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

 Qualified Personal Residence Trusts significantly reduce estate taxes that will be assessed on a personal residence. For married couples, I often recommend that the husband and wife each transfer a 50% interest in the residence to separate QPRTs. When both spouses establish separate trusts, you hedge the mortality risk associated with QPRTs. The other benefit from separate QPRTs was demonstrated by the recent Ludwick case in which the husband and wife each transferred 50% of their $7 million Hawaiian home to a separate QPRT. The court ruled that the value of each 50% interest was 17% less than 50% of the value of the entire home. The 17% fractional interest discount significantly reduced the gift tax cost of establishing the QPRTs.

There is also a way to take advantage of fractional interest QPRTs when it is not possible or practical to establish separate husband and wife QPRTs. One person can establish two separate QPRTs with different terms, for example, 6 years and 8 years, and transfer a 50% interest to the two separate QPRTs.

My clients seldom establish QPRTs for their Tennessee residences because they do not want to pay Tennessee gift taxes. Therefore, most QPRTs that my clients establish are for vacation homes located in other states. Generally, QPRTS in other states do not generate any federal or state gift taxes.

If you are buying an expensive home in Tennessee or elsewhere, there is a technique called a joint purchase trust that can be used without any gift taxes having to be paid. Joint purchase trusts have a lot in common with QPRTs. However, they must be established prior to purchasing the home.

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The term “dynasty trust” refers to a trust that will last for several generations. Since 2007, Tennesseans have been able to establish dynasty trusts that can last for 360 years. Prior to 2007, trusts had to terminate after approximately 100 years.

In order to qualify for the longer duration, the trust must provide a testamentary limited power of appointment to at least one member of each generation of your descendants who dies more than 90 years after the trust is established. A testamentary limited power of appointment provides the beneficiary with the right, through a provision in his or her Will, to terminate the trust in favor of certain beneficiaries or charities or to keep the property in trust with different provisions. Tennessee’s law is unique in requiring this power of appointment in order to qualify for the longer term.

The required power of appointment will be eliminated for trusts established on or after July 1, 2010. Even though the power of appointment will no longer be required, I still recommend that you provide future generations with the ability to modify the trust.  Imagine that your great great grandparents had established a trust in 1910 which now benefits you. Could they have possibly anticipated all of the changes that have occurred over the past 100 years and determined a sensible trust design for your descendants? It is much more likely that you can design a better trust to accommodate the specific attributes of your children and grandchildren and numerous changes that have occurred in the world over the last century.

If 360 years is not long enough for you, there are several states that allow trusts to last into perpetuity. Even if you live in Tennessee, you can take advantage of the laws in one of these other states. To date, only one of my clients has not been satisfied with 360 years.
 

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If you are a beneficiary of a trust that requires income to be distributed to you, you may be able to increase your trust distributions by taking advantage of a new Tennessee law that will become effective on July 1, 2010. Section 21 of Public Chapter No. 725 of the Tennessee Public Acts of 2010 authorizes a trustee of a trust that requires mandatory distributions of net income to convert the trust to a total return unitrust.

The effect of a conversion is to change the trust distributions from “income” to a fixed percentage of the value of the trust. Assume that your trust has $1 million of assets and generates net income of $25,000 per year. If the trust is converted to a 4% unitrust, your distributions will increase to $40,000.

The fixed percentage must be between three percent (3%) and five percent (5%). Ideally, the income and remainder beneficiaries of the trust will agree to the percentage in advance. If the beneficiaries fail to agree in advance, the trustee will either not make the conversion or will choose the percentage on its own.

The conversion can be made without a court proceding if certain procedures are followed. If the Trustee is not “disinterested,” the Trustee must appoint a disinterested person to determine the unitrust percentage, the method to be used in determining the fair market value of the trust, and which assets are to be excluded in determining the unitrust amount. The trustee must send written notice of the proposed conversion to all qualified beneficiaries of the trust and not receive an objection within thirty (30) days. If a beneficiary objects, the Trustee can petition the Court to approve the conversion.

