.

  1. Pass-Through Foundations

A pass-through foundation is a private grant making organization that distributes all of the contributions it receives each year (not just 5 percent of its assets). The pass-through option may be made or revoked on a year-to-year basis.

  1. Private Operating Foundations

A private operating foundation uses the bulk of its income to actively run its own charitable programs or services. Examples include the operation of a museum, library, research facility or historic property. Some private operating foundations also choose to make some grants to other charitable organizations

A private foundation permits a donor to donate assets to charity, while still effectively maintaining control over the donated assets. For many donors maintaining control is an attractive aspect of a private foundation; however, this virtue also leads to the greatest vice of a private foundation. There is a perception particularly susceptible to abuse, and elaborate rules have been enacted to ensure that private foundations are not misused. While a private foundation may involve significant restrictions and administrative expenses, it is often a useful vehicle where a donor desires to maintain a high degree of control over the donated assets.

COMMUNITY FOUNDATIONS
While a community foundation does not permit the donor to retain the same degree of control as a private foundation, it does allow the donor to avoid the complicated administrative issues associated with private foundations. Indeed, the community foundation, rather than the donor, is responsible for maintaining records and ensuring that all of the administrative details are handled properly.

When a donor donates assets to a community foundation, an account is created in the donor’s name. Funds are then distributed from this account to other charitable organization, typically (although not necessarily) in the donor’s community. Following a donation, the donor gives up the legal right to make binding directives dictating where the donated assets are to be distributed in a particular manner, and community foundations are generally sensitive to the reasonable recommendations of donors. In other words, the donor can not legally control the dispositions of the assets, but may still be able to exercise control from a practical standpoint.

A particular advantage of a community foundation is that it permits the donor to benefit several charitable causes with a single gift. Rather than addressing a single charitable cause, a community foundation may make distributions to a diverse group of causes. For example, rather than creating a private foundation that is limited to providing food for the needy, a community foundation may distribute a portion of its funds to support educational institutions. A community foundation can also adjust its donations as particular issues emerge or subside. For example, while the donor may generally desire to donate money to support medical research, a distribution may be made to assist victims of a disaster in a particular year.

While donations to a private foundation are only deductible to the extent that they are less than thirty percent of the donor’s adjusted gross income, donations to community foundations are subject to a limit of fifty percent of adjusted gross income. Moreover, donating certain appreciated assets to a community foundations are not subject to certain excise taxes, thus ensuring that more of your money goes to the charitable cause of your choice, rather than the government.

Perhaps most notably, a community foundation provides the donor with a simple and convenient method of benefiting their favorite charitable causes without the administrative expenses and complications involved in creating and running a private foundation. The community foundation presents less opportunity for mischief than a private foundation because the community foundation acts as an intermediary between the donor and the distribution of assets. Unlike a private foundation (which may be wholly controlled by the donor), the government has greater assurance that assets donated to a community foundation will be used for charitable purposes, as opposed to a private person. Consequently, the rules governing community foundations are far less restrictive than those relating to private foundations. While a donation to community foundation will be used for charitable purposes, as opposed to a private person. Consequently, the rules governing community foundations are far less restrictive than those relating to private foundations.

While a donation to a community foundation does not permit the donor to retain the same degree of control that would be permissible with a private foundation, issues of flexibility and convenience make a community foundation the right charitable vehicle for many donors. We will be happy to assist you in determining if a community foundation is right for you.

CONCLUSION
Charitable giving is often an effective method of minimizing taxes while advancing your estate planning and philanthropic goals. In order to maximize the benefits to you, your family, and your favorite charitable cause, it is imperative that the transaction be structured appropriately for your individual needs, and a careful analysis of your circumstances is necessary.

INTRODUCTION

A conservatorship is a proceeding where a court appoints a responsible person (called a conservator) to care for another adult who cannot care for him or herself physically or financially (called a conservatee.) The conservator is responsible to the court.

There are two kinds of conservators. A conservator of the person cares for and protects a person when the court decides that the person can no longer do it. A conservator of the estate handles the conservatee’s financial matters, such as paying bills and collecting a person’s income. The court can order a conservator of the person or estate or both.

WHEN IS A CONSERVATORSHIP NEEDED?

If someone has an illness, such as Alzheimer’s, or an accident that leaves them mentally or physically incapacitated. They may need to have a conservator make caregiver decisions or manage their affairs. Typically, a conservator is appointed when a court decides that a person is physically or mentally incapable of managing their affairs.

In a conservatorship of the person, the conservator arranges for the conservatee’s care and protection. The conservator determines where the conservatee will live and is in charge of health care decisions.

In a conservatorship of the estate (money and property), the conservator is responsible for the management of the estate. Often, the reason the court will step in and appoint a conservator is to prevent misuse of the person’s assets. The court will examine all the financial decision made by the conservator.

WHO CAN FILE FOR A CONSERVATORSHIP?

A petition for conservatorship is filed with the court. Notice is given and a hearing is held to determine if the proposed conservatee needs someone to handle his or her affairs. A court investigator will report to the court and make a recommendation concerning whether or not a conservatorship is needed. If the court determines that the proposed conservatee is not competent enough to manage their physical or financial needs, a conservator is appointed.

The court usually appoints a relative to be conservator. Once appointed, the conservator will submit a list of assets of the estate and debts to the court. The conservator will develop a plan of conservatorship. The court must approve the conservator’s accounting of assets and approve all sales. The conservatorship process can be very slow and cumbersome at times.

WHAT RIGHTS DOES A CONSERVATEE HAVE?

A conservatee does not lose all rights. They can still have a say in important decisions. They have a right to be treated with understanding and respect, have their wishes considered, and be well cared for. In general, conservatees keep the right to make or change their will, get married, get mail, have an attorney, have an allowance and make their own health care decisions, unless the court gives that right to the conservator.

WHAT IS THE DUTY OF THE CONSERVATOR?

The conservator has a duty to make smart investments, keep assets separate from anyone else’s property, and use interest-bearing accounts and other investments. The conservator is not allowed to pay himself or an attorney without court approval. The conservator is not allowed to give away the estate or borrow money without court approval.

WHAT IS A TEMPORARY CONSERVATORSHIP?

If the court orders a temporary conservatorship, the conservator has the same duties and powers that a regular conservator has except that the conservatorship will end on the date the a permanent conservator is appointed. A temporary conservator should not make irreversible decisions without informing the court.

