Using the Beneficiary Controlled Trust

What is a Beneficiary Controlled Trust?

A Beneficiary Controlled Trust is an estate or gift tax planning technique where parents leave property to their children in a trust rather than outright.  As the name implies, the child-beneficiary is the trustee of the trust.  Thus, the Beneficiary Controlled Trust.

Why are estate planners and their clients increasingly using Beneficiary Controlled Trusts?

It is easier to explain why, if we first understand that there are essentially two methods to leave property to the typical child, excluding those that are irresponsible, etc., they are:

• Outright to the child
• In a trust for the child where the child is the trustee

As we are assuming that there are only two methods to leave the property, we need to compare them against one another.

What are the factors used in the comparison?

We start by listing the things that a beneficiary can do when the property is left outright and free of trust with how those same things included in a Beneficiary Controlled Trust.

What can an owner of property do with the property?

There is actually a fairly limited number of things, they can do, they are:

• Give the property away
• Leave the property to anyone they want
• Use the property without paying for the use
• Sell the property
• Destroy the property
• Lose the property to a creditor
• Lose the property to a divorcing spouse

Do I understand correctly that you are now going to compare the ability of the beneficiary-trustee of a Beneficiary Controlled Trust to do the same things that an outright beneficiary could do?

Yes, that is exactly correct.  Let’s see what the comparison shows:

• Give the property away:  The beneficiary-trustee of a Beneficiary Controlled Trust may be given the power to make gifts of the property in the trust to anyone other than the beneficiary or the creditors of the beneficiary.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Leave the Property to anyone they want:  The beneficiary-trustee may be given the power to leave the property to anyone other than the beneficiary’s estate, creditors of the beneficiary, or the creditors of the beneficiary’s estate.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Use the property without paying for the use:  The beneficiary-trustee of the Beneficiary Controlled Trust may be authorized to use the property of the trust without paying for the use.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Sell the property:  The beneficiary-trustee may be given the power to sell the property and reinvest the proceeds.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Destroy the property:  The beneficiary-trustee may not be given the power to destroy the property.  The Beneficiary Controlled Trust provides more property protection than an outright bequest.  We’ll give the Trust a Superior Protection rating.
• Lose the property to a creditor:  The Beneficiary Controlled Trust may be prepared in such a manner that creditors of the beneficiary-trustee may not attach assets held in the Beneficiary Controlled Trust.  The Beneficiary Controlled Trust provides better creditor protection. We’ll give the Trust a Superior Protection rating.
• Lose the property to a divorcing spouse:  The Beneficiary Controlled Trust can be prepared such that a divorcing spouse has little or no rights to the Beneficiary Controlled Trust’s property.  The Beneficiary Controlled Trust provides  better asset protection.  We’ll give the Trust a Superior Protection rating.

Now, let’s see how the Beneficiary Controlled Trust did in the item by item comparison:

Give the property away	EQUAL RATING
Leave the property to anyone they want	EQUAL RATING
Use the property without paying for the use	EQUAL RATING
Sell the property	EQUAL RATING
Destroy the property	SUPERIOR PROTECTION
Lose the property to a creditor	SUPERIOR PROTECTION
Lose the property to a divorcing spouse	SUPERIOR PROTECTION

Since the Beneficiary Controlled Trust is so far superior to outright bequests, why doesn’t everyone use them?

The primary reason is many estate planning practitioners are simply not familiar with the technique.  In addition, some clients simply do not want, what they perceive to be, “complicated estate plans.”

Are Beneficiary Controlled Trusts complicated?

No, they are not. An easy comparison is the Family or Credit Shelter Trust that holds the estate tax free amount for the first spouse to die.  An annual tax return is due and accounting and monitoring must be done.  However, it seems to me that the benefits provided by the Beneficiary Controlled Trust far outweigh the additional costs after the surviving spouse has died.

Inheritance Trust to Protect an Inheritance from Creditors

Many of my clients are deeply concerned about how litigious our society has become and fear that their assets may one day be taken by creditors.  As a result, they desire to legally protect their assets from creditors, including the possibility of divorce.  If you share these concerns, I want you to be aware of an important technique that can asset protect an inheritance and provide an important piece of your estate plan.

The traditional estate planning process focuses exclusively on passing assets downstream to beneficiaries (i.e., to children and grandchildren), often ignoring a potential inheritance from parents or other family members.  However, Americans are living longer and longer and trillions of dollars will change hands in the coming decades.  Most of these assets will be transferred in a manner that is not protected from the claims of creditors or former spouses.

The laws of most states, including North Carolina, prohibit so-called "self-settled trusts" - an irrevocable trust you establish for your benefit, yet which purports to protect the trust assets from creditors.  Therefore, once you receive an inheritance, it is too late to asset protect it.  For potential inheritances, we can, by creating an Inheritance Trust to be the recipient of the inheritance, protect these assets.  An Inheritance Trust legally protects the inherited assets yet allows you to access them as necessary.  It also may remove a substantial portion of the assets from your potential taxable estate, thereby saving estate taxes at your death.

