Decanting – A New Look at an Old Friend

Diana S.C. Zeydel Greenberg Traurig, LLP 333 S.E. 2 nd Avenue Miami, FL 33131 305-579-0575 [email protected]

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New Estate Tax Law Summary

Annual Exclusion Gifts (Don’t Count at All) Tuition and Medical Direct Payment Exemption Lifetime Exemption Estate Tax Exemption Estate Tax Rate Discounts and Installment Sales/GRAT’s, etc.

2009

$13,000 Unlimited Like Before $1,000,000 $3,500,000 (less what was used of $1,000,000 above) 45% Available

2010

$13,000 Unlimited Like Before $1,000,000 Unlimited 35% Available

2011-2012

$13,000

2013

$14,000 (unless adjusted )

2014

$14,000 Unlimited Like Before Unlimited Like Before Unlimited Like Before 2011 - $5,000,000 2012 - $5,120,000 2011 - $5,000,000 2012 - $5,120,000** (less portion of used lifetime gifting exclusion) $5,250,000 $5,340,000 $5,250,000 (less portion of used lifetime gifting exclusion) $5,340,000 (less portion of used lifetime gifting exclusion) 35% Available 40% Available 40% Available

Portability of First Dying Spouse’s $5,120,000 Exemptions

No No Yes Yes Yes 2

2013 TAX RATES SUMMARY FROM BOOK ENTITLED THE ESSENTIAL PLANNING

GUIDE TO THE 2013 INCOME AND ESTATE TAX INCREASES

Copyright © 2012 Haddon Hall Publishing, LLP

Long Term Capital Gain Short Term Capital Gain C Corporation Dividend Income Ordinary Income Employment Taxes FICA/FUTA Taxes Estate Tax 2012

15% 35%

2013

20% 39.6%

2013 Medicare Tax

3.8% 3.8% 15% 35% Employer: Employee: 1.45% Total: 1.45% 2.9% 39.6% 3.8% 39.6% Employer: Employee: 2.35% Total: 3.8% 1.45% (The additional .9% only applies as shown to the right.) 3.8% Additional .9% on wages exceeding $200,000 for single taxpayers and $250,000 or married taxpayers.

N/A 6.2% Employer/4.2% Employee on wages up to $110,100.

$5,120,000 Exemption 35% Rate 6.2% Employer 6.2% Employee on wages up to $113,700.

$5,340,000 40% Rate N/A

2014 Highest Tax

23.8% 43.4% 43.4% 43.4% 3.8% total 6.2% Employer 6.2% Employee on wages up to $117,000.

$5,340,000 40% Rate 3

During both spouse’s lifetimes:

PROTECTIVE TRUST LOGISTICAL CHART

First Dying Spouse’s Revocable Trust Surviving Spouse’s Revocable Trust Upon first death in 2014: $5,340,000* Remaining Assets During surviving spouse’s remaining lifetime: Family (By-Pass) Generation Skipping Trust (Not taxed in surviving spouse’s estate) Upon second death: Surviving spouse can have the right to redirect how assets are distributed on second death.

QTIP Non-GST Trust (Marital Deduction Trust that is not generation skipping) Surviving Spouse’s Revocable Trust (Will include assets owned jointly on first death) $5,800,000?* Remaining Assets After deaths of both spouses: Generation Skipping Trusts for Children Children’s Trust (or distributions) Generation Skipping Trusts for Children (Will merge with first dying spouse’s Generation Skipping Trusts shown on left) Children’s Trust (or distributions) Benefits children and grandchildren.

Not estate taxable in their estates.

Benefits children.

Taxable in their estates.

Benefits children and grandchildren.

Not estate taxable in their estates.

Benefits children.

Taxable in their estates.

*Assumes first spouse dies in 2014 and that the surviving spouse dies in a later year when the estate tax exemption has gone up to $5,800,000 (based upon 8.57% cumulative inflation). The estate tax exemption is $5,340,000 for those that die in 2014, and increases with inflation in $10,000 increments.

If the first spouse does not use the entire exemption amount, what remains may be added to the surviving spouse’s allowance under the “portability rules” but will not grow with inflation.

