Tennessee Approves Tenants by the Entirety Trusts

On April 14, 2014, the Tennessee Legislature approved a new type of trust known as a Tenants by the Entirety Trust (“TBET”).

A TBET is a joint trust for a married couple that provides the same protection from the claims of the separate creditors of the husband and wife as would exist if the husband and wife owned the trust assets directly as tenants by the entirety. 

Being able to transfer tenants by the entirety property to a TBET without sacrificing creditor protection will make it more feasible for couples to use revocable trusts for their various benefits, including incapacity management, probate avoidance, and privacy.

A TBET only provides creditor protection for property that was held by the spouses as tenants by the entirety property prior to the conveyance of the property to the trust.  The additional requirements of a TBET include: (1) the husband and wife must remain married; (2) the property must continue to be held in trust by the trustee(s) or their successors in trust; (3) while both the husband and wife are living, the trust must be revocable by either spouse or by both of them acting together; (4) both spouses must be beneficiaries of the trust; and (5) the trust instrument, deed, or other instrument of conveyance must specify that the provisions of the new statute apply to the property. 

Traditional tenants by the entirety property automatically passes to the survivor upon the death of the first spouse.  A TBET is more flexible.  For example, the TBET could convert to an irrevocable trust for the benefit of the survivor, with the remainder to pass to children after the survivor’s death.  This structure would provide better asset protection for the survivor as well as better protection to the children if the survivor remarries.

After the death of the first spouse to die, the property will continue to be exempt from the claims of the decedent’s separate creditors.  To the extent the survivor may withdraw the trust assets, the property will be subject to the claims of the survivor’s separate creditors.

Creditor protection may be waived as to any specific creditor or any specifically described trust property, but only if expressly permitted by the trust instrument, deed, or other instrument of conveyance or if the husband and wife both give their written consent.  This provision allows a house subject to a mortgage to be transferred to a TBET.

TBETs may be created on or after July 1, 2014. 

2014 Trust and Estate Planning Steps - PART 3: Asset Protection Trusts Facilitate Income Tax Savings

This is the third article of a series regarding 2014 Trust and Estate Planning

For the prior articles, see:

[Link to PART 1:  Introduction]

[Link to PART 2:  65 Day Rule for Trust Distributions]

The previous article highlighted the opportunity of making a distribution from a trust by March 6th in order to reduce income taxes.  The problem for some of our clients is that they don’t want the beneficiary to get their hands on a large sum of money.  One trust would like to make a distribution of $265,000 in order to reduce overall income taxes.

Several of our clients have utilized asset protection trusts to capture income tax savings in a manner that does not result in their children receiving a lot of cash.  These clients have been able to persuade their child to establish an asset protection trust with the parent as the trustee.  The child’s trust (typically established by the child’s parent or grandparent) then makes a distribution directly to the asset protection trust

The asset protection trust uses the social security number of the child as its taxpayer identification number.  The trust income tax rules treat the distribution from the child’s trust to the asset protection trust as a distribution to the child.  The income will be taxed on the child’s Form 1040 where it will enjoy a lower tax rate than if the child’s trust had not made a distribution.

You can use an asset protection trust even if it is established after March 6.  First, make a distribution to the child on March 6 and have the child deposit the distribution in a savings account.  After the asset protection trust is established, the child will then move the funds to the asset protection trust.  This technique is not as good as the direct trust-to-trust transfer, because the child has access to the funds for some period of time.

Minors are not able to establish asset protection trusts.  However, there are other techniques that can be used to make a distribution to a minor in order to reduce income taxes.  All of these techniques have flaws, but the flaws should be evaluated against the potential income tax savings.

Service Grants Extension to Make Portability Election

Since 2010, the Federal estate tax exemption has been $5 million or higher. When a person dies and does not use all of his or her estate tax exemption, his spouse is able to add the unused exemption to his or her exemption if an estate tax return is filed, which elects to carry over the decedent’s unused exemption to the surviving spouse. This election is referred to as a portability election.