If you want to know more, please contact me.

Patrick

Transferring Business Interests to Family Members: Sale of Non-Voting Stock Interests to Grantor Dynasty Trusts

Most of us have at least one client who has a family-owned or closely held business interest as a major part of their estate. Typically, that client has done nothing to plan for the succession of the business. That kind of planning can be challenging because of the complex tax issues and the human element (egos, relationships, etc.) involved. On the other hand, it can be most rewarding, and it offers excellent opportunities to create a deeper relationship with an existing client and build a relationship with the next generation. It also offers the opportunity to create ongoing professional relationships with other key advisors, as we must work together to achieve the best results for our mutual client.

Below, we will examine a case study of how clients can benefit from selling non-voting stock in a closely held business to a specific type of "grantor" dynasty trust.

Our Case Study

The Facts: Harry the husband, age 62, is married to Wilma the wife, age 58. This is a second marriage for both of them. They have no prenuptial agreement and no estate plan. Steve, who is Harry's son, is actively involved in Harry's business. Wilma's daughter Dottie is unemployed and not involved in Harry's business, which Wilma and Dottie resent. Harry and Wilma have one joint child, Mark, who is a minor and is also not involved in Harry's business. Neither Harry nor Wilma has used any of their $1,000,000 lifetime gift tax exemption.

Harry owns 100% of a business that is an S-corporation. It is very successful and has a current fair market value of $10 million. It also has significant cash flow and high growth potential. Harry's desire (which Steve shares) is for Steve to own and continue the business after Harry retires or dies.

There are significant other assets in the estate, including their home and other investments. Some are owned jointly by Harry and Wilma, and some are owned solely by Harry.

Under the probate laws of the state in which they live, if Harry dies intestate Wilma will receive half interest in each of Harry's assets and Steve and Mark will each receive a one quarter interest in each of them. As a result, Wilma, as Mark's guardian, will end up controlling 75% of the business while Steve will only control 25%. In addition, assuming Harry does not die in 2010, there will be a potentially huge estate tax liability. This is not what Harry wants to happen.

Harry's Goals and Objectives: After meeting with his team of advisors, Harry has defined his goals and objectives as:

1. To have a comprehensive plan that will ensure ownership of the business will pass to his son Steve. (Steve also wants the security of knowing the business will one day become his.)
2. To be in control of the timing of the transfer of the business.
3. To treat his stepdaughter and his younger son fairly.
4. To have enough cash flow for now and to provide for Wilma if he dies first.
5. To save estate taxes.

Harry also understands that Steve does not have the cash to buy the business from him.

To meet Harry's goals and objectives, here is the plan his advisors recommend and why:

Phase 1: Reorganize and Recapitalize the S-Corporation

In a tax-free reorganization, convert the S-corporation to a limited liability company taxed as an S-corporation with voting and non-voting common units.

Harry owns all of the 1,000 outstanding shares of the company. They are all voting shares. After the reorganization and issue of voting and non-voting membership units, Harry still owns 100% of the business, only now it is 10 LLC membership units (1%) that are voting and 990 (99%) that are non-voting. Why reorganization of the S-corporation into an LLC is part of the plan will be explained later.

Phase 2: Create Dynasty Trusts

Establish an irrevocable trust for each child that is designed so that its income is taxable to Harry and make initial contributions to the trust.

Harry creates three irrevocable grantor trusts, one for each child, in a jurisdiction that permits perpetual private trusts. The trusts are all "grantor" trusts for income tax purposes, but not for estate and gift tax purposes. These are known as Irrevocable Deemed Owned Trusts (IDOTs). Some call them Intentionally Defective Grantor Trusts (IDGTs).

Planning Tip: It is possible (and an excellent idea) to design the IDOTs so that their income being taxed to Harry can be stopped if that becomes desirable later.

Harry makes a $600,000 cash gift to the trust established for Steve. This is a taxable gift that must be reported on a Federal gift tax return (IRS Form 709). However, no gift tax will be due because $600,000 of Harry's $1 million lifetime gift tax exclusion will be used to shelter the gift from taxation.

Harry will also allocate $600,000 of his generation skipping transfer tax exclusion to Steve's trust. Steve's trust will therefore have a zero inclusion ratio (i.e., have a 0% tax rate) for generation skipping transfer tax purposes.

Planning Tip: In 2010, because the generation skipping transfer tax is suspended, this allocation cannot be made. Therefore, consider making late GST exemption allocations in 2011 when the GST returns, if Congress amends the tax code to permit doing so. Alternatively, delay implementing Phase 2 until 2011.

When Harry and Wilma make gifts to the trusts for Dottie and Mark, they do the same kind of allocations.

This trust structure provides a huge benefit to their descendants because the trusts' assets will never be included in their descendants' estates for estate tax purposes.