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About our Presenter – Diana Zeydel

Diana S.C. Zeydel is a shareholder of the law firm of Greenberg Traurig, P.A., in Miami, Florida, and a member of the Florida, New York and Alaska Bars. She is a member of the Board of Regents and immediate past Chair of the Estate & Gift Tax Committee of the American College of Trust and Estate Counsel. She is a member of the Executive Council of the Real Property, Probate and Trust Law Section of the Florida Bar and an ACTEC liaison to the Section. Diana is a frequent lecturer on a variety of estate planning topics. She has authored and co-authored several recent articles, including “Portability or No: The Death of the Credit Shelter Trust,” Journal of Taxation, May 2013; “Imposition of the 3.8% Medicare Tax on Estates and Trusts,” Estate Planning, April 2013; “Congress Finally Gives Us a Permanent Estate Tax Law,” Journal of Taxation, February 2013; “Tricks and Traps of Planning and Reporting Generation Skipping Transfers,” 47th Annual Heckerling Institute on Estate Planning, 2013; “New Portability Temp. Regs. Ease Burden on Small Estates, Offer Planning for Large Ones,” Journal of Taxation, October 2012; “When Is a Gift to a Trust Complete: Did CCA 201208026 Get It Right?” Journal of Taxation, September 2012; “Turner II and Family Partnerships: Avoiding Problems and Securing Opportunity,” Journal of Taxation, July 2012; “Developing Law on Changing Irrevocable Trusts: Staying Out of the Danger Zone,” Real Property, Trust and Estate Law Journal, Spring 2012; “An Analysis of the Tax Effects of Decanting,” Real Property, Trust and Estate Law Journal, Spring 2012; Comments submitted by ACTEC in response to Notice 2011-101 on Decanting, April 2012; Comments submitted by ACTEC in response to Notice 2011-82 on Guidance on Electing Portability of the DSUE Amount,” October 2011; Contributor to A Practical Guide to Estate Planning, Chapter 2 Irrevocable Trusts, 2011; “Estate Planning After the 2010 Tax Relief Act: Big Changes, But Still No Certainty,” Journal of Taxation, February 2011; “The Impossible Has Happened: No Federal Estate Tax, No GST Tax, and Carryover Basis for 2010” Journal of Taxation, February 2010; “Tax Effects of Decanting – Obtaining and Preserving the Benefits,” Journal of Taxation, November 2009; “Estate Planning in a Low Interest Rate Environment” Estate Planning, July 2009; “Directed Trusts: The Statutory Approaches to Authority and Liability,” Estate Planning, September 2008; “How to Create and Administer a Successful Irrevocable Life Insurance Trust” and “A Complete Tax Guide for Irrevocable Life Insurance Trusts,” Estate Planning, June/July 2007; “Gift Splitting - A Boondoggle or a Bad Idea? A Comprehensive Look at the Rules,” Journal of Taxation, June 2007; “Deemed Allocations of GST Exemption to Lifetime Transfers” and “Handling Affirmative and Deemed Allocations of GST Exemption,” Estate Planning, February/March 2007; “Estate Planning for Noncitizens and Nonresident Aliens: What Were Those Rules Again?” Journal of Taxation, January 2007; “GRATs vs.

Installment Sales to IDGTs: Which is the Panacea or Are They Both Pandemics?” 41st Annual Heckerling Institute on Estate Planning, 2007; and “What Estate Planners Need to Know about the New Pension Protection Act,” Journal of Taxation, October 2006. Diana received her LL.M. in Taxation from New York University School of Law (1993), her J.D. from Yale Law School (1986), and her B.A., summa cum laude, from Yale University (1982), where she was elected to Phi Beta Kappa.