The IRS previously ruled that the portability election could only be made on a timely filed estate tax return, either nine months after the decedent’s death or 15 months if an extension is requested. A lot of surviving spouses who might benefit from electing portability neglected to file a timely estate tax return. Fortunately, the IRS has published Revenue Procedure 2014-18, which gives an extension until the end of 2014 to file the estate tax return to make the portability election. The Revenue Procedure will only help for a decedent who died between January 1, 2011 and December 31, 2013 and whose estate was below the estate tax filing threshold.

The Revenue Procedure will also help the surviving spouse of a same-sex marriage. Prior to the Windsor decision by the Supreme Court, a federal law known as the Defense of Marriage Act (“DOMA”) did not allow the surviving spouse of a same-sex marriage to make the portability election. Now that the Supreme Court has ruled DOMA to be unconstitutional, the surviving spouse is allowed to make a portability election. The new Revenue Procedure will allow an estate tax return to be filed in 2014 so that the surviving spouse can benefit from portability, even if the deadline for filing the return has already passed.

 

Tennessee Ranks 5th in Decanting

Tennessee adopted its decanting statute in 2004 and made improvements to the statute in 2013.  Decanting has allowed many of our clients to improve troublesome provisions contained in prior trust agreements.  There are now 22 states that have adopted decanting statutes.  I predict that all states will adopt some version of decanting within the next 10 years. 

Steve Oshins has compiled a ranking of the decanting statutes.  Tennessee ranks 5th on his list.  Two of the three areas where Tennessee loses points are misleading.  Tennessee does allow a trust with an ascertainable standard to be decanted into a discretionary trust.  Mr. Oshins correctly points that our statute does not allow a mandatory income interest to be removed.  We included this prohibition in the statute due to a concern that eliminating a mandatory income interest might create adverse income, gift, and generation-skipping tax results.

Attached is a decanting paper I presented last year when there were only 18 states that allowed decanting.

2014 Trust and Estate Planning - PART 2: 65 Day Rule for Trust Distributions

This is the second article of a series regarding 2014 Trust and Estate Planning

For the prior article, see:

PART 1:  Introduction

Trusts that are not treated as grantor trusts are now subject to income tax at much higher rates.  Trusts are taxed at the maximum individual income tax rates on all income beyond $11,950 for 2013 and $12,150 for 2014.  As a general rule, non-grantor trusts are taxed as follows: to the extent income is distributed to the beneficiaries, the beneficiaries are taxed; the portion of the income retained in the trust is taxed to the trust.  There is a special rule for capital gains, which generally makes capital gains taxable to the trust whether or not the proceeds are distributed to the beneficiary. 

When the beneficiary of the trust is not in the top income tax bracket, it is often possible to reduce overall income taxes by making distributions to the beneficiary.  This assumes that circumstances are appropriate for making distributions.  First, the trust must authorize the trustee to make the distributions.  Second, the beneficiary must not waste the distribution.  It is better to pay a high tax within the trust and keep the after-tax proceeds than to make a distribution and have it wasted by the beneficiary. 

There is a special election that allows the trust to treat distributions made within the first 65 days of the following calendar year as having been made in the previous calendar year.  Thus, if there is a beneficiary who is in a lower tax bracket and circumstances are appropriate for making a distribution to the beneficiary, the trust may be able to reduce its taxes for 2013 by making a distribution on or before March 5, 2014.

Due to certain rules that apply to individuals but not to trusts, the maximum tax bracket for individuals is slightly higher than the maximum tax bracket for trusts.  When the beneficiary is in the top bracket, it may work out better for the trust to pay tax on the income than for the beneficiary.  If circumstances warrant, consideration should be given to accumulating income within the trust.  If income is distributed within the 65-day period, the trust is not required to treat it as having been made in the prior year.

In addition to the federal income tax consequences, state income taxes may also be relevant.  When the beneficiary lives in Tennessee, the Hall income tax will be paid whether or not a distribution is made.  However, if the beneficiary lives in another state, Tennessee taxes will not be payable.  Whether or not taxes are paid to the beneficiary’s state of residence may depend on whether or not distributions are made from the trust.