Phase 3: Sell Non-Voting Membership Units to Steve's Trust for an Installment Note

To give Steve ultimate ownership of Harry's business, start by selling all of the non-voting membership units to the dynasty trust for Steve.

To make a private sale or gift between family members of something valuable that does not have a known value, the IRS requires that a qualified valuation expert determine its fair market value. When what is sold or given away is an interest in a business, there are two steps to the valuation. First, the balance sheet assets owned by the business (real estate, specialized equipment, inventory, etc.) are valued. Then a business evaluation is performed to determine whether and to what extent the value of the assets underlying an interest in the business needs to be adjusted for lack of control over the business and lack of marketability of the membership interests.

The reason that the S-corporation was reorganized into an LLC taxed as an S-corporation is that limitations on the transferability of a business interest are disregarded in the valuation if they are greater than the default provisions of the state law that govern the business. The default provision for corporations is that there is no limitation on transferability. On the other hand, some states' default provision on LLC membership transfer is that all members must consent.

When the adjustments for lack of control and lack of liquidity are made to non-voting interests in an LLC, it is not uncommon that their cumulative effect is to depress the fair market value by a significant amount. In this case, we assume that the non-voting units' value will be depressed 40% because of lack of control and lack of marketability. Thus, the non-voting units will have a value of $6,000 per unit, making the total value of the 990 non-voting units $5,940,000.

Voting units will have a premium value to reflect the control value. In this example, the voting units have an appraised value of $12,000 per unit, making the total value of the 10 voting units equal to $120,000.

The fair market value of the entire company, sold as a unit, is still $10 million, but the value of the parts does not add up to $10 million! That it is only $5,940,000 + $120,000 = $6,060,000.

In this phase, Harry sells his 990 non-voting units to the dynasty trust for Steve using a 20-year installment note, payable annually. The note is for $5,940,000 (the fair market value of the 990 non-voting units) and is at a rate of 4.26% (which is slightly above the current long-term AFR rate). Based on the value and terms of the note, the trust will pay Harry $447,197 every year for 20 years. This is a legitimate arms-length business transaction because Steve's dynasty trust is a creditworthy borrower since its assets ($600,000 initial gift + $5,940,000 in LLC units) exceed the value of what it has bought by more than 10%.

Planning Tip: There is no "bright line" test for what is a commercially reasonable loan-to-value ratio. Many practitioners use 10%, but some are more comfortable at 20%.

Planning Tip: Make sure the installment note is handled just like an installment sale to a non-family member or to a bank. Have a signed pledge or security agreement, pay any tax required, do any filings required. Make sure you have a documented paper trail.

The Outcome

Company Ownership and Control

After Phase 3 is completed, Harry owns 10 voting units, which gives him 100% control of the business and 1% of the equity. The dynasty trust for Steve owns 990 non-voting units, which gives it no control over the business and 99% of the equity. The dynasty trust also has $600,000 in cash that Harry gifted to it as seed capital.

Income Tax Reporting

Harry is deemed to be the "owner" of the dynasty trust for Steve for purposes of reporting its income. As long as that is so, the dynasty trust for Steve does not have to file a Form 1041 fiduciary income tax return. Instead, an information return is filed, with the dynasty trust income tax information reported to Harry as the trust's deemed owner, for reporting on his personal Form 1040 income tax return.

Income Tax Effect of Sale of Membership Units

Harry's sale of LLC units to the dynasty trust for Steve is a "non-recognition" event. Because Harry is the deemed owner of the trust for income tax purposes, it is treated as a sale by Harry to himself. Thus no gain is recognized on the sale of the stock and no interest income is recognized on the installment note payments. Of course, the trust does not receive a deduction for interest payments made either.

"Pass Through" Dynasty Trust Income

Income from the LLC will be allocated to the unit holders based on their unit ownership percentages. Let's assume the business has $500,000 in net income. Harry owns 10 voting units, which is equal to 1% of the equity. Therefore, Harry will be allocated $5,000 in K-1 income. The dynasty trust for Steve owns 990 non-voting units, which is equal to 99% of the equity. Therefore it will be allocated $495,000 in K-1 income.

Because the dynasty trusts are structured as grantor trusts for income tax purposes, Harry must pay the income tax attributable to all of their income, including the S-corporation income that is allocated to the trust for Steve. But that is what he was doing before the sale of his non-voting units to Steve's trust, so he is paying the same income tax before and after the sale of the units. Harry's payment of the trusts' income tax is not an additional gift to the trusts, which means that every year Harry is transferring, gift tax free, additional estate assets to the trusts for the children.

How the Dynasty Trust Makes the Required Note Payments

We assume for this case study that the LLC will have $500,000 per year of cash flow to distribute to its unit holders. That will provide Steve's dynasty a cash distribution of $495,000 ($500,000 x 99% = $495,000). Thus at the end of year one it will have $1,095,000 in cash ($495,000 from the LLC and the $600,000 that was gifted to it as seed capital). The trustee can thus easily make the $447,197 note payment to Harry.