WHAT HAPPENS WHEN THE CONSERVATEE DIES?

Upon the death of the conservatee, the conservator must account to the court and distribute any proceeds of the estate to an administrator of a probate or to a trustee of a trust.

ARE THERE ALTERNATIVES TO A CONSERVATORSHIP?

One option to conservatorship proceedings is a durable power of attorney. A durable power of attorney is an arrangement whereby one person authorizes another to take action on the first person’s behalf as his or her agent. This agent has the authority to conduct business and make health care decisions.

Another option is the living trust. With a living trust one can decide in advance and appoint the person who would manage assets should one become incapacitated. The trustee has the right to manage assets for the trust without court supervision.

INTRODUCTION

Most people we talk to in Las Vegas are aware of the fact that they should have a will and an estate plan so that upon death their estates can be administered and distributed to their beneficiaries promptly and efficiently. However, many people fail to plan adequately for lifetime disability. You should be concerned about the possibility of your disability, that is, your inability to legally handle your affairs (business, financial, and personal). Disability can arise from a number of different causes, for example, illness (such as stroke), injury, accident, or old age. If you are unable handle your affairs, who can and will do this for you?

In such cases, Nevada law provides for a probate court proceeding to have an individual or bank appointed to act for you. Guardianship and conservatorship proceedings involve time, expense and perhaps even the embarrassment of trying to prove that you are mentally incompetent. Furthermore, you have no assurance as to whom the court will appoint.

However, a Durable Power of Attorney can save you and your family the time, expense, and inconvenience of a probate court proceeding as well as giving you the power to choose the person who will handle your affairs.

WHAT IS THE POWER OF ATTORNEY?

A power of attorney is a document by which you appoint a person to act as your agent. An agent is one who has authorization to act for another person. The person who appoints the agent is the principal; the agent is also called the attorney-in-fact. If you have appointed an agent by a power of attorney, acts of the agent within the authority spelled out in the power of attorney are legally binding on you, just as though you performed the acts yourself. The power of attorney can authorize the attorney-in-fact to perform a single act or a multitude of acts repeatedly.

WHAT IS THE DURABLE POWER OF ATTORNEY?

Many people are unaware that an ordinary power of attorney is revoked, and the agent’s power to act for the principal automatically stops, if the principal becomes incapacitated. A durable power of attorney is not affected if the principal becomes disabled or incapacitated.

DO I NEED A POWER OF ATTORNEY IF ALL MY PROPERTY IS OWNED JOINTLY WITH MY SPOUSE?

Yes. If you are disabled, your spouse can still sign checks and make withdrawals on joint bank accounts, but your spouse cannot sell jointly owned stocks or your jointly owned home without your signature. Your spouse cannot name or change a beneficiary on your life insurance or your retirement benefits. Even if you own everything jointly, you both should consider having Durable Powers of Attorney.

CAN A DURABLE POWER OF ATTORNEY BE REVOKED?

As long as you are competent you can revoke your Durable Power of Attorney. The revocation should be in writing, and it should be delivered to the agent and to third parties with whom the agent is dealing. A conservator appointed by the probate court can revoke the Durable Power of Attorney. Finally, the Durable Power of Attorney terminates at the time of your death, except for making funeral arrangements. However, a third party is entitled to rely on a power of attorney which has been terminated or revoked until the third party has actual notice of the termination.

WHOM SHOULD I NAME AS MY AGENT?

You may name any adult. But, you should select an agent who is willing to act and in whom you have confidence and trust. Remember, your agent may be making important financial and personal decisions for you. Some of the criteria you should consider include the following:

  1. Who cares about you?
  2. Is the person too young or too old?
  3. Does the person live close to you?
  4. Is the person organized and know when to ask for professional help?

WHAT ARE THE AGENTS OBLIGATIONS TO ME?

You can revoke the Durable Power of Attorney or, if because of your disability you are unable to revoke it, anyone interested in your welfare can ask the probate court to intervene and appoint a conservator to handle your affairs. The conservator can require the agent to account and report, and can even suspend or revoke the Durable Power of Attorney. In addition, you (or your conservator) can sue your agent for damages caused by the agent’s abuse of authority.

PROBLEMS WITH A DURABLE POWER OF ATTORNEY

The biggest problem with any power of attorney is that there is no guarantee that it will be accepted or recognized by third parties. For example, if the purpose of the Durable Power of Attorney is to deal with governmental agencies, such as the Social Security Administration, the Veterans Administration, or the Internal Revenue Service, one must either use the agency’s special Power of Attorney form, or make sure that the Durable Power of Attorney presented to the agency contains the special wording required by each agency’s particular form. Many powers of attorneys do not contain this language.

Another problem occurs if your agent quits, dies, or becomes disabled, in such an event, if you haven’t named an alternate agent, there will be no one to act on your behalf.

DANGERS IF POORELY DRAFTED

The first danger is that one cannot make gifts using a Power of Attorney, unless the Power of Attorney specifically allows for gifting. This is a major concern for those on Medicaid. Many drafters of power of attorneys are unaware of this. This is very important for the middle class, as this gifting language is necessary to do proper public benefits planning.

Furthermore, unless a Power of Attorney includes this explicit gifting language, death bed gifts of the annual exclusion amount cannot be made.

Second, a trust cannot be amended or revoked using a Power of Attorney, unless the Power of Attorney specifically allows this. Many drafters are unaware of this as well

Third, inherited property cannot be disclaimed unless the Power of Attorney specifically allows disclaimers.

Fourth, legal descriptions of property you own should be attached to the Power of Attorney to allow your agent to buy, sell, or refinance the property. If this is not attached to the Power of Attorney, most title companies will not issue title insurance as the Power of Attorney will not properly be on the chain of title without the attached legal description.

ADVANTAGES OF A DURABLE POWER OF ATTORNEY

  1. You (not a court) select your agent.
  2. It can give you and your family some peace of mind knowing that you have named someone to handle your affairs.
  3. It can save time and the expense of a court proceeding.

INTRODUCTION

How many times a year does THAT question come up? It comes up at my house every spring. Wonder why?

The IRS just gave us a great guide. Here’s the scoop:

EXECUTIVE SUMMARY:

The length of time a document must be retained depends on the action, expense, or event the document records. Generally, records that support an item of income or deductions on a tax return must be retained until the period of limitations for that return runs out.

FACTS:

* PERIOD OF LIMITATIONS DEFINED:

The period of limitations is the period of time in which a tax return can be amended to claim a credit or refund, or that the IRS can assess additional tax.

