Tennessee Estate Planning Law : Tennessee Estate Planning Lawyer & Attorney : Bryan Howard : Howard & Mobley Law Firm : Nashville, Chattanooga, Memphis

I just talked with the daughter of a deceased client regarding a trust established a few years ago. When I worked with her father on his estate planning a few years ago, his three children were all happily married and doing well financially. I encouraged him to leave each child’s inheritance in a trust just in case one of the children had marital difficulties and/or creditor difficulties.

My client was somewhat unsure of my recommendation, but agreed to establish separate trusts for his three children, with each child being the Trustee of their own trust. Each child has discretion to make distributions to the child and descendants of the child for their health, education, maintenance, and support. The child also has a testamentary limited power of appointment which gives them the power to decide how the trust will be distributed following their death.

The daughter has had a bad run of luck. The business owned by the daughter and her husband has done poorly due to the economy. Furthermore, her husband had a stroke and she has been recently diagnosed with cancer. They have serious creditor problems and are most likely headed for bankruptcy.

The good news is that the trust is protected from their creditors. The daughter will be able to live comfortably for the rest of her life. Furthermore, she has the ability to provide for her husband in the event that she predeceases him. If the father had not had the foresight to leave the daughter’s inheritance in a trust, it would all belong to creditors. This is exactly what the father wanted to avoid.

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In the attached Carnahan decision, the Tennessee Court of Appeals appointed a disabled man’s daughter as his conservator despite his objections.  The Court also allowed the daughter to file a divorce on behalf of her father.

It is somewhat unusual for a child to be appointed as a conservator ahead of a spouse who is willing and able to serve in such role. However, in this case, the ward’s wife had signed a prenuptial agreement that waived her right to seek the appointment of a conservator for him. If there had not been a prenuptial agreement, it is likely that the wife would have been appointed as the conservator due to the priorities set forth by Tennessee law.

It is also unusual for a court to give the conservator the power to file a divorce on behalf of the ward. This is generally thought to be such a personal matter that it should not be exercised by a conservator. When the daughter’s father had legal capacity, he decided to get married. By allowing the daughter to file for divorce in her capacity as conservator, the court allowed the daughter to substitute her judgment regarding her stepmother in place of her father's decision made while he was competent. Have you ever seen a friend or family member marry someone whom you did not approve of?

There are two lessons to be learned from this case. You should address conservatorship in your prenuptial agreement and your financial and healthcare powers of attorney. If you do not want your future spouse to participate in the appointment of your conservator, then make sure that point is addressed in the prenuptial agreement.

Your financial and healthcare powers of attorney should clearly state who you want to serve as your conservator in the event that you become incapacitated. Further, your powers of attorney should state whether or not you want the agent or conservator to be able to file for a divorce on your behalf. I personally do not like the idea of an agent under a power of attorney or a conservator being able to file for divorce. When your spouse is not your agent or conservator, it will often be one of your children. Your children are likely to benefit financially if you obtain a divorce before you die. Therefore, your conservator or agent has a built-in financial conflict of interest. Even if there is not a financial conflict of interest, a lot of step-children dislike their step-parents and might file for divorce just to be mean.
 

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This is the sixth article of a series dealing with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). For the first five articles, see:

Part 1 – Charitable IRA Rollovers
Part 2 – Estate Tax/Carryover Basis Election for 2010 Decedents
Part 3 – Temporary $5 Million Estate Tax Exemption
Part 4 – Temporary $5 Million Gift Tax Exemption: Use it or Lose It
Part 5 – Gifting Without Making Yourself a Pauper

Part 5 discussed methods for making gifts that do not decrease your cash flow. One significant blow to your cash flow could be Tennessee gift taxes. Tennessee does not have an exemption from taxable gifts. If you make a $5 million taxable gift, you will owe $463,400 of Tennessee gift taxes. A lot of our clients would be willing to make a significant taxable gift if they did not have to pay Tennessee gift taxes. This article will explain methods for avoiding or reducing Tennessee gift taxes.