Planning Tip: If the company does not generate enough income to pay the note, take the same approach as if a borrower can't repay a bank loan. Options would include deferring payment until such time as the business recovers or renegotiating the term or interest rate of the note.

Results After Year One

At the end of the first year, the note has been reduced to $5,745,847 and the dynasty trust has a cash balance of $647,803. The trustee of the dynasty trust could use this cash to:

• Invest and save. (Income taxes on the earnings would be taxed to Harry.)
• Make distributions to the trust beneficiaries. (Distributions would be gift tax-free.)
• Buy life insurance on Harry's life.

Harry has received $5,000 from the LLC and $447,197 from the note payment, for a total of $452,917 in income. He will pay income taxes on this full amount. For example, if he is in a 25% effective income tax bracket (after all deductions), he would pay $125,000 in income taxes, leaving with him $327,917 income to support his and Wilma's lifestyle and/or make annual exclusion gifts to the dynasty trusts for Mark and Dottie, which they could use to buy life insurance on Harry's life. (This would be an excellent way to provide for Mark and Dottie. See explanation under "When Harry Dies" below.)

Planning Tip: A higher income tax rate would mean less income, but there may be other sources of income. For example, Harry is still in control of his company, and he may receive a salary as well as compensation as a Director on its Board.

Planning Tip: Harry may be able to reduce his salary from the LLC if he does not need the cash flow. This would save payroll tax and would give the business more cash flow. However, make sure he receives enough in salary to continue to qualify for group health insurance coverage.

When Harry Dies

If Harry has either consumed or gifted the net after the tax note payments that he receives from Steve's dynasty trust, only the unpaid balance of the note will be included in his taxable estate; there is no asset "build-up" inside his estate as the company grows.

The dynasty trust for Steve is GST "exempt" so that following Harry's death its assets will never be subject to estate, gift or GST taxation (unless the Congress changes the rules).

So are the dynasty trusts established for Dottie and Mark, so the life insurance proceeds received by them on Harry's death are also GST "exempt," providing a legacy for them and their descendants.

Harry could leave the 10 voting units (1%) to Steve in trust, too.

This arrangement would leave Steve's trusts owning 100% of the business and the other children's GST exempt trust shares owning cash.

Harry's wife Wilma will continue to receive the remaining note payments for her support.

Estate Tax Results

1. Harry has removed $10,600,000 of appreciating assets from his gross estate that, at his death, would be subject to estate tax. Unless the Congress acts quickly, the top rate after the catch-up tax will be 55% in 2011.
2. Harry has received an asset (the self-amortizing note) that is based on a discounted asset value, frozen (will not appreciate in value) and depreciating (the note principal will decrease over the 20-year note amortization term).
3. If Harry does not accumulate the note payments, then at the end of the note term (20 years), he will have totally removed the $10,600,000 (plus all future appreciation on this amount) from his gross estate without making a taxable gift other than the initial $600,000 seed capital gift.
4. The trust assets are in a generation skipping tax-exempt trusts that can include asset protection features. These trust assets are not included in the children's or grandchildren's gross estates at their deaths.

Conclusion

Using this technique, all of Harry's goals and objectives were met. His son Steve would receive the business without having to buy him out, yet Harry could control the timing of the business transfer. He was able to provide for his other children and his wife. In addition, Harry saved substantial estate taxes.

This technique also presents excellent opportunities for strengthening professional relationships, as it requires a team of advisors to work together to achieve these goals. Remember to collaborate as needed. Also remember to present the information to your clients and their advisors in a way that is easily understood and therefore less threatening. In order for your clients to be motivated to act, they must understand what you are recommending and the benefits to them.

Limited Partnerships and LLCs – Do you want to pass business assets to your family in a structured way?

The IRS continues to attack the discounted valuation of limited partnerships and LLCs, but taxpayers have had some recent court victories. These cases are very fact-specific but have some common elements. To note a few, the discounted valuation of an entity is more likely to be respected if: there were legitimate non-tax purposes for forming the entity; there is an ability to document active management of the entity’s assets; the client refrains from the use of an entity as a “pocketbook” for personal expenses; and sufficient assets are maintained outside the entity to provide for the client’s support and the payment of estate taxes on the client’s death. Clients with limited partnerships or LLCs in existence should ensure, in consultation with counsel and other advisors, that all necessary legal formalities (e.g., tax filings, periodic meetings, etc.) are being observed.

A Trust for an Inheritance

Many of my clients are deeply concerned about how litigious our society has become and fear that their assets may one day be taken by creditors.  As a result, they desire to legally protect their assets from creditors, including the possibility of divorce.  There is a way that clients can asset protect their inheritance, providing an important piece of the overall estate planning puzzle.