We’ve listed below the periods of limitations that apply to income tax returns. (Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.)

* KEEP RETURNS FOR 3 YEARS IF:

If you file a claim for credit or refund after you file your return; keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.

* KEEP RETURNS FOR 4 YEARS IF:

It is an employment tax record. Keep all such records for at least 4 years after the date

that the tax becomes due or is paid, whichever is later.

* KEEP RETURNS FOR 6 YEARS IF:

You do not report income that you should report, and it is more than 25% of the gross income shown on your return.

* KEEP RETURNS FOR 7 YEARS IF:

You file a claim for a loss from worthless securities or bad debt deduction;

* KEEP RECORDS INDEFINATELY IF:

You have filed a fraudulent return, or

You do not file a return;

BUT WAIT, THERE’S MORE:

The following questions should be applied to each record as you decide whether to keep a document or throw it away.

* PAY SPECIAL ATTENTION TO RECORDS CONNECTED WITH PROPERTY:

Records relating to property must be retained until the period of limitations expires for they year in which you dispose of the property in a taxable disposition.

Those records are needed to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.

Generally, if property is received in a nontaxable exchange, your basis in that property is increased by any money you paid. Records must be retained on the old property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.

* THE TIME IS UP. NOW WHAT?

Even when records are no longer needed for tax purposes, they should be retained until it is certain they will not be needed for other purposes. For example, an insurance company or creditors may require the records to be held for a period of time beyond what the IRS requires.

INTRODUCTION

Generally, if a decedent owned an Individual Retirement Account (“IRA”) during his or her lifetime, upon death, a myriad of rules exist governing the distribution of the IRA based on the beneficiary designations chosen. This article gives the basics of some issues involved with IRA distribution during estate administration, and serves to highlight the importance of involvement of legal counsel during this process.

REQUIRED BEGINNING DATE

The Required Beginning Date (“RBD”) is the date at which a person is required to take distributions from an IRA. The RBD is April 1 of the year after the owner of the IRA reaches 70 ½ years old. If the decedent had reached his or her RBD as of the date of death, it is imperative that any remaining minimum distribution (not already taken by the decedent), for the year of the decedent’s death is taken by December 31of the year of decedent’s death in order to avoid any penalties. This must be taken by the beneficiary of the account and not by the estate, unless the estate is the beneficiary.

If the decedent had not yet reached his or her RBD at the time of death, the decedent’s minimum distribution (based on his or her life expectancy in the year of his or her death) must be taken by December 31 in the year after his or her death to avoid any penalties.

SINGLE BENEFICIARIES

If a single individual is the named beneficiary of the IRA, the beneficiary may receive distributions based on his or her life expectancy as determined by the Single Life Table discussed in the United States Treasury Regulations.

MULTIPLE BENEFICIARIES

If multiple individuals are named the beneficiaries of the IRA, they all must use the oldest beneficiary’s life expectancy to calculate the required distributions. However, if the IRA benefit is split into “separate accounts” for the benefit of each individual beneficiary, the beneficiary of each separate account can receive his or her distributions based on his or her individual life expectancy, as determined by the Single Life Table. These separate accounts must be established by December 31 in the year following the decedent’s death. The IRA plan administrator will need to be contacted for more information regarding the establishment of “separate accounts” if this is applicable.

TRUST AS NAMED BENEFICIARY

Generally, if a trust is a beneficiary of the IRA, the benefits must be entirely distributed out of the plan within five years of the decedent’s death if he or she died before reaching 70 ½, or over the decedent’s remaining single life expectancy in the year of his or her death if he or she died after reaching 70 ½. However, if the beneficiary is a qualifying trust (as more particularly described below), the distribution rules differ. To be a qualifying trust, the trust must comply with Treasury Regulations Section 1.401 (a) (9)-4, A-5. These Regulations allow one to “look through” the trust instrument and treat the trust beneficiaries as though they had been directly named as beneficiaries in the IRA.

Therefore, if only one person is named the beneficiary of a qualifying trust, the benefits can be distributed over the life expectancy of that individual beneficiary, even though the trust is named as the beneficiary of the IRA.

If multiple individuals are named as the beneficiaries of a qualifying trust, the benefits can be distributed to each individual beneficiary over the life expectancy of the oldest beneficiary of the trust, even though the trust is named as the beneficiary of the IRA.

However, some IRA plan administrators allow one to completely “look through” a qualifying trust with multiple individual beneficiaries. In these cases, the plan administrators allow “separate accounts” to be set up for each individual beneficiary. This allows each individual beneficiary to take his/her benefits over his/her life expectancy, even though the trust was the IRA plan administrator to obtain more information on this possibility, if applicable.

While some plan administrators allow one to completely “look through” a qualifying trust with multiple beneficiaries, we do not believe this is the correct interpretation. Regulations Section 1.401(9)-4, A-5 (c) states that the separate account rules are not available to beneficiaries of a trust. Therefore, the two previous distribution options stated above generally must be followed.

QUALIFYING TRUST

A qualifying trust must meet the following requirements of Regulation Section 1.401(a)(9)-4, A-5 in order to allow one to “look through” the trust instrument and treat the trust beneficiaries as though they had been directly named as beneficiaries in the IRA.

  1. The trust must be valid under state law.
  2. The trust is irrevocable.
  3. The beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit are identifiable from the trust instrument.
  4. Certain documentation must be provided to the plan administrator. If a “designated beneficiary” trust is named as beneficiary of the IRA, a list of the beneficiaries as well as a copy of the trust instrument must be sent by October 31 in the year after death.
  5. All beneficiaries of the trust must be individuals.

SPOUSE AS SOLE BENEFICIARY

The Spouse is the sole beneficiary if the spouse, alone, will inherit all of the benefits if he or she survives the IRA owner. The fact that other beneficiaries are named as contingent beneficiaries (who will take is Spouse does not survive the IRA owner, or does not survive the IRA owner for some specified period of time) does not impair his or her status as “sole” beneficiary.

If the IRA is to be divided into “separate accounts” payable to different beneficiaries, then the test of whether the Spouse is the “sole beneficiary” is applied only to the separate account of which Spouse is the beneficiary.

For purposes of post-death minimum distribution rules, it is not essential that Spouse be the sole beneficiary at the time of the decedent’s death, only that Spouse is “a” beneficiary on the date of death, only that she is the sole beneficiary on September 30 of the year after the year in which the IRA owner died is called the “Designation Date.”