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Introduction to Decanting

> > – – – What is decanting? EPTL 10-6.6: The first decanting statute Motivation for act Legislative history statements: declaratory of the common law Basic requirements of original statute Greenberg Traurig, LLP | gtlaw.com

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Decanting Statutes

> Alaska, Arizona, Delaware, Florida, Illinois, Indiana, Kentucky, Michigan, Missouri, New Hampshire, New York, Nevada, North Carolina, Ohio, South Dakota, Tennessee, Texas, Virginia, Wyoming Greenberg Traurig, LLP | gtlaw.com

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Common Law

>

Cases:

– Phipps, 142 Fla. 782 (1940)  “The general rule gleaned from the foregoing and other cases of similar import is that the power vested in a trustee to create an estate in fee includes the power to create or appoint any estate less than a fee unless the donor clearly indicates a contrary intent.” – Estate of Spencer, 232 NW 2d 491 (Iowa 1975) – Wiedenmayer v. Johnson, 106 NJ Super (1969) Greenberg Traurig, LLP | gtlaw.com

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Wiedenmayer

>

“The son's ‘best interests' is not defined in his father's trust indenture. The expression is not limited to a finding that distribution must be to the son's best ‘pecuniary’ interests. His best interests might be served without regard to his personal financial gain. They may be served by the peace of mind, already much disturbed by matrimonial problems, divorce and the consequences thereof, which the new trust, rather than the old contingencies provided for in his father's trust indenture, will engender.”

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Wiedenmayer

>

“Of what avail is it to rest one's ‘best interests' on a purely financial basis, and without regard to the effect upon a man's mind, heart and soul, if the end result would produce a wealthier man, but a sufferer from mental anguish?”

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Morse v. Kraft – Massachusetts Supreme Court

> Court cited Phipps but appeared more inclined to rely on Wiedenmayer > Court relied on fundamental principle that in interpreting a trust the intent of the settlor is paramount > The court focused on the authority to distribute “for the benefit of” as evidence of the settlor’s intent that the trustee have authority to distribute in further trust > The court admitted affidavits of the settlor, attorney/draftsperson and the trustee Greenberg Traurig, LLP | gtlaw.com

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Morse v. Kraft

> The court indicated that a more recent trust instrument without express decanting authority may create a negative inference > Declined, as requested in the Boston Bar Association amicus brief, to recognize an inherent power of trustees of irrevocable trusts to exercise their distribution authority by distributing property in further trust, irrespective of the language of the trust Greenberg Traurig, LLP | gtlaw.com

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In re Kross – Nassau County Surrogate’s Court

> Decanting under EPTL 10-6.6(j)(1) – Original Trust settled by beneficiary’s grandparents – Beneficiary was special needs and the purpose of the decanting was to preserve eligibility for government benefits – Wholly discretionary trust until age 21, at 21 mandatory income quarterly, principal at 25, 30 and 35 Greenberg Traurig, LLP | gtlaw.com

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In re Kross

> Attorney General’s arguments – Trustees had no authority to decant because the beneficiary would be entitled to mandatory payments in the future  Court disagrees – Decanted trust is self-settled  Decanting Notice sent May 1, 2012, beneficiary attained 21 on May 7, 2012  On May 2, beneficiary’s father consented on behalf of the beneficiary to the decanting • Trust instrument provided that parent or guardian who is not a trustee may act on behalf of the beneficiary Greenberg Traurig, LLP | gtlaw.com

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In re Kross

> Court holds as follows: – Trustees are an authorized trustees – Trustees complied with the statute – Consent by parent was effective to shorten the 30-day notice period – Decanting was effective May 2, 2012, prior to the beneficiary attaining age 21 – The appointed trust is an effective third party special needs trust – No requirement for a payback provision in the appointed trust Greenberg Traurig, LLP | gtlaw.com

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Reasons to Decant

– – – – – – Correct a drafting error Avoid an adverse tax effect such as qualifying “fixing” a trust so it can be a qualified subchapter S trust Extend the time or event when a trust will end Add or eliminate a spendthrift provision Change the situs of a trust Avoid a state or local tax Greenberg Traurig, LLP | gtlaw.com

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Reasons to Decant

– – – Grant a presently exercisable or later exercisable power of appointment  PLR 200243026 • Discretionary power to invade for care, support, maintenance, education, advancement of life and comfortable living  Rev. Rul. 75-550 • • Calculating value of life estate under 2013 Include “estimated amount of all possible invasions” for the benefit of others Make a trust a grantor trust or reverse Dividing one trust into separate trusts for asset protection or separate share reasons Greenberg Traurig, LLP | gtlaw.com

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Tax Concerns

> Income Tax > Gift Tax > Estate Tax > GST Tax Greenberg Traurig, LLP | gtlaw.com

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Conclusion

> Decanting provides an opportunity to change the terms of an existing trust > Can preserve or even enhance the tax benefits Greenberg Traurig, LLP | gtlaw.com

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To register for one of the seminars please email Janine Gunyan at [email protected]

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To view this webinar please email Mark Carrington at [email protected] or Alan Gassman at [email protected]

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Planning with Self-Cancelling Installment Notes and Private Annuities: Don’t Get Burned Wednesday, November 20, 2013 12:30 – 2:00 p.m.