The traditional estate planning process focusses exclusively on passing assets downstream to beneficiaries (i.e. children and grandchildren), often ignoring a potential inheritance from parents or other family members.  However, Americans are living longer and longer, and trillions of dollars will change hands in the coming decades.  Most of these assets will be transferred in a manner that fails to protect them from the claims of creditors and former spouses.

The laws of most states, including North Carolina, do not recognize any asset protection for a "self-settled trust" - an irrevocable trust you establish for yourself.  Therefore, once you receive an inheritance, you cannot easily asset protect the inheritance.  The inheritance, however, could be asset protected by creating a trust to receive the inheritance for you. 

Such a trust legally protects the inheritance, while alo allowing you access to the funds as well.  It can also remove a substantial portion, if not all, of the inheritance from being subject to estate tax at your death.

Inheritance Protection Planning

Protecting an inheritance from predators, creditors, divorce and irresponsible spending is a major concern for many parents and grandparents today. Many feel that their children and grandchildren lack strong financial skills, and difficult economic times can make inheritances more vulnerable to creditor claims and/or maintaining a lifestyle beyond the beneficiary's means.

Difficult economic times also increase the likelihood of divorce, which is already at a 50% rate. Most people do not want to see their hard-earned money ending up in the hands of a former daughter- or son-in-law.

Planning Tip: Your trust can include provisions to protect inheritances from divorce, creditors and from the beneficiaries themselves.

Spousal Gift Trusts

A gift trust established for a spouse can receive gifts that either use the $1 million lifetime exemption or use the annual exclusion. This is a way to utilize exemptions now without having to give assets outside of the marital unit. The annual exclusion to a spouse is a freebie most taxpayers miss.

Best States for Trusts

Interesting Article with a chart.

IRA Issues

Nationally, Americans’ retirement assets total more than $14.5 trillion. Even considering the recent bear market, this amount is up significantly over the last decade.


No matter the amount of your retirement assets, proactive planning is critical because of the sometimes confiscatory taxes these assets are subject to – up to 70% or more in certain circumstances. As you may know, traditional retirement assets are not subject to income tax until withdrawal – and because the withdrawals consitute income, the larger the withdrawal, the higher the tax rate. If you’re like many of our clients, you want these assets to grow to the maximum extent possible, since assets not taxed until withdrawal grow much faster than assets that are taxed every year.

I recently hosted a seminar on Asset Protecting IRAs and Qualified Plans (which includes 401(k)s, defined contribution plans, defined benefit plans, etc.) and learned several strategies that can help defer and perhaps eliminate the tax liability of these hard-earned assets, while at the same time legally protecting them from creditors. These strategies can also help coordinate retirement plans with your overall estate and financial planning objectives to ensure that those objectives are met.

LLC dissolution

I was asked today whether one member of a two member North Carolina LLC could force a dissolution of an LLC.  While the operating agreement for the LLC could so provide, North Carolina statutes requires all members to consent in writing in order to dissolve an LLC.  Of course, if it has no members, then it could be dissolved by the Organizers, and if no members for more than 90 days, it dissolves automatically.

Patrick

Retirement Plan Trust Benefits

Establishing a Retirement Plan Trust and naming it as the beneficiary of an IRA or qualified plan can provide a number of benefits. These include:

• Spendthrift protection - Protecting the individual trust beneficiary from his or her temptation to waste "found money."
• Predator protection - Even if the individual beneficiary does not have spendthrift tendencies, there are many out there whose interest lies in separating the beneficiary from their money and property.
• Creditor protection - Ours is a litigious society in which we never know who is going to be the target of a lawsuit. A trust makes the beneficiary a less attractive "target."
• Divorce protection - With the national divorce rate above 50%, it is impossible to determine which marriages will stand the test of time. A Retirement Plan Trust keeps the inherited IRA from being divided or even lost in a divorce.
• Government benefits protection - As with divorce, whether a healthy beneficiary will suffer some catastrophe that makes him or her dependent on needs-based government programs is unpredictable. Inheriting an IRA can easily disqualify someone from receiving needs-based government benefits until the IRA is exhausted.
• Providing consistent investment management (often from the participant's investment advisor).
• Estate planning.
• Control over use of the retirement plan/IRA assets (e.g., to fund education, start a business, or buy the beneficiary's first home or, in the case of a mixed family, to prevent diversion away from the owner/participant's descendants).

Planning You Should Consider Now

These are difficult times. The "experts" now acknowledge that we are in a recession - and that we have been so for some time. Consumer confidence is low. As a result many of us are concerned, wondering what planning we should do now, if any.

For the vast majority of Americans, planning is not discretionary. These individuals continue to have - or perhaps for the first time have - personal concerns that they need to address now because these concerns are unrelated to the economy. In fact, some of these concerns may even be made worse by our current economic situation.