The main benefit of making a conversion is to eliminate an inherent conflict of interest between the income and remainder beneficiaries. With an all income trust, the income beneficiaries generally want the trustee to purchase investments that generate a lot of income and remainder beneficiaries want the Trustee to purchase assets that will appreciate in value. As a general rule, high income investments do not appreciate as much in value. When payments to the income beneficiary are dependent on the value of the trust rather than income received, the income beneficiary prefers for the trustee to maintain an investment policy that results in growth of the value of the trust over time. Growth will increase distributions to the income beneficiary and will also benefit the remainder beneficiaries of the trust.

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The past decade has seen a vast improvement in Tennessee's trust laws, making it one of the leading states for establishing a trust. Major laws that have been enacted include the Uniform Principal and Income Act (2000), the Tennessee Uniform Prudent Investor Act of 2002, the Tennessee Uniform Trust Code (2004), the Tennessee Investment Services Act of 2007, and the Tennessee Community Property Trust Act of 2010.

On April 9, 2010, the Governor signed another law that makes numerous improvements to the trust laws. The new law includes provisions providing enhanced creditor protection for various trusts, including special needs trusts and inter vivos marital trusts, and contains a provision allowing a Trustee to convert a mandatory income trust to a “unitrust” with an annual payment of between three percent (3%) and five percent (5%). I will be writing additional articles to provide more details about these changes.
 

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Federal and state lawmakers continue to pass laws that provide tax and non-tax benefits to trusts. I have often wondered why legislators love trusts so much.

Richard Johnson and I did a presentation to the Nashville Estate Planning Council titled “60 Trusts in 60 minutes.” We came up with 65 different types of trusts. Let me know if we forgot any.
 

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Recently, a client told me “as is so often the case second marriages, the value of the wife’s estate that she can leave her children will vary significantly depending on whether she predeceases her husband.” My client’s observation is so accurate. I have encountered this dilemma when working with other clients, but had not understood that this problem affects numerous second marriages.

My client’s husband is very wealthy and plans to make a generous bequest to her in his Will. Furthermore, they jointly own a valuable house.

If her husband dies first, she will own the house and will receive the bequest from her husband’s Will. If she dies first, she will have neither the house nor the bequest.

She is comfortable with the amount that she will be able to leave her children if she survives her husband. However, she is concerned that the inheritance for her children will be insufficient if she predeceases her husband.

The solution that I proposed works as follows:

The couple establishes an irrevocable life insurance trust (“ILIT”) that will buy a last to die insurance policy on the lives of the husband and wife. If the wife dies first, her children will be the beneficiaries of the ILIT. If the husband dies first, his children will be the beneficiaries of the ILIT.
The parties agreed to split the premium payments during their joint lives. The will of the first to die will make a bequest to the trust that is sufficient to pay premiums during the period of survivorship.

The “Switch ILIT” solved my client’s dilemma of making sure that her children will be well provided for regardless of whether she predeceases her husband.
 

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I discourage the use of a marital trust for a surviving spouse when the decedent’s children from a prior marriage will be the remainder beneficiaries. Such trusts have an inherent conflict of interest and should be avoided when possible.

Most marital trusts base the payments to the surviving spouse on the trust’s income. The surviving spouse wants the Trustee to purchase investments that produce a lot of income. Conversely, the stepchildren prefer the Trustee to invest in assets that will appreciate in value over time.

When a marital trust is the only practical solution, I recommend a marital unitrust, which works as follows: The surviving spouse receives the greater of the income earned by the trust or five percent (5%) of the value of the trust determined as of the beginning of each calendar year. In order to reduce volatility in the amount of the annual payments to the spouse, payments should be based on a 3 year average of the value of the trust.

The Trustee invests in a mixed portfolio of equities and fixed income investments. Principal assets will need to be liquidated each year to make the payments to the spouse because income will be significantly less than 5%.

The spouse wants growth because it will increase distributions in the future without reducing current distributions. The Trustee’s job will be much easier to accomplish because the spouse and the stepchildren will have the same goals.  
 

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My clients often want to make changes to an irrevocable life insurance trust (“ILIT”). Fortunately, there are at least 6 methods for making changes to an ILIT.

I recently worked with a business owner who used 4 different techniques to restructure a series of ILITs that he established over a 25 year period. Two of the ILITs owned insurance on his life. Two other ILITs owned last-to-die policies insuring the business owner and his wife.