The Spouse can elect to treat the deceased spouse’s IRA as the Spouse’s own IRA as long as the election is made at any time after the IRA owner’s death, provided that the Spouse is the sole beneficiary at the Designation Date.

REQUIRED COMMENCEMENT DATE FOR SPOUSAL DISTRIBUTIONS

If the IRA owner dies on or after his or her RBD, the required commencement date for distributions to Spouse is December 31 of the year after the year of the IRA owner’s death.

If the IRA owner dies prior to his or her RBD, and the Spouse is the sole designated beneficiary, the annual distributions to Spouse over his or her life expectancy do not have to begin until the end of the later of: the year following the year in which the IRA owner died, or the year in which the IRA owner would have reached age 70 ½. In contrast, non-spouse beneficiaries must always commence the minimum required distributions by the end of the year after the IRA owner’s death.

DISTRIBUTIONS TO SPOUSE AS SOLE BENEFICIARY

During the Spouse’s lifetime, Spouse must take distributions over his or her life expectancy, recalculated annually; beginning in whatever year he or she is required to begin distributions (see above). The Spouse’s life expectancy is determined by using the single life expectancy table based on the Spouse’s age on his or her birthday in each year for which a distribution is required.

INTRODUCTION

Life insurance often plays a key role in estate planning in Las Vegas. It is frequently useful in providing liquidity and flexibility, as well as to achieve overall estate planning goals.

WHAT IS LIFE INSURANCE?

Life insurance is a contractual agreement between the owner of a policy and the insurance company. The insurance company agrees to pay a certain dollar amount upon the death of the insured in exchange for the payment of premiums. There are primarily three types of life insurance, “term life,” “whole life,” and “universal life” although there are an infinite number of variations on these three types.

Term life insurance is an insurance policy covering a person’s life for a specified number of years. It is often offered with a guaranteed premium for a particular number of years. Term life does not have accumulated cash value. Accumulated cash value generally is the distinction between term life insurance and whole life or universal life insurance. Cash value policies are initially much more expensive than term life insurance policies for the same amount of coverage.

Whole life insurance provides coverage for an individual’s whole life, rather than a specified term. A savings component called cash value or loan value, builds over time and can be used for wealth accumulation. Whole life is the most basic form of cash value life insurance. The insurance company essentially makes all of the decisions regarding the policy. Regular premiums both pay insurance costs and cause equity to accrue in a savings account. A fixed death benefit is paid to the beneficiary along with the balance of the savings account. Premiums are fixed through the life of the policy even though the breakdown between insurance and saving swings toward the insurance over time. Management fees also eat up a portion of the premiums. The insurance company will invest money primarily in fixed-income securities, meaning that the savings investment will be subject to interest rate and inflation risk.

A common variation on these themes is “universal life insurance,” which is a flexible premium life insurance policy that acts as a hybrid between a term life and whole life policy. This type of policy permits variations in the payment of premiums, and typically the insured (rather than the insurance company) controls the investment of policy funds.

IRREVOCABLE LIFE INSURANCE TRUSTS (ILIT)

An irrevocable life insurance trust (ILIT) is a trust designed to cause life insurance proceeds to be excluded from the grantor’s estate for estate tax purposes. This type of trust is often useful to provide liquidity, so that cash may be used to pay estate taxes attributable to assets that remain in the taxable estate. For example, suppose that an estate with no liquid assets owes $500,000 in estate taxes. This may require that the estate sell property in order to pay the government. An ILIT can help to avoid this result. The ILIT can receive $500,000 in life insurance payable on the death of the settler, which can then be used to purchase property from the settlor’s estate. The estate then uses cash to pay estate taxes, and the beneficiaries of the ILIT receive the assets that were purchased from the estate.

There are certain specific requirements that must be met in order for the insurance to be excluded from the settlor’s estate. In summary the settlor must give up control over the trust and the life insurance policy following its formation. An ILIT is irrevocable. While the settlor can decide upon the terms of the trust initially, it generally cannot be changed after its formation. In addition, the settlor cannot retain “incidents of ownership” over the life insurance policy. This requires the appointment of a neutral third party to act as trustee, who may then control the life insurance policy.

In order for premium payments to be eligible for the $13,000 annual gift tax exclusion, notice must be given to the beneficiaries of their right to withdraw the contribution to the trust. This withdrawal right is called a “Crummey power” (which is named after a case in which the taxpayer was named Crummey). Essentially, the settlor is giving the beneficiaries money which is then used to purchase life insurance on the life of the settlor. As a practical matter, this withdrawal right is almost never exercised because the beneficiaries stand to gain more in the long run by waiting until the life insurance is paid upon the death of the settlor.

LIFE INSURANCE FOR BUSINESS

Life insurance is often useful in designing a buy-sell agreement triggered by the death of an owner of a business entity. The type of insurance policies required will depend upon the structure of the buy-sell agreement. It may be necessary for each of the owners to obtain a policy on the life of other owners if the agreement is between the owners directly, although one survivor joint-life policy may sometimes be used to accomplish the same purpose. By contrast, a redemption agreement causes a buyout at the entity level, rather than by the individual owners. This type of agreement typically requires the entity to purchase a joint life policy or separate policies on the life of each member.

The specific type of buy-sell agreement that is appropriate under a given set of circumstances requires careful planning and analysis. In many cases, life insurance may provide the liquidity necessary to make a buy-sell agreement practicable. This is but one example of the fact that estate planning and business planning needs frequently coincide.

ESTATE PLANNING IN BLENDED FAMILIES

Many estate plans provide that assets are to be held in trust for the benefit of a surviving spouse, and then distributed to the settlor’s children when the surviving spouse dies. This does not always reflect the best plan of distribution.

Suppose that a fifty-five year old settlor is married to a forty year old, and has a thirty year old child by a prior relationship. In other words, the settlor’s new spouse is only ten years older than the child. The child will be waiting a long time to receive their inheritance if assets will be held in trust for the lifetime of the surviving spouse. Life insurance may be used to provide the child an immediate inheritance upon the death of the settlor, and the surviving spouse may receive the other assets outright.

LIFE INSURANCE IN NON-TAXABLE ESTATES

Even where it is not anticipated that the estate will be subject to estate taxes, life insurance is often an important estate planning tool. (Currently estate taxes are only imposed on estates exceeding $3.5 million.)