As you can see, the timing and amounts of trust distributions can affect the amount of federal and state income taxes that are paid.  You should analyze these opportunities now in case distributions need to be made prior to March 6, 2014.

2014 Trust And Estate Planning Steps - Part 1: Introduction

2013 was a year of tremendous change in the estate planning field.  The American Taxpayer Relief Act of 2012 (“ATRA”) gave us higher income tax rates, a “permanent” unified estate, gift, and generation-skipping transfer tax exemption of $5 million indexed for inflation, portability of the estate tax exemption, and an estate tax rate of 40%.  The Affordable Care Act imposed a new 3.8% tax, the Net Investment Income Tax (“NIIT”), on many types of passive income received by high-income taxpayers.  Finally, the Tennessee inheritance tax exemption increased to $1.25 million per person, with scheduled increases to $2 million in 2014 and $5 million in 2015 before this tax disappears in 2016.

The net effect of all these changes is that fewer people need to worry about estate and inheritance taxes.  For individuals who have more than $5 million, or couples who have more than $10 million, the higher estate and gift tax exemption and portability open up a lot of planning opportunities to reduce or eliminate estate taxes.

The news is not so good on the income tax side.  Most of you will be paying significantly more income taxes for 2013 and later years than you paid prior to 2013.

The combination of lower estate taxes and higher income taxes has led to a new tax environment in which some familiar planning techniques need to be discarded and new planning techniques have emerged.  In some cases, income taxes can be reduced by unwinding or modifying trusts or business entities that you previously established.  We will examine these new opportunities in a series of articles over the coming weeks.  

When Should You Tell Your Children About Your Estate Plan

Last week, two clients scheduled appointments with me while their children were home for the holidays.  The goal of the meetings was to explain the parents’ estate plan to the children.  I did not disclose the extent of the parents’ net worth.  We discussed various trusts that would be established, the identity of executors and trustees, and the disposition of specific assets.  We also covered some premarital asset protection planning concepts.  Both meetings were positive.

I am often asked whether children should be informed about their parents’ estate plan and, if so, when is the appropriate time.  The answer is: It depends.

On the positive side, making sure that your children know about your estate plan can make things go smoother during your senior years and after you die.  As we are living longer, it becomes more likely that you will live for some period of time in which you need assistance from your children.  If they understand your overall plan, they can better carry out your wishes. 

Knowledge of your estate plan may assist your child with their financial or estate planning.  For example, if you have established a trust that gives your child a testamentary limited power of appointment, your child may want to exercise the power in a way that coordinates with the child’s estate plan.

On the negative side, if children are disappointed with their future inheritance they might whine or connive to change the outcome.  This might accelerate a stressful condition that would otherwise not manifest itself until after your death.  Your child may have a mental illness or might be married to a person whose family values differ markedly from your own.  Conversations about estate planning might be uncomfortable.  Some of my clients understandably have the attitude of “Why should I put up with that during my lifetime?”

Knowledge about a substantial future inheritance might cause your child not to realize their maximum potential.  In my practice, I have encountered children who seem to be waiting on their parents to die.  They expect that their parents will take care of the child’s retirement years, so the child does not work as hard.

Overall, I believe that sharing your estate plan with your children is healthy.  You need to judge when your children are mature enough to receive this information.  If you have a dysfunctional child, it may be best to wait until after your funeral.

Judge Promotes Ex-Spouse to Primary Beneficiary of Trust

Imagine that you set up a trust for your son and give an independent trustee the discretion to make distributions to your son for his health, education, maintenance and support.  Next, imagine that your son gets divorced, loses his job, and is unable to pay his alimony.  Can your son’s ex-wife access the trust to satisfy the unpaid alimony.  In Tennessee and some other states, the answer is a resounding “No.”  These states zealously protect a person’s right to determine the beneficiaries of the person’s largesse.  Other states have determined that the public policy of making sure that alimony is paid is a higher priority.