Professor Jerry Hesch, Lawrence Katzenstein, Edward P. Wojnaroski, Jr., Alan S. Gassman, J.D., LL.M. and Kenneth J. Crotty, J.D., LL.M.

To register for this event please visit: http://www.bna.com/planning-selfcancelling installment-w17179878865/ For discount information please email [email protected]

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MORE THAN ONE WAY TO SCIN A GRAT? (The “SCGRAT”) WHAT IF THERE IS NOT TIME TO APPRAISE THE UNDERLYING ASSETS AND ENTITY DISCOUNTS BEFORE COMPLETING A SELF-CANCELLING INSTALLMENT NOTE TRANSACTION?

GRAT provides that first $400,000 worth of assets remain in GRAT and any excess from initial contribution will be payable over 5 annual installments of excess amount plus the 7520 Rate.

GRAT Can benefit spouse and descendants after 5 years of payments to Grantor.

100% CLIENT/GRANTOR SCIN $1,500,000 Step 1 – Client places assets in LLC owned by client and receives back a Self Cancelling Installment Note.

Step 2 – Client gifts 100% ownership in the LLC to the GRAT.

Step 3 – A valuation firm values the assets under the LLC and actuarial tables are used to determine the SCIN value.

Step 4 – The excess of asset value over the SCIN value is the GRAT contribution amount.

Step 5 – The GRAT may provide for holding assets equal to $400,000, and distributing back 5 annual payments based upon any excess over $400,000. $2,000,000 - $1,500,000 = $500,000 . $500,000 - $400,000 = $100,000. $100,000/5 = $20,000 Step 6 – If the IRS determines that the valuation assumptions used are incorrect, any excess value will pass back to the Grantor over 5 annual payments, and will qualify for the estate tax marital deduction if the grantor dies during the first 5 years survived by a spouse.

LLC Assets estimated to be worth $2,000,000 ($500,000 in cash plus $1,500,000 in Grandpa’s LLC interest (90%)) 90% Cash $500,000 Grandpa, 10% GRANDPA LLC $1,928,571 in assets ($1,928,571 x .9 x .7 = $1,500,000) 23

SCIN vs. PRIVATE ANNUITY vs. GRAT

Can be valued based upon standard life expectancy tables, if taxpayer has better than 50% chance of living one year.

Must pass the “probability of exhaustion test” (significant minimum value held under trust and/or by guarantors)

.

Must make annual payments.

Compatible with defective grantor trust.

Payments must include principal.

Explainable to the client.

Income tax imposed upon death.

SCIN This is being contested by the IRS.

No.

Probably, interest only until it balloons.

Yes.

Not until it balloons.

PRIVATE ANNUITY GRAT Safe, under Treasury Regulation Sections 20.2031-7(d); 20.7520-3(b) Yes.

Possibly not, but IRS may not agree. (See Zaritsky,

Tax Planning for Family Wealth Transfers

§ 12.04[h], (4 th ed. 2002)) No.

Safe, under Internal Revenue Code Section 2702(a)(2)(B); 20.7520 3(b).

Yes- According to Treasury Regulation Section 1.7520 3(b)(2)(i); 20.7520-3(b)(2)(i); 25.7520-3(b)(2)(I), but is the IRS’s position under the Regulation incorrect? – See Katzenstein,

Turning the Tables: When do the IRS Actuarial Tables Not Apply?

, Thirty-Seventh Univ.of Miami Inst. On Est. Planning, Ch. 3 (2003).

No- The

Kite

case allowed no payments for the first 9 years.

Subject to probability of exhaustion test.

Probably not- as in the

Kite

case.

Yes.

No, if structured as a

Walton

-style GRAT.

Yes.

Yes, it is a Grantor Trust.

Equal or increasing payments would represent income and principal conceptually.