Tennessee is one of only two states that impose gift taxes. Therefore, if you can arrange for the gift to be made by someone who is not a Tennessee resident, you can avoid paying Tennessee gift taxes. Several of our clients have either changed their residence to another state or are considering making this change.

Sometimes, one spouse has become a resident of another state, while the other spouse has remained a Tennessee resident. If the gift is made by the spouse who is not a Tennessee resident, no Tennessee gift taxes will be required. The gift by the non-Tennessee spouse can be split for federal gift tax purposes (this would allow a total gift of up to $10 million). Splitting the gift for federal gift tax purposes would not require the Tennessee non-donor spouse to file a Tennessee gift tax return.

Someone who is planning to move to Tennessee should make the gift prior to moving here.

The Tennessee gift tax does not apply to gifts from QTIP Trusts that were established by someone who was not a resident of Tennessee. This may be useful for someone who moved to Tennessee after a QTIP was established when they lived in another state. The beneficiary of the QTIP trust might be able to convey their interest in the trust to the remainder beneficiaries, thereby accelerating the vesting of the trust in the remainder beneficiaries.  If the QTIP Trust has a spendthrift clause, you will first have to modify the trust to eliminate this clause.

Tennessee gift taxes do not apply to gifts of real estate or tangible personal property that is physically located in another state. Our clients frequently take advantage of this exception by establishing Qualified Personal Residence Trusts for vacation homes located in other states.

It is much less common to deliver possession of tangible personal property while outside of the state. Assume that you want to give a valuable painting or piece of jewelry to a child. You and your child could drive to Bowling Green, Kentucky, and exchange the property while present in Kentucky. I recommend that you take a picture and perhaps prepare a contemporaneous memorandum that is witnessed by someone who is not a party to the gift transaction.

Tennessee gift taxes do not apply to gifts to 529 accounts. 529 accounts work best when the funds in the account will be used for college education expenses of the beneficiary. However, it is possible for the beneficiary to withdraw the portion of the account that is not needed for these expenses. When withdrawals are not made for qualified education purposes, federal income taxes and a penalty will be assessed on the income earned by the account.

If you plan to make a gift that requires you to pay Tennessee gift tax, you should consider splitting the gift between 2011 and 2012. If you split the gift between two years, this will reduce the overall taxes by $11,600. For example, if you make a gift of $440,000 in 2011 and a gift of $4,560,000 on January 1, 2012, your total taxes will be $451,800 rather than $463,400. Furthermore, the time for paying most of the tax will be postponed until April 15, 2013. Unlike income taxes, you are not required to make estimated payments throughout the year. 

Alternatively, you could reduce the gift on January 1, 2012 to $4,120,000. If the $5 million gift tax exemption is extended to 2013, you could make the final gift of $440,000 on January 1, 2013.  If the exemption is not extended, you would make the final $440,000 gift later in 2012.  Waiting gives you the opportunity to reduce taxes by another $11,600 if the higher gift tax exemption is extended.

When deciding whether to delay making a portion of your gift in order to reduce Tennessee gift taxes, keep in mind that the sooner you make the gift, the sooner you can get income and appreciation out of your estate.

Tennessee gift taxes are a serious concern for clients who want to take advantage of the 2 year opportunity to make large taxable gifts without paying federal gift taxes. There are various types of gifts that can be made without incurring Tennessee gift taxes.  If you must pay the taxes, splitting your gift between multiple years can soften the blow.

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This is the fifth article of a series dealing with the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Act”). For the first four articles, see:

Part 1 – Charitable IRA Rollovers
Part 2 – Estate Tax/Carryover Basis Election for 2010 Decedents
Part 3 – Temporary $5 Million Estate Tax Exemption
Part 4 – Temporary $5 Million Gift Tax Exemption: Use It or Lose It

The Act temporarily increases the gift tax exemption to $5 million for 2011 and $5 million increased by inflation for 2012. The Act decreases the gift tax exemption to $1 million for gifts in 2013 or later. Our clients are actively considering methods to take advantage of this 2 year window of opportunity to make large tax-free gifts.

