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.
 

A lot of my clients recently received a Franchise and Excise Tax Annual Exemption Renewal Form from the Tennessee Department of Revenue. This form applies to Limited Liability Companies and Limited Partnerships that claim an exemption from Tennessee Franchise and Excise Taxes.

The three most common exemptions that apply to my clients are the obligated member entity (“OME”) exemption, the family-owned non-corporate entity (“FONCE”) exemption, and the farm exemption. If your company qualifies for one of these exemptions, you need to fill out the renewal form with the help of your CPA and send it to the Department of Revenue no later than April 15, 2010. If your company qualifies for an exemption and you have not received the form, you can get the form at http://tennessee.gov/revenue/forms/fae/fae183.pdf, or you can call the Department of Revenue at (615) 253-0600.

If you do not file the form by April 15, 2010, you will lose your exemption for 2009. The Department has the discretion to allow a late filing. If they allow a late filing, they will charge you a $1,000 penalty.
 

Tennessee imposes Franchise and Excise Tax on limited partnerships and limited liability companies unless they qualify for an exemption. Due to a law change enacted earlier this year, numerous entities converted from the family owned non-corporate entity (“FONCE”) exemption to the obligated member entity (“OME”) exemption.

The OME exemption requires the entity’s owners to assume personal responsibility for liabilities of the entity. Most entities that switched to the OME exemption own commercial real estate.

In order to qualify for the OME exemption for 2009, appropriate documentation had to be filed with the Tennessee Secretary of State by October 1, 2009. On November 10, 2009, the Department of Revenue imposed an additional requirement to qualify for the OME exemption for 2009.

Each entity that switched to the OME exemption must file a new Application for Exemption with the Department of Revenue on or before November 30, 2009. If the entity does not file an Application for Exemption by November 30, 2009, it will not be exempt for 2009.

The Department of Revenue has discretion to allow a late filing of the application. However, if they permit the late filing, they must charge a $1,000 penalty.

If the entity failed to convert to an OME prior to October 1, 2009, it has the option of converting to an OME prior to December 31, 2009 if the entity wants to be exempt from franchise and excise taxes for 2010 and future years.

If you are an owner of an OME and are concerned about your potential exposure to liabilities of the entity, you should consider transferring a portion of your assets to an asset protection trust.
 

Wealthy grandparents often make gifts to their grandchildren. A grandparent can give $13,000 per year to each grandchild without incurring gift tax. If gifts are made over several years, estate taxes upon the death of the grandparents can be substantially reduced.

There is a hidden trap in making gifts. The danger is that your grandchild may get divorced in the future. Some states consider all property owned by either spouse to be marital property which is subject to a 50/50 division upon divorce.

The problem is illustrated by a family that I now represent. The grandmother made gifts of stock of the family business to her granddaughter in the 80s and 90s. The grandmother died in 1997. Two years later, her granddaughter married a man the grandmother never met.

I did not know the grandmother, but have represented the grandmother’s daughter for the last several years. The daughter continued her mother’s pattern of making annual exclusion gifts to her daughter. Rather than direct gifts, the gifts were made to a Cristofani Trust (pdf) that benefits the daughter’s husband and all of her children and grandchildren.

The granddaughter recently obtained a divorce in a state that treats all property owned by either spouse as marital property. In accordance with state law, the judge awarded one-half of the granddaughter’s stock in the family business to the granddaughter’s husband.  The net result is that when the grandmother made gifts to her granddaughter, she was also making a gift to her granddaughter’s future ex-husband.

The stock awarded to the ex-husband was subject to a Shareholder’s Agreement, which allowed the company to purchase the stock from the ex-husband. As you might imagine, the family was upset about having to buy back the stock.

The laws of the states where the grandmother and granddaughter lived at the time of the gifts would not have included the gifts in the marital estate if the granddaughter had obtained a divorce in either one of those states. However, division of property is determined by the state in which the couple resides at the time of the divorce.

Fortunately, because the gifts by the daughter were made to a trust, these gifts were protected in the divorce. The moral of this story is to consider making gifts to a properly designed trust in order to reduce the chance that the donee will lose part of the gift if they subsequently obtain a divorce in the wrong state.
 

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.

 

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.