Slightly more complicated.

No- but on death, there is a negative estate tax impact.

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SCIN vs. PRIVATE ANNUITY vs. GRAT (Continued)

Stepped up basis on death of seller if assets are sold or transferred to individuals or non-grantor trusts.

Stepped up basis if assets are sold or transferred to grantor trusts. Possible usury issues for older taxpayer.

Are Payment Rights Creditor Protected?

SCIN PRIVATE ANNUITY GRAT Only to the extent of payments made before the death of the seller. The purchaser only gets basis to the extent of payment actually made.

Yes, hopefully. (See Blattmachr, Gans and Jacobson, Income Tax

Effects of Termination of Grantor Trust Status by Reason of the

Grantor’s Death, Journal of Taxation, September 2002) Yes, unless the risk premium is applied to the note principal.

Generally not, but can be held by family limited partnership or other entities that provide charging order or creditor protection. Only to the extent of payments made before the death of the seller. The purchaser only gets basis to the extent of payment actually made.

Yes, hopefully. (See Blattmachr, Gans and Jacobson, Income Tax

Effects of Termination of Grantor Trust Status by Reason of the

Grantor’s Death, Journal of Taxation, September 2002) No.

Yes, in several states. Non-applicable– GRATs do not involve sales of assets. Yes, hopefully. Depending upon structuring.

No.

Yes, in several states. 25

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Today

HAROLD AND CLAUDIA SANDERS

Residence Investments $750,000 $6,500,000 Annual Growth Rate 3.03% Annual Additions $50,000 Annual Growth Rate 10.98%less 15% fees SCENARIO: SAMPLE DATA Visualization over 20 Year Time Span Harland Sanders Life Expectancy is 9.2 Years Claudia Sanders Life Expectancy is 19 Years

ILIT - HARLAND GIFTING TRUST(S)

Value $0 Annual Gifts $56,000 (adj for inflation) Annual Growth Rate 10.98% less 15% fees Death Benefit $100,000 Annual Premium $5,000

ILIT - CLAUDIA ILIT - SURVIVORSHIP

Death Benefit $100,000 Annual Premium $5,000 Death Benefit $100,000 Annual Premium $5,000 Upon 1 st Residence Death (in Year 10) $850,000 Annual Growth Rate 3.03%

CLAUDIA SANDERS

$50,000 Investments $4,000,000 Annual Additions Annual Growth Rate 10.98%less 15% fees

BY PASS TRUST

Initial funding upon first death - $3,500,000

GIFTING TRUST(S)

Value $914,316 Annual Gifts $28,000 (adj for inflation) Annual Growth Rate 10.98% less 15% fees Annual Growth Rate 10.98% less 15% fees

ILIT - HARLAND

Death Benefit $100,000 Annual Growth Rate 10.98% less 15% fees

ILIT - CLAUDIA ILIT - SURVIVORSHIP

Death Benefit $100,000 Annual Premium $5,000 Death Benefit $100,000 Annual Premium $5,000 Upon 2 nd Death (in Year 25) Residence

CLAUDIA'S ESTATE

Investments Exclusion/Portability $850,000 $16,000,000 ($10,000,000) Net Taxable Estate: $6,850,000

TOTAL PASSED TO BENEFICIARIES

Claudia's Trust $4,110,000 Bypass Trust Gifting Trust ILIT - Harland ILIT - Claudia ILIT - Survivorship $6,589,000 $2,356,246 $230,000 $100,000 $100,000

TOTAL: $13,485,246 ESTATE TAX $2,740,000

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SAVINGS AFTER 21 YEARS WITH DISCOUNTED GIFT, LOW INTEREST NOTE, AND GRANTOR PAYS INCOME TAX IS $5,112,565 32

SAVINGS AFTER 21 YEARS WITH NO DISCOUNT IS $3,888,882. DISCOUNTING SAVED IS $1,223,683.

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SAVINGS AFTER 21 YEARS WITH TRUST PAYING INCOME TAX IS $2,903,932.

SAVINGS FROM GRANTOR PAYING INCOME TAX IS $2,208,633.

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SAVINGS USING A 20 YEAR SCIN IF THE CLIENT DIES IN YEAR SEVEN IS $2,686,697.

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