The first commandment of gift planning is to take care of yourself. This article will explain techniques for taking advantage of the gift tax exemption without decreasing your cash flow below your comfort zone.

Valuable assets that do not provide much cash flow are good candidates for gifting. Typical examples are stock of a family business that does not declare dividends and real estate that does not generate income.

Personal residences can also be gifted. A Qualified Personal Residence Trust is the favored technique for gifts of a personal residence.

If you are married, you should consider making gifts to a spousal access trust and maintaining a good relationship with their spouse. Spousal access trusts allow distributions to be made to your spouse. Assuming that you can persuade your spouse to use distributions for the joint benefit of the two of you, this gives you indirect access to the trust assets. The flaw with this plan is that your spouse could predecease you. You might hedge this risk by purchasing life insurance on your spouse. Also keep in mind that your expenses will decrease after your spouse dies.

Spouses sometimes ask whether they can set up spousal access trusts for each other. This is dangerous due to the reciprocal trust doctrine. Careful design of the trusts can minimize, though not totally eliminate this risk. Due to the potential estate tax risk associated with reciprocal trusts, I encourage other alternatives.

We generally recommend that gifts be made to “grantor” trusts so that the donor can pay income taxes on the income of the trust. We design these trusts with an escape hatch so that the donor can cease paying taxes if the taxes become too much of a burden. The most common power that we use to make the trust a grantor trust is a power of substitution that allows the donor to swap assets with the trust as long as the swap has equivalent value. Assume that you give a high income asset to a spousal access trust and your spouse predeceases you. You could use the power of substitution to swap low income assets such as undeveloped land for cash in the trust or for the income producing property.

We frequently recommend gifts of non-voting stock in a corporation, non-voting units of an LLC, or limited partnership interests in a limited partnership. Generally, the donor and/or spouse maintain voting control of the entity that is being gifted. By maintaining voting control, they determine who runs the company and a reasonable salary to be paid to the managers of the company. Assuming the donor still participates in management, the company can pay the donor a reasonable salary.

One of our favorite gifting techniques involves a gift combined with an installment sale to a grantor trust. The trust will have an obligation to make payments to your over time. Your continued access to cash flow through note payments makes it more feasible to give assets to the trust.

Another popular gifting technique is a grantor retained annuity trust. These trusts allow you to receive payments from the trust for a period of years.

To this point, I have discussed gifts of non income producing property and methods for obtaining access to cash flow from property gifted to a trust. Other techniques reduce expenses that you would otherwise have to pay, which has the same effect as if you had maintained access to the cash flow.

One type of gift that relieves an expense is a Charitable Lead Trust. Assume that you plan to give at least $50,000 per year to charity for the next 10 years. If you make a gift to a Charitable Lead Trust that pays $50,000 to charity for 10 years, this will reduce the funds that you would otherwise have to spend for the charitable donation. Charitable Lead Trusts represent a fantastic opportunity for leveraging your gift tax exemption, especially when the amount going to charity does not increase.

Another technique for reducing your expenses involves the “leapfrog” (also referred to as “decanting”) power under the Tennessee Uniform Trust Code. The leapfrog power allows a trustee of one trust to make distributions to another trust that benefits the same beneficiaries. Assume that you previously established a life insurance trust (“ILIT”) that requires premium payments of $30,000 per year. If you make a gift to another trust that benefits the same beneficiaries, the trustee could distribute income from the new trust to the ILIT to enable it to pay life insurance premiums. The donor cannot ensure this result because the donor must give up all control over the gift. However, trustees generally can be counted on to assist with an overall plan that helps the beneficiaries of the trust.

There are several methods of taking advantage of the $5 million federal gift tax exemption without decreasing your cash flow. You can give away non income producing property. Some techniques provide cash flow directly to you or your spouse. Others reduce your expenses.
 

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