The first step was to create two new ILITs. The wife is a beneficiary of the new Family Trust which now owns the single life policies. The other new ILIT was designed as a Dynasty Trust and now owns the last-to-die policies, as well as one single life policy.

Next, the wife exercised a power to appoint the assets of one ILIT to the Dynasty Trust. The trustee of another ILIT used the leapfrog power of TCA Section 35-15-816(27) to distribute its policy to the Family Trust.

The trustee of a third ILIT merged that trust into the Dynasty Trust pursuant to TCA Section 35-15-417. Finally, the trustee of the fourth ILIT sold its policy to the Dynasty Trust, which was structured as a grantor trust in order to avoid potential income tax issues associated with this sale.

I would have preferred to use the same technique for moving all 4 of the old ILITs into the Family Trust and the Dynasty Trust. However, different techniques were required due to the specific wording of the trusts, and other factors including tax consequences. Even though it was complicated, the business owner accomplished his goals and several generations of his family will benefit from these changes.

Incidentally, the two techniques that we did not use were: (i) amending the trust pursuant to TCA Section 35-15-411; and (ii) buying a new policy, which was not a viable alternative due to the age of the policies involved and health changes that have occurred.

See the enclosed article (PDF) for more detail on these techniques.

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If you are planning to buy a new home, you might want to know about Joint Purchase Trusts. These trusts can provide significant estate tax savings.

One of my clients named John asked me whether he or his children should buy a vacation home that will cost $900,000. I recommended that John and his children establish a Joint Purchase Trust.

John will contribute $630,000 (70%) to the Trust and his children will contribute the remaining $270,000 (30%). John’s children have the ability to fund this investment due to prior gifts they have received from John and his parents.

John will have the use of the home for his lifetime and will pay all taxes, insurance and maintenance costs. With John’s permission, his children will also be able to use the home.

John can sell the home if he chooses. If the home is sold, the Trust would either purchase another home or other investments.

Upon John’s death, the trust will terminate, and the home will belong to his children. Nothing will be included in John’s estate for estate tax purposes.

Neither the $630,000 paid by John nor the appreciation of the home will ever be subject to estate or gift tax. This will be a substantial estate tax savings as compared to John buying the home in his name.

A Joint Purchase Trust can also be established by married couples. The husband and wife would retain the right to live in the home until the death of the survivor.

I do not recommend these trusts if you plan to borrow money to buy the home or to use the home as collateral for a home equity line of credit.
 

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More than 50% of marriages end in divorce. When one spouse enters the marriage with significant assets, they often leave with less than they started with.

The traditional method for protecting your assets is to enter into a prenuptial agreement before you get married. I recommend this to all of my clients who are getting married.

In lieu of or in addition to a prenuptial agreement, Tennessee residents can protect their assets by transferring them to an asset protection trust {pdf} before they get married. Even if they do not have a prenuptial agreement, their spouse will not be entitled to any of the trust assets upon divorce. Furthermore, their spouse will not be able to claim any portion of the trust assets upon death. This latter point is especially important for later-in-life marriages when one or both spouses have children from prior marriages.

I have mostly used pre-marital asset protection trusts for young adults who have received substantial gifts and/or inheritances from their parents and grandparents. As a general rule, these young adults have relied solely upon the protection afforded by the trust because they were not willing to discuss a prenuptial agreement with their future spouse.

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If one of your parents is alive, you should consider asking your parent to give you any inheritance that you will receive in a beneficiary-controlled trust.

A properly designed beneficiary-controlled trust can provide protection from creditors, including divorced spouses, and from estate taxes upon your death. When discussing this matter with your parents, blame your attorney for raising the issue.

At my suggestion, one of my clients persuaded his mother to amend her Will to leave his future inheritance in a trust controlled by my client. The amendment did not affect the bequests to my client’s siblings. His mother died last year and the trust has been funded with approximately $800,000. My client is currently distributing cash from the trust to his son, who recently lost his job. This is not a taxable gift by my client. My client's son is in a low income tax bracket, which significantly reduces the income taxes payable with respect to the trust’s income.

The ability to divert income to a child without losing control of the assets is one of the many benefits from receiving your inheritance in a trust.

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