In addition, for anyone who may be subject to federal or state estate tax in the future, unusual circumstances have created a "perfect planning storm" that will not last long. This post addresses some of the planning needs unrelated to the economy and discusses strategies that create the biggest planning opportunities today.

Planning Needs Unrelated to the Economy

Many planning needs are unrelated to the economy. They include:

• Disability and retirement planning;
• Special needs planning;
• Beneficiary protection planning (for example, protection from divorce, creditors and/or perhaps the beneficiaries themselves); and
• Second marriage and "blended family" protection.

These planning needs are often more critical for those with fewer assets than for those with more wealth.
Disability Planning
According to the Family Caregiver Alliance and recent MetLife Mature Market Study, of those Americans currently age 65 and older:

• 43% will need nursing home care;
• 25% will spend more than a year in a nursing home;
• 9% will spend more than 5 years in a nursing home; and
• The average stay in a nursing home is more than 2.5 years.

Nursing home costs are increasing much faster than the inflation rate would imply. Thus, many of us quite appropriately are very worried about how we will pay for that kind of care if we need it.
Planning Tip: Careful consideration of how to pay for long-term care is critical for most individuals.
Also of concern to many people is who will provide long-term care and whether those caregivers will care for us in the way we desire. For many, there is a strong desire to stay at home as long as possible. For others, the companionship found in an assisted living facility makes that choice preferable. Still others need care that cannot be provided at home or only at a prohibitive cost. And, not surprisingly, these goals often change over time and with changing circumstances.
Planning Tip: A trust that sets forth your current, carefully thought-out disability objectives is the best way to ensure that your planning meets your personal goals and objectives.
Special Needs Planning
Special needs planning is another area unrelated to the economy. According to the 2002 U.S. census:

• 51.2 million people reported having a disability;
• 13-16% of families have a child with special needs;
• Autism occurs every 1 in 150 births and between 1 and 1.5 million Americans have an Autism spectrum disorder.

Failure to properly plan for a person with special needs can have disastrous consequences, especially if the person is receiving government benefits.
Planning Tip: A Special Needs Trust that incorporates specific care provisions is a critical component of the planning necessary for a special needs person who needs ongoing support.
Planning Tip: Insurance on the lives of the parents or grandparents of a special needs person frequently funds the ongoing care of that special needs beneficiary.
Beneficiary Protection Planning
Protecting an inheritance from being lost in a divorce or to a beneficiary's creditors is a serious concern of many individuals. Many from the older generation fear that their children and grandchildren lack strong financial decision-making skills - and the potential for creditor attack or for beneficiary dissipation of an inheritance is greater during difficult economic times.
Also, divorce rates exceed 50% nationally. Many individuals express concern over their children and grandchildren divorcing - they don't want the assets they worked so hard to accumulate winding up in the hands of a former daughter-in-law, son-in law, etc. Since divorce rates increase in difficult economic times, this planning is even more important now than in better economic times.
Blended Family Planning
A higher divorce rate also leads to more second and subsequent marriages - each with a higher statistical probability of ending in another divorce. With blended families (in other words with potentially his, her, and their kids), it is critical that each parent's planning protect his or her children in the event that parent predeceases the subsequent spouse. Failure of blended-family parents to do this type of planning practically guarantees that somebody's kids will be disinherited or a messy probate will result.
Planning Tip: Carefully drafted estate plans protect beneficiaries from divorce, creditors and themselves. Such plans can also provide for children from prior marriages, which is often the only way to ensure that these beneficiaries actually receive any inheritance.
The "Perfect Storm" for Taxable Estate Tax Planning
Certainty as to the Federal Estate Tax
The prospect for a repeal of the federal estate tax in the foreseeable future is essentially zero and, in half the U.S. jurisdictions, there is also a state estate tax (which can apply if you own property in that state or move there). Nobody knows whether the Congress and President will agree to a new federal estate tax exemption amount (the amount an individual, with planning, can pass free of federal estate tax). Despite rumors from Capitol Hill, we also do not know what that new amount might be - especially in light of the federal spending developments of the past few months. If that spending leads to greatly increased inflation, many more individuals may face being subject to the federal estate tax. Because of the virtual certainty that we will continue to have an estate tax, many individuals must plan if they wish to avoid paying it.
As the U.S. Supreme Court said:

Anyone may so arrange his affairs that his taxes shall be as low as possible; he
is not bound to choose that pattern which will best pay the Treasury; there is
not even a patriotic duty to increase one's taxes. Therefore, if what was done
here was what was intended by [the statute], it is of no consequence that it was
all an elaborate scheme to get rid of [estate] taxes, as it certainly was.