Florida is one of the states that places more importance on satisfying alimony claims.  In the recent case of Berlinger v. Casselberry, the Court prohibited the trustee from making distributions to the primary beneficiary of the trust unless and until the beneficiary was current on his alimony obligations.  The Judge’s Order effectively meant that the alimony had to be paid first, and thus, the beneficiary’s ex-wife became the primary beneficiary of the trust.  The reason that the ex-wife sought the Court’s help is because her ex-husband was not working and was receiving no income that she could attach to satisfy her alimony.  Her ex-husband’s trust was directly paying all of his living expenses.  This technique of paying a beneficiary’s expenses out of the trust is specifically authorized by a recent Tennessee statute, but it was not allowed in the Florida case.

The Berlinger case highlights the significance of choosing the state law that will govern the trusts that you establish.  Tennessee passed substantial changes to its trust laws in 2013 to strengthen the rights of a grantor to choose who will benefit from the trust.  If you believe you can do a better job of picking your beneficiaries than a judge, you should make Tennessee law the governing law for your trusts.

Two-Trust Gifting Plan Finesses Tennessee Inheritance Tax and Wandry Formula Concerns

 I am currently working with an elderly gentleman who wants to make a gift of $5.25 million of LLC units to a trust for his wife and children.  The value of the LLC units is uncertain.  We are obtaining an appraisal of the LLC units; however, the IRS may disagree with the appraisal.

In addition to the valuation issue, my client may die within the next two years, which will cause the value of the gift to be added to his estate for Tennessee inheritance tax purposes.  Unless the gift qualifies for the Tennessee inheritance tax marital deduction, his estate will owe Tennessee inheritance taxes which could be as much as $400,000.  This tax will apply even if he gives his entire estate to his wife.

In order to address the valuation issue and the Tennessee inheritance tax issue, my client will establish a typical family trust, and a Tennessee QTIP Trust.  The family trust will receive LLC units equal in value to $1.25 million as finally determined for federal gift tax purposes.  The technique of making a gift that depends on the value determined for federal gift tax purposes is known as a “Wandry” formula, based upon a recent Tax Court case involving an analogous gift by Mr. Wandry.

The Tennessee QTIP trust will receive my client’s remaining LLC units that he intends to give which have an appraised value of $4 million.  When my client files his 2013 federal gift tax return, he will make a QTIP election for the gift to the Tennessee QTIP trust of whatever amount is necessary to reduce federal gift taxes to $0.  This formula marital deduction will ensure that no federal gift tax is payable even if the appraised value of the LLC units is successfully challenged by the IRS.

If my client dies before 2016, the gifts to both trusts will be added to his estate for Tennessee inheritance tax purposes.  His estate will make a Tennessee QTIP election for the Tennessee QTIP trust pursuant to T.C.A. § 67‑8‑315(a)(6).  By making the Tennessee QTIP election, inheritance tax will be avoided upon his death.  If his wife also dies before 2016, the assets of the Tennessee QTIP trust must be included on her Tennessee inheritance tax return.  However, if she lives to 2016 or beyond, Tennessee inheritance tax will be totally avoided.

Estate Tax Exemption Will Increase to $5,340,000 in 2014

The American Taxpayer Relief Act of 2012 established a $5,000,000 estate and gift tax exemption to be adjusted on a yearly basis due to changes in inflation.  The IRS has announced that the indexed exemption for 2014 will increase from $5,250,000 to $5,340,000.  This means that, with proper planning, a married couple can transfer $10,680,000 to their children without paying estate or gift taxes. 

A lot of our clients used their full exemption in 2012 ($5,120,000) and are taking a breather in 2013.  However, some of them have also given away the extra $130,000 that can be given in 2013 without paying gift taxes. 

The increased exemption also applies for generation-skipping transfer tax purposes.  A few of our clients who made the maximum gift in 2012 did not have sufficient generation-skipping transfer tax exemption to totally protect the trust.  They can now file a gift tax return to use the extra exemption to protect the trust from future generation-skipping transfer taxes. 

The annual gift tax exclusion will remain at $14,000 per donee in 2014.