Life insurance is often useful to buy out the share of a beneficiary. For example, suppose that a settlor with three children owns a property with a value of $200,000, and that only two of the children are interested in inheriting the property. The settlor may leave the property to two of the children, and purchase a $100,000 life insurance policy payable to the third child, so that each child receives $100,000 in value.

For a younger person with a modest estate, life insurance is often an affordable method to protect loved ones against the possibility of an untimely death. This is particularly appropriate where the person has young children, who will have a need for funds for many years until they reach adulthood.

CONCLUSION

Life insurance is often a useful tool to achieve estate planning goals. The particular type and amount of insurance can vary greatly from case to case. Please consult with your attorney to learn more about the use of life insurance in your estate plan.

INTRODUCTION

The popularity of living trusts has exploded in recent years, supplanting the will as the estate planning tool of choice for estate management and distribution. A living trust often reduces the cost, hassle, and time involved in post-death administration. A living trust accomplishes these goals because, if properly drafted and funded, it avoids probate. Living trusts, therefore, make good sense and we recommend them for the majority of our clients in Las Vegas.

Unfortunately, the living trust phenomenon has given rise to a new industry. Many states have become overrun by “trust mills”—companies that mass market living trusts by traveling from town to town holding seminars and promoting living trusts like time shares or diet programs. Trust mills have been especially prevalent for two reasons: (1) real estate prices—and hence probate fees, which are calculated as a percentage of the estate—are high; and (2) overburdened local district attorneys offices either do not have the time to prosecute the unauthorized practice of law or view this as a victimless crime.

While the quality of the “cookie cutter,” “one size-fits-all” documents produced by the trust mills varies, the vast number of drafting errors and ambiguities we have found in documents sent to us for review has been discouraging. Unfortunately, most errors are not discovered until after the trustor has died, when remedial action can be taken only through expensive court proceedings, if at all. Equally disturbing is the practice of some trust mills that use the preparation of living trusts as a front to peddle annuities and other financial products.

The fact is most people can obtain competent estate planning assistance from local attorneys for about the same cost as the trust mills charge. Moreover, the local estate planning attorney is far more likely to meet with you personally, customize your trust to your particular situation, be around to answer questions over the years, and be there at death or the onset of incapacity when legal advice and planning becomes critical.

WHAT IS A TRUST?

A trust is a legal relationship in which assets are transferred to a trustee to be used for the benefit of one or more beneficiaries. The person who establishes the trust is called the settlor, grantor, creator, or trustor. Upon accepting the assets as trustee, the trustee undertakes the obligation to use the trust assets in accordance with the trustor’s directions.

WHAT IS A LIVING TRUST?

A living trust is the name given to trusts created during the trustor’s lifetime. A living trust may also be referred to as an inter-vivos trust. A living trust is usually created for the trustor’s benefit during his or her life. After the trustor’s death, the trust assets are distributed or managed for the benefit of the trust beneficiaries, per the instructions in the trust document.

CAN A LIVING TRUST BE CHANGED?

Your living trust may be revocable or irrevocable depending on your objectives as conditions in your life change; you can alter or terminate a revocable trust at any time during your lifetime. A living trust that you create for your own benefit is usually revocable, contains safeguards in the event of illness or incapacity, and may continue after your death for the benefit of others. After your death, the trust becomes irrevocable.

A trust can also be irrevocable, meaning that it cannot be changed or revoked once it has been established. Unlike revocable trusts, one advantage of an irrevocable trust is that it can be arranged so that trust assets are not subject to estate taxes at the trustor’s death. Because of this, life insurance is often placed in an irrevocable trust in a manner that will remove the policy proceeds from the insured’s taxable estate.

CAN I SERVE AS TRUSTEE OF MY LIVING TRUST?

Usually, the trustor (you) will serve as the trustee of the trust while he or she is alive and competent. The trustor names a successor trustee to serve in the event of the incompetence or death of the trustor.

ADVANGTAGES OF A LIVING TRUST

* PROBATE AVOIDANCE

Probate is the process by which title to assets owned in your name alone are transferred after you death. Probate may be expensive and time-consuming depending on the value and type of assets in your estate.

* TAX PLANNING ON FIRST DEATH

In a properly drafted trust, on the first death the assets are split into various sub-trusts depending on the size of the estate. This allows the survivor to do a great deal of tax planning involving the discounting of various assets. For example, if a piece of real property was owned in the trust, on the first death a portion of the property could be funded into various sub-trusts in order to take advantage of fractional ownership discounts, and thus potentially lower estate tax liability.

In the situation of a three trust subdivision (survivor’s trust, marital trust, and credit trust), such a discount can only be taken when assets are funded between the survivor’s trust and the marital trust if the trust instrument is properly drafted by making the marital trust a QTIP trust. Discounting is always available if the asset was funded partially into the credit trust and partially into the survivor’s trust.

* PRIVACY

When your estate goes through probate, your will and other documents become public record. A living trust provides you with a greater degree of privacy because the trust provisions and the assets in your estate are not subject to public disclosure. However, with a living trust that becomes irrevocable at death, Nevada law states that all heirs and beneficiaries are entitled to a copy of the trust.

* EXPEDITES ASSET DISTRIBUTION

As a trust administration is not overseen by court, asset distribution to beneficiaries, or to sub-trusts in a married situation, is often much faster than asset distribution in a probate.

* PROPER MANAGEMENT OF ASSETS

A living trust may reduce the risk of inexperienced and unskilled management of property by allowing you to select a successor trustee to act in the future. Should you die or become incapacitated, the successor trustee takes over management of assets. In addition, the trust assets can be maintained in the trust after your death instead of being distributed outright to beneficiaries who may be unable to handle the management of assets themselves due to their age or other factors.

PLACING ASSETS IN THE LIVING TRUST

To achieve full benefit from a living trust, it is important that appropriate action be taken to transfer assets into trustee ownership. This process is often referred to as “funding” the trust. Funding a trust consists of retitling your bank accounts, bonds, stocks, real estate, and other assets so that the trustee of the living trust is the owner of the assets. Only assets that are funded into the trust will avoid probate.

SELECTING A TRUSTEE

The trustee is responsible for ensuring that the trust is administered pursuant to the trust. A trustee, particularly one who acts after your death or incapacity, should be available to handle all aspects of managing your assets and be willing to act for an extended period of time.