For those who may be subject to federal or state estate tax, we are in a "perfect storm" that creates exceptional planning opportunities not likely to be seen again for many years. The factors that have come together to create this "perfect storm" are (a) reduced asset values; and (b) historically low interest rates.
Reduced Asset Values
Reduced values for stocks, real estate, businesses, etc., mean that individuals can transfer these assets for less today than they could have just a few months ago.
For example, if a particular stock you own declined from $100 per share to $80, now you can transfer 162.5 shares with a $13,000 annual gift tax exclusion (it went up from $12,000 on January 1, 2009) instead of 130 shares had it remained at $100. Married couples can give twice that amount, or $26,000 per person, per year. Typically, clients transfer this amount to children, grandchildren and other close family members.
In addition, reduced real estate and business values mean that you can transfer a larger percentage of these assets free of federal gift tax by taking advantage of your $1 million lifetime exemption from federal gift tax.
Planning Tip: At a minimum, if you are subject to federal or state estate tax, you should take advantage of the annual gift tax exclusion ($13,000 per person as of January 1, 2009) to transfer assets with reduced values to children, grandchildren and others. Ideally, you should make these gifts in trust to provide the beneficiaries protection from divorce, creditors, predators, and themselves.
Historically Low Interest Rates
The other piece to the "perfect storm" is today's historically low interest rates. The January 2009 Applicable Federal Rates (AFRs) - the "safe harbor" interest rates provided by the government for, among other things, loans among family members - are as follows:

• Short-term (not over 3 years): 0.81%
• Mid-term (over 3 but not over 9 years): 2.06%
• Long-term (over 9 years): 3.57%

February Rates are even lower. Due to a number of reasons, these low interest rates make many estate planning strategies even more attractive, including:

• Strategies that involve the use of loans at current interest rates; and
• Strategies that assume (as required by the IRS) that the assets you transfer will grow at current interest rates.

For transfers made in January 2009, this rate is 2.4%.
I encourage you to contact your advisors to determine if one or more of these strategies is appropriate for you under the circumstances.
Conclusion
Despite these difficult economic times, there are many reasons why you should plan or update your planning now rather than wait until we have more economic certainty. Furthermore, in the current economic and political climate it is impossible to know which of us will be subject to federal (or state) estate tax in the future. We do know, however, that the federal estate tax is not going away. If you may be subject to estate tax, the current "perfect storm" creates a unique opportunity for the planning team to help you meet your goals and objectives.
To comply with the U.S. Treasury regulations, I hereby inform you that (i) any U.S. federal tax advice contained in this blog was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer's particular circumstances.

Understanding the Significance of Trusts

In the right circumstances, trusts can provide significant advantages to those who utilize them, particularly in protecting trust assets from the creditors of beneficiaries. Admittedly this can be a complex topic, but you see its implications in the headlines every day. Today’s post attempts to simplify the subject and explain the general protection trusts provide for their creator (the “trustmaker”) as well as the trust beneficiaries. Given the numerous types of trusts, I will only explore the most common varieties of Trusts. I encourage you to seek the counsel of your wealth planning team if you have questions about the application of these concepts to your specific situation, or if you have questions about specific types of trusts.

Revocable vs. Irrevocable Trusts

There are two basic types of trusts: revocable trusts and irrevocable trusts. Perhaps the most common type of trust is revocable trusts (aka revocable living trusts, inter vivos trusts or living trusts). As their name implies, revocable trusts are fully revocable at the request of the trust maker. Thus, assets transferred (or “funded”) to a revocable trust remain within the control of the trust maker; the trust maker (or trust makers if it is a joint revocable trust) can simply revoke the trust and have the assets returned. Alternatively, irrevocable trusts, as their name implies, are not revocable by the trust maker(s).

Revocable Living Trusts

As is discussed more below, revocable trusts do not provide asset protection for the trust maker(s). However, revocable trusts can be advantageous to the extent the trust maker(s) transfer property to the trust during lifetime.

Planning Tip: Revocable trusts can be excellent vehicles for disability planning, privacy, and probate avoidance. However, a revocable trust controls only that property affirmatively transferred to the trust. Absent such transfer, a revocable trust may not control disposition of property as the trust maker intends. Also, with revocable trusts and wills, it is important to coordinate property passing pursuant to contract (for example, by beneficiary designation for retirement plans and life insurance).

Asset Protection for the Trust Maker

The goal of asset protection planning is to insulate assets that would otherwise be subject to the claims of creditors. Typically, a creditor can reach any assets owned by a debtor. Conversely, a creditor cannot reach assets not owned by the debtor. This is where trusts come into play.

Planning Tip: The right types of trusts can insulate assets from creditors because the trust owns the assets, not the debtor.

As a general rule, if a trust maker creates an irrevocable trust and is a beneficiary of the trust, assets transferred to the trust are not protected from the trust maker’s creditors. This general rule applies whether or not the transfer was done to defraud an existing creditor or creditors. Until fairly recently, the only way to remain a beneficiary of a trust and get protection against creditors for the trust assets was to establish the trust outside the United States in a favorable jurisdiction. This can be an expensive proposition. However, the laws of a handful of states (including Alaska, Delaware, Nevada, Rhode Island, South Dakota, and Utah) now permit what are commonly known as domestic asset protection trusts. Under the laws of these few states, a trust maker can transfer assets to an irrevocable trust and the trust maker can be a trust beneficiary, yet trust assets can be protected from the trust maker’s creditors to the extent distributions can only be made within the discretion of an independent trustee. Note that this will not work when the transfer was done to defraud or hinder a creditor or creditors. In that case, the trust will not protect the assets from those creditors.

