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

Unconfirmed rumors are circulating that the Super Committee may propose to reduce the current $5 million gift tax exemption to $1 million, potentially effective as early as November 23, 2011. It seems unlikely to me, but the rumor could be based upon “leaks” from insiders who are familiar with the Super Committee deliberations.

A lot of our clients have already made their $5 million gifts. Others are taking their time and studying their options. A couple of our clients who were studying their options are now mobilizing to complete their gifts prior to November 23, 2011. 

If you are concerned about a potential law change but will not be able to complete your gift by November 23, 2011, there is one technique that you should consider. An inter vivos QTIP trust would allow you to beat the law change, if there is one, yet provide you with the flexibility to unwind the transaction if there is no law change. Assume that Husband makes a $4 million gift to a marital trust that benefits Wife for her lifetime and then continues in trust for the benefit of their children. If the Super Committee does not change the law, and the gift tax exemption remains in place until December 31, 2012, the marital trust will be liquidated and the assets will be distributed to the wife. The couple will then decide how to best use their $5 million gift tax exemption. If this course is followed, Husband will need to file Tennessee and federal gift tax returns on April 15, 2012 (or October 15, 2012 with an extension), and make QTIP elections on both returns.

Alternatively, if the $5 million gift tax exemption is eliminated as of November 23, 2011, the QTIP trust will stay in place and the husband’s federal gift tax return for 2011 will not make a QTIP election.   The Tennessee gift tax return for 2011 will still make a QTIP election in order to avoid paying Tennessee gift taxes for 2011.

The QTIP plan will allow the husband to utilize his gift tax exemption but does not allow the wife to utilize her exemption. If the wife establishes a similar $4 million trust for the husband, there is a danger that the reciprocal trust doctrine will eliminate all of the proposed benefits from the transaction. In theory, the separate trusts for the husband and the wife can have different provisions that will avoid the application of the reciprocal trust doctrine. However, it is my opinion that there is still some risk if they each establish trusts that benefit the other, especially since the two trusts will be created very near in time to each other. Accordingly, I do not recommend the establishment of QTIP trusts by both spouses.

I am very skeptical about Congress closing the gift tax window as of November 23, 2011. Nevertheless, you might as well consider acting before that date if you are committed to making a gift anyway. An inter vivos QTIP trust is one method for hedging your bets.

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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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I came across an interesting article regarding estate planning for second marriages. The article highlights some of the most common issues faced by male business owners who have children from a prior marriage. Women, of course, face many of the same issues.

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A recent article discussed the use of Inter Vivos Marital Trusts to reduce estate taxes. These trusts can also be used to provide asset protection from future creditors. When the objective is asset protection, the trust is designed differently.

One spouse transfers property to a trust for the benefit of the other spouse. If the donee spouse predeceases the donor spouse, the donor spouse becomes the beneficiary of the trust. The donor spouse’s retention of a successor beneficial interest in the trust represents the key distinction of a marital trust that is used for asset protection rather than reducing estate taxes.

This type of trust has always been exempt from future creditors during the donee spouse’s lifetime because it is a third party created spendthrift trust. When the donor spouse becomes the beneficiary, the trust has traditionally been available to all creditors of the donor spouse since the transfer was made to a trust of which the donor is a beneficiary.

A new Tennessee law will make these trusts exempt from the donor spouse’s future creditors after July 1, 2010. This means that one spouse can transfer substantially all of his or her assets to a trust and protect the assets from future creditors of both spouses.

Inter Vivos Marital Trusts may not be used to avoid the donor’s obligations to creditors that already exist at the time of the transfer to the trust. If the donor spouse does not retain sufficient assets to pay existing creditors, the preexisting creditors can attack the trust as a fraudulent conveyance.

Another potential benefit of an Inter Vivos Marital Trust is to make sure that the donee spouse has sufficient assets to utilize his or her federal estate tax exemption and Tennessee inheritance tax exemption. This will reduce estate taxes upon the surviving spouse’s death. No gift taxes will be payable if the donor spouse files timely federal and Tennessee gift tax returns which make a QTIP election.

For federal income tax purposes, the donor spouse will be taxed on all of the taxable income of the trust, including capital gains, during his or her lifetime. The donee spouse will be taxable on the ordinary income of the trust following the death of the donor spouse and may be taxed on some or all of the capital gains of the trust.
 

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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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