A family member, friend, professional, or bank can serve as a trustee during your life or after your death or incapacity. A trustee is usually not subject to court supervision, and a bond is only rarely required. Because of the varied challenges associated with this duty and the tremendous power a trustee is given, choosing a trustee requires careful consideration.

THE LIVING TRUST MYTH

All the talk and excitement about living trusts has given rise to certain misconceptions about living trusts. We will refer to these myths collectively as “The Living Trust Myth.”

Myth 1: “Living trusts eliminate costs, administration chores, and lawyers.”

This is the number one myth of living trusts. At one time, many estate planning attorneys, including ourselves subscribed to this myth. But then the clients for whom we had prepared living trusts over the years started dying. From our experience in handling hundreds of living trusts after death, we soon learned the truth: there is work to be done and there are costs and expenses involved. Does it cost as much, take as much time, and require as much work as a probate? In most cases, the answer is no. But a living trust does not waive a magic wand over your estate making all your administration troubles disappear.

What has fueled popularity of living trusts is the public’s fear of probate in particular, and its even more pervasive fear and distrust of attorneys and the court system. All too often, the trust mills and other non-attorney trust promoters exaggerate these fears to entice unsuspecting consumers into buying their living trust packages. Thus, to understand the allure of living trusts, one must first understand what probate is and why everyone is so afraid of it.

Probate is simply a court procedure whereby a court-appointed personal representative performs three distinct functions: (1) inventory and appraise the decedent’s assets; (2) pay the decedent’s debts and taxes; and (3) distribute the remaining assets to the decedent’s beneficiaries. People often wonder, “Why do we need probate?” Imagine for a moment the chaos that would result if upon death a person’s relatives, creditors, and the taxing authorities all started grabbing assets and fighting over who gets what, with no civilized system in place to resolve these issues. Probate is the system that developed in England in the Middle Ages to handle the disposition of a person’s assets at death. Since our laws derived from the law of England, the probate system has been passed down to us and is still used today.

Living trusts avoid probate because, unlike a will, the trust does not have to be proved in court and the successor trustee need not be appointed by the court in order to take charge of a decedent’s affairs. In the typical case, the administration baton is simply passed at death from the trustor-trustee to a named successor trustee with no court involvement. The successor trustee then assumes the job of carrying out the trustor’s instructions as set forth in the trust instrument.

What functions does the successor trustee perform after the death of the trustor? There are three: (1) inventory and appraise the decedent’s assets; (2) pay the decedent’s debts and taxes; and (3) distribute the remaining assets to the decedent’s beneficiaries. Do these functions look familiar? They should. These are exactly the same three functions that must be done in probate!

In reality, the only difference between probate and post-death administration of a living trust is that probate is supervised by the court. There is a structured, formal system with rules for handling estate administration. Living trust administration is not supervised by the court. There are few, if any, rules. It is this informality that makes living trust administration cheaper, faster, and easier. It is also this informality that can result in confusion, mismanagement, lawsuits, and potential liability for the successor trustee.

To avoid these problems, the successor trustee must be knowledgeable about the operation of trusts or be willing to learn. He or she must also be well organized and committed to carrying out his or her fiduciary responsibilities in strict accordance with the terms of the trust and the Trust Law. Finally, the successor trustee must work closely with qualified professionals, an estate attorney and CPA, who will prepare required documents and tax forms and who will advise the trustee concerning the complex legal and tax issues that arise at death.

Myth 2: “Living trusts save estate taxes”

There is also a common misconception that living trusts save estate taxes. In the case of an unmarried individual, no estate tax savings result from a revocable living trust because the Internal Revenue code requires the inclusion of the trust’s assets in the trustor’s taxable estate.

Even for the married couple, living trusts do not save a penny in taxes. The estate tax savings that are so often touted by the trust mills can also be obtained through a well-drafted will designed to create a Tax Savings Trust (“bypass trust”) at death. The only difference between the two plans is that the Tax Savings Trust created by will requires a probate at the death of the first spouse to die, whereas the Tax Savings Trust creating under a living trust document does not require a probate. In other words, tax savings is not an additional advantage of living trusts. Rather, it is the same probate-avoidance advantage already discussed above. Thus, to market the living trust as a tax savings device is misleading.

Myth: 3 “Living Trusts Avoid Conservatorships”

Another common myth is that living trusts avoid conservatorships. A conservatorships is a court-supervised procedure, similar to a probate, except for a living person who has become incapacitated (the “conservatee”), rather than for someone who is deceased. It is true that no conservatorship will be needed for assets in a living trust because the successor trustee takes over without court appointment or supervision. However, by law, a trust established on or after July 1, 1987 is subject to mandatory accounting requirements. If the trust trustor is incompetent, to whom will the trustee account? Arguably, a conservator must be appointed by the court to review the trustee’s financial reports on behalf of the incompetent trust trustor. If the trust instrument is carefully drafted, this potential problem may be avoided. Unfortunately, many trust documents simply ignore this issue.

Myth 4: “Living trusts are private and avoid all court proceedings”

A living trust is essentially a contract. A contract signed under duress or as the result of fraud or undue influence, is subject to challenge. Although the law relating to challenges to living trusts is not as well developed as the law relating to will contests, living trusts are not beyond legal challenge by a disgruntled heir.

There may be other instances where court supervision or intervention is sought by the trustee or a beneficiary. The trustee may seek the court’s stamp of approval on accountings or certain proposed actions, such as the sale of a business, especially where there is a hostile beneficiary. As mentioned above, where a trust instrument is ambiguous or improperly drafted, a trustee or beneficiary may petition the court for interpretation of the trust instrument or to reform it. A trust beneficiary may also ask for court intervention where the trustee has refused to make an accounting or where the trustee has acted in violation of the trustee’s fiduciary duties. In fact, suits against trustees of living trusts for mismanagement and breach of trust may be the growth industry of the next decade for law firms who handle probate and trust litigation.

CONCLUSION

On balance, living trusts remain the estate planning tool of choice for disposition of assets after death and for effective estate tax planning. We believe in living trusts and prepare hundreds of such documents each year for a large number of our clients. However, we also believe in educating our clients about the dangers of the Living Trust Myth. We want our clients to make an informed decision about their estate plan based on fact rather than marketing hype.

If you are wondering whether a living trust is right for you, please call us for an initial consultation. If you, or a friend or relative, had a living trust prepared by a trust mill, paralegal, or other non-attorney source, we would be happy to review it. We look forward to hearing from you.

WHAT IS PROBATE?