Planning Tip: A handful of states permit what are commonly known as domestic asset protection trusts.

Given this insulation, asset protection planning often involves transferring assets to one or more types of irrevocable trusts. As long as the transfer is not done to defraud creditors, the courts will typically respect the transfers and the trust assets can be protected from creditors.

Planning Tip: If you are concerned about personal asset protection but are unwilling to give up a beneficial interest to protect your assets from creditors, consider a domestic asset protection trust or even a trust established under the laws of a foreign country.

Asset Protection for Trust Beneficiaries

A revocable trust provides no asset protection for the trust maker during his or her life. Upon the death of the trust maker, however, or upon the death of the first spouse to die if it is a joint trust, the trust becomes irrevocable as to the deceased trust maker’s property and can provide asset protection for the beneficiaries, with two important caveats. First, the assets must remain in the trust to provide ongoing asset protection. In other words, once the trustee distributes the assets to a beneficiary, those assets are no longer protected and can be attached by that beneficiary’s creditors. If the beneficiary is married, the distributed assets may also be subject to the spouse’s creditor(s), or they may be available to the former spouse upon divorce.

Planning Tip: Trusts for the lifetime of the beneficiaries provide prolonged asset protection for the trust assets. Lifetime trusts also permit your financial advisor to continue to invest the trust assets as you instruct, which can help ensure that trust returns are sufficient to meet your planning objectives.

The second caveat follows logically from the first: the more rights the beneficiary has with respect to compelling trust distributions, the less asset protection the trust provides. Generally, a creditor “steps into the shoes” of the debtor and can exercise any rights of the debtor. Thus, if a beneficiary has the right to compel a distribution from a trust, so too can a creditor compel a
distribution from that trust.

Planning Tip: The more rights a beneficiary has to compel distributions from a trust, the less protection that trust provides for that beneficiary.
Therefore, where asset protection is a significant concern, it is important that the trust maker not give the beneficiary the right to automatic distributions. A creditor will simply salivate in anticipation of each distribution. Instead, consider discretionary distributions by an independent trustee.

Planning Tip: Consider a professional fiduciary to make distributions from an asset protection trust. Trusts that give beneficiaries no rights to compel a distribution, but rather give complete discretion to an independent trustee, provide the highest degree of asset protection.

Lastly, with divorce rates at or exceeding 50% nationally, the likelihood of divorce is quite high. By keeping assets in trust, the trust maker can ensure that the trust assets do not go to a former son-in-law or daughter-in-law, or their bloodline.

Irrevocable Life Insurance Trusts

With the exception of domestic asset protection trusts discussed above, a transfer to an irrevocable trust can protect the assets from creditors only if the trust maker is not a beneficiary of the trust. One of the most common types of irrevocable trust is the irrevocable life insurance trust, also known as a wealth replacement trust. Under the laws of many states, creditors can access the cash value of life insurance. But even if state law protects the cash value from creditors, at death, the death proceeds of life insurance owned by you are includible in your gross estate for estate tax purposes. Insureds can avoid both of these adverse results by having an irrevocable life insurance trust own the insurance policy and also be its beneficiary. The dispositive provisions of this trust typically mirror the provisions of the trust maker’s revocable living trust or will. And while this trust is irrevocable, as with any irrevocable trust, the trust terms can grant an independent trust protector significant flexibility to modify the terms of the trust to account for unanticipated future developments.

Planning Tip: In addition to providing asset protection for the insurance or other assets held in trust, irrevocable life insurance trusts can eliminate estate tax and protect beneficiaries in the event of divorce.

If the trust maker is concerned about accessing the cash value of the insurance during lifetime, the trust can give the trustee the power to make loans to the trust maker during lifetime or the power to make distributions to the trust maker’s spouse during the spouse’s lifetime. Even with these provisions, the life insurance proceeds will not be included in the trust maker’s estate for estate tax purposes.

Planning Tip: With a properly drafted trust, the trust maker can access cash value through policy loans.

Irrevocable life insurance trusts can be individual trusts (which typically own an individual policy on the trust maker’s life) or they can be joint trusts created by a husband and wife (which typically own a survivorship policy on both lives).

Planning Tip: Since federal estate tax is typically not due until the death of the second spouse to die, trust makers often use a joint trust owning a survivorship policy for estate tax liquidity purposes. However, a joint trust limits the trust makers’ access to the cash value during lifetime. In these circumstances, consider an individual trust with the non-maker spouse as beneficiary.