The purpose of probate is to establish clear title or ownership to assets after death. Probate is the legal way to take a name off title of an asset and put another name on it after death. Probate is a method of transferring assets as provided in a will (testate), or, if a person dies without a will (intestate), in accordance with state law.

IS PROBATE ALWAYS NEEDED?

The size of the estate determines whether it will be probated. If the value of the assets in probate are $20,000 or less, a simple affidavit of entitlement may be used instead of a lengthy and costly probate. If the value of the assets, less encumbrances is between $20,000 and $100,000 a set aside proceeding may be used. This is an expedited form of probate, that does not require the publication of a notice to creditors. For estates between $100,000 to $200,000 a “summary administration” may be used. For estates in excess of $200,000 a full administration will be required.

DO ALL ASSETS GO THROUGH PROBATE?

Not everything in a person’s estate automatically goes through probate. For example, assets held in a living trust avoid probate. Also, a jointly owned asset, such as a bank account, that transfers to the surviving spouse will generally avoid probate while the surviving spouse is alive. However, after the second spouse’s death the asset may have to go through the probate process. Also, assets with valid named beneficiaries such as insurance policies, IRA’s and annuities, avoid probate as long as the beneficiary is alive.

Assets in the deceased’s name alone must be probated to transfer title. The deceased’s share of assets owned as tenant in common must be probated, as well as, life insurance, annuities and retirement assets without beneficiary designations or if the named beneficiaries are deceased, and no continent beneficiary is named.

WHAT HAPPENS IN PROBATE?

The process depends on whether or not the deceased left a will. If there is a will (testate), and it names someone to be appointed as executor, then that person, usually with the assistance of an attorney, files with the court to be appointed executor and to admit the will to probate. Notice must be given to persons named in the will, all known creditors of the deceased, and the deceased’s natural heirs. If the deceased left no will (intestate), the court appoints an administrator to over see the probate process.

The executor or administrator must collect the assets of the estate that are subject to probate, pay debts and death taxes, and request court approval to transfer assets to the decedent’s heirs or the persons named in the will. The executor or administrator will prepare an inventory and appraisal, file tax returns, settle creditor’s claims and distribute the estate.

HOW LONG DOES IT TAKE TO PROBATE AN ESATE?

For most estates, probate of an estate takes nine months to two years. The size and complexity of the estate determines the duration of the probate process. If there is a conflict between the heirs or the beneficiaries, the process can take longer.

WHAT IS THE COST OF A PROBATE?

There are two kinds of fees that are paid by the estate; statutory and extraordinary fees. Statutory fees are established by the state legislature and are calculated as a percentage of the gross value of probate assets, plus income receipts and net gains on sale of assets during the probate administration. The personal representative is entitled to statutory fees: 4% of the first $15,000, 3% of everything above $85,000 and 2% of the assets above $100,000 of the Attorney’s fees must be approved by the probate court. Attorney’s fees may be hourly or a set fee, but said fees generally may not exceed 5% of the estate.

WHAT ARE THE ADVANTAGES OF A PROBATE PROCEEDING?

The advantages of a probate proceeding are that the heirs and beneficiaries are protected by the court. A probate proceeding cuts off the claims of creditors and clears title to property. In addition, questions and disputes are settled under the jurisdiction of the court.

WHAT ARE THE DISADVANTAGES OF A PROBATE PROCEEDING?

The disadvantages of a probate proceeding are that it is costly, time-consuming and lengthy. Probate proceedings, as court proceedings, are inherently inflexible because the court controls the process. All probate transactions are a matter of public record; therefore, there is a lack of privacy.

IS THERE AN ALTERNATIVE TO PROBATE?

The expense and duration of probate is the reason many people execute living trusts. A living trust is a way to protect ones heirs and beneficiaries form the cost, stress and time lost in probate court. Most people want to consider ways to avoid probate, and yet ensure that their assets are protected for their family and beneficiaries by creating a trust. Administering a trust should be done with the help of an attorney to make sure all the estate assets are transferred into the trust properly and that the intent of the trustor is carried out.

WHAT IS A QPRT?

A qualified personal residence trust (QPRT—pronounced “kew-pert”) is an irrevocable trust that allows you to leverage your $5 million lifetime gift tax exemption. A QPRT takes advantage of certain provisions of the law to allow a gift to the QPRT by its creator (the “grantor”) of his or her personal residence, usually for the ultimate benefit of children, at a “discontinued” value. This, in turn, may remove the asset from the grantor’s estate, reducing potential estate taxes on the grantor’s death. If a trust conforms to all of the requirements set forth in regulations, it is not subject to certain special valuation provisions of the Internal Revenue Code which limit such discounts, and the retained and remainder interests will be valued under traditional gift tax valuation rules.

Under a QPRT, the Grantor is the person who owns the residence to begin with and creates the trust, reserving the right to live in the house for a specified period of time. This interest is called the “retained interest” because it is what the grantor retains. At the end of that period, the ownership of the residence goes to the beneficiary or beneficiaries. This interest is called the “remainder interest,” and each beneficiary is called a “remainder beneficiary.”

THE BASIC IDEA

A QPRT may serve a useful purpose when the grantor wishes to transfer his/her personal residence to family members (usually children) at some time in the future, and reduce the overall transfer tax cost—that is, estate and gift tax cost—of the transfer. For gift tax purposes, the original transfer will be treated as a gift of the remainder to the remainder beneficiaries (for example, the children) and the grantor must file a gift tax return at the time the residence is transferred to the trust. The value of the remainder is derived by first determining the fair market value of the entire property, and then subtracting the value of the retained interest.

The value of the retained interest is a function of the length of the trust term and the age of the grantor, calculated in conjunction with interest rates published by the IRS for making present value calculations. Other things being equal, the longer the term of the trust, the larger the value of the retained interest, the smaller the value of the remainder, and the smaller the taxable gift. The amount of gift tax due will usually be offset by the grantor’s lifetime gift tax exemption amount ($5,000,000).

To create a QPRT, a homeowner transfers his or her residence to a trust that exists for a predetermined period of time (for example, 5, 10, 15 years). The homeowner retains the right to use the residence during the trust term. The trust terminates at the end of the term and title to the residence is transferred to the beneficiaries of the trust, usually the homeowner’s children, or a trust for the homeowner’s children. If properly structured, the homeowner may also lease back the residence at the end of the trust term for its then fair market rental value, thereby making an even greater transfer out of his-her estate to his/her children. When rent is received, the child will then be required to pay income tax on this amount.

THE “BET”

If the grantor dies before the trust has terminated the residence will be included in his or her taxable estate, and estate tax will be paid on it, because the grantor retained the use of the property for a period that did not end before his or her death. That is, the purpose of the trust will have been defeated. However, the estate will get credit for the exemption previously allocated.

Usually, a provision in the QPRT will provide that, in the even of premature death, the property will be distributed back to the homeowner’s probate estate to be distributed under his or her will, or to the homeowner’s revocable living trust to be distributed with his or her other assets. In other words, if the homeowner dies before the end of the trust term, the only thing to lose are the fees and costs incurred in setting up the trust. On the other hand, if the homeowner survives the term, the property will be distributed to the QPRT beneficiary (the children) without further transfer tax, which can result in substantial estate tax savings.

As mentioned above, when the trust term is relatively long, the value of the gift to the remainder beneficiaries will be relatively low, and the gift tax cost of transferring the residence to the trust will be correspondingly low. In contrast, when the trust term is relatively short, the value of the gift to the remainder beneficiaries will be relatively high and the gift tax cost of transferring the residence to the trust will also be correspondingly high. However, the lower the gift tax cost that results from a relatively long trust term must be weighed against the greater risk that the residence will be included in the grantor’s gross estate if he or she dies before expiration of the trust term. In theory, a QPRT will afford the greatest transfer tax savings when the grantor is young and the trust term is long.

For a grantor who is not young, the risk of death before expiration of the trust term is real and has to be weighed against the expenses of the trust (including initial documentation and ongoing accounting services), the loss of stepped up basis, discussed below, and the loss of alternative strategies (e.g. annual exclusion gifts of interests in the property to donees not now the beneficiaries gifts).

EXAMPLE

Hank Client, a widower aged 67, owns a home worth $500,000. Hank owns other assets which puts him in the 46 percent estate tax bracket (the top estate tax bracket for 2009). Hank has a life expectancy of 15.2 years. After consultation with his estate planning attorney and CPA, Hank decides to create a 15-year QPRT. At the end of the term, the property will pass to Hank’s children outright. The applicable IRS table rate for the month in which the QPRT is established is 4.8%. Hank estimates that the property will appreciate at 5% per year.

Without QPRT

Present value of residence: 500,000

Value of residence at Hank’s death: 1,039,464

Death tax paid on residence: 498,943

Net to children at Hank’s death: 540,521

With QPRT

Present value of residence: 500,000

Amount of taxable gift: 132,880

Value of residence at Hank’s death: 1,039,464

Death tax paid on residence: 0

Net to children at Hank’s death: 906,564

Summary

Net to children without QPRT: 540,521

Net to children with QPRT: 906,564

Increase to children (estate tax savings): 366,043

POTENTIAL SAVINGS

The calculations involved in determining the valuation of the gift is rather complex. In general, the longer the term of the trust, the lower the use of the gift tax exemption and the higher the estate tax savings. Of course, if the grantor does not survive the term of the trust, there is no estate tax savings at all because the trust assets are included in the grantor’s estate for estate tax purposes. The obvious disadvantage with the longer term is that it reduces the likelihood that the grantor will outlive the trust term; that is it increases the chance that none of the hoped-for benefits of the trust will be realized. The longer term also increases the likelihood of substantial market appreciation, i.e., a large trade-off of capitol gains tax savings (see below) for transfer (estate and gift) tax savings.

CAPITOL GAINS TAX SAVINGS TRADEOFF

The effects of a carry over income tax basis must also be considered. This concerns the income tax liability to the remainder beneficiaries if they sell the residence either following the grantor’s death or following termination of the trust. If they were to take the residence by inheritance, it would have an income tax basis “stepped-up” to its value as of the date of the parent’s death. On the other hand, if the QPRT “bet” succeeds, i.e., if the grantor outlives the trust term and the children take the remainder under the terms of the trust, their basis will be the same as the grantor’s. If there is substantial market appreciation over the price the grantor paid, the increased capital gains tax may well offset the lower gift tax achieved by the QPRT.

However, the estate tax rates currently far exceed the capitol gains rates. The children could defer or eliminate the income tax by structuring the sale as a like-kind exchange or establishing a charitable remainder trust. The basis step-up might also be preserved if the homeowner buys back the residence at the end of the trust term.

WHAT PROPERTY CAN BE USED?

A QPRT may be created using a primary residence or second home, such as a cabin, a vacation condominium, or even a yacht. Business or investment property, such as an apartment complex, office building, or farm cannot be used. For a married couple owning a home jointly, even greater estate tax savings are possible because their respective ownership interests are entitled to minority interest and marketability discounts.

PERMANENCE

A QPRT is an irrevocable trust. Unless the trust ceases to qualify as a qualified personal residence trust, the grantor cannot expect to regain ownership of the residence, and when the trust term expires according to the provisions of the trust instrument, the residence will automatically pass to the remainder beneficiaries. After expiration of the trust term the residence may be unavailable to the grantor either as a residence or as an asset that can be sold if financially necessary. However, the grantor may rent back the respective residence at fair market rent.

ADMINISTRATIVE BURDEN AND EXPENSE

Because the trust is irrevocable, it must keep its own books and file annual federal and state income tax returns if there is any income, which is usually not the case unless the residence is sold, the expense and bother of these factors should be considered.

ELIGIBILITY FOR ONE-TIME EXCLUSION AND ROLLOVER

The trust instrument must require that any income of the trust be distributed to the grantor, the trust is a “grantor trust” for income tax purposes and the grantor will be treated as the owner of the trust for income tax purposes. Because of this, the grantor must still pay tax on any income and can still qualify for the $250,000 exclusion of gain on any sale of the residence.

USE OF RESIDENCE ON TERMINATION OF TRUST

The grantor may be required to leave the personal residence when it is distributed, at the end of the trust term, to the remainder beneficiaries. However, the grantor may be permitted to remain in the residence if he or she pays fair market rent for the use of the residence. This rental payment will also allow the grantor to transfer more money out of his or her state to the ultimate beneficiaries. It may be risky to enter into a lease arrangement before the end of the original trust term. If, before the residence is transferred to the trust, there is any arrangement, whether formal or informal, that the grantor will not in fact lose the use of the residence on expiration of the trust term, but will have some right to remain in the residence beyond that time, it is possible that the trust might not be recognized as a QPRT and the advantages of the trust would be totally lost.

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