Dedon on Estate Planning

Building Flexibility Into Irrevocable Trusts

Irrevocable Trusts are a common estate planning tool to remove assets from the taxable estate. The "grantor" creates the Irrevocable Trust, transfers assets to the Trust, and after accounting for any gift tax issues, the Trust assets are removed from the grantor’s taxable estate for estate tax purposes. However, to obtain the advantage of estate tax removal, the grantor must give up control over the Trust assets, including the right to change the Trust.

However, often times Trusts need to be, or should be, amended. There may be a change in the law or circumstances that require an amendment. Because Irrevocable Trusts are often designed to last many years – sometimes in perpetuity – there can be a number of reasons why it would need to be amended. For example, there could be ambiguities in the language or a drafting error. Perhaps the Trust should be divided to separate assets or, conversely, perhaps different Trusts should be consolidated.

Herein lies the dilemma: we know the grantor cannot amend the Trust or he would lose the estate tax benefits. A common solution to amend a Trust is to ask a judge to judicially reform the Trust. However, this can be expensive and it may require the consent of the beneficiaries.

A second alternative available in certain states is to take advantage of a "decanting" statute. The decanting statutes allow a Trustee, without court involvement, to essentially prepare a new Trust to address changes in circumstances. (Of course, the assumption is that the Trustee is acting pursuant to the grantor’s wishes during the grantor’s lifetime and after his death.) This flexibility is provided by pouring the assets from the old Trust into the new Trust without court involvement or beneficiary permission. At least seven states allow decanting, including Delaware, New York and Florida. Basic requirements are that the Trustee has the ability to invade Trust principal and the beneficiaries of the new Trust will be identical, or at least similar, to the beneficiaries of the old Trust.

Even states that do not have decanting statutes still allow for some limited Trust amendment without court involvement. For example, a properly drafted Irrevocable Trust will allow for changes of Trustees, the merger of identical trusts, and changes in the Trust situs.

In sum, an "irrevocable" trust will be irrevocable but not necessarily inflexible.

Are Foreign Accounts Worth It?

Clients often ask whether they should utilize offshore accounts for tax planning and asset protection. For asset protection, offshore accounts may work if both the taxpayer and the assets are offshore. However, U.S. Courts have held U.S. taxpayers in contempt of court, and put them in jail, if the taxpayer asserts in front of the judge that he cannot obtain the assets because they are in a foreign account. Thus, offshore accounts for asset protection in most situations is not a viable option.

Regarding tax matters, U.S. residents or citizens are taxed on all income and assets regardless of where the assets are held. Many individuals erroneously think by titling assets overseas they are avoiding income or estate tax. Often what these U.S. citizens were falsely relying on was merely the secrecy laws of foreign countries.

As you may have read in newspapers and the popular press, many countries are loosening their secrecy laws in the face of increased U.S. pressure. UBS and other banks are now cooperating with the IRS. The IRS has targeted offshore accounts as a major enforcement issue. The IRS has hired thousands of new agents and imposed greater reporting requirements.

Among these reporting requirements is a return taxpayers must file by June 30th for the 2008 year. (Report of Foreign Bank and Financial Accounts or "FBAR.") There are a number of other returns associated with foreign accounts. You may have also read about a voluntary disclosure program announced by the IRS for taxpayers who confess their wrongdoing. However, this voluntary disclosure program does not eliminate the requirement to pay taxes, interest and all penalties. What it does do is avoid criminal sanctions and may reduce penalties.

In sum, foreign accounts may present opportunities and advantages for certain U.S. taxpayers. However, considering the reporting requirements, the suspicion of fraudulent conveyance, and the cost involved, most clients should conduct their asset protection and tax planning within the U.S.

Potential Changes In Estate Strategies

Attached is a copy of an article I wrote that was recently published in the Virginia Business Magazine on the Obama administration proposals to restrict certain estate planning strategies.  You can see the article by clicking below.

Download Va bus art 5-19-09

The Latest On GRATs

In prior columns I have written about GRATs and how they allow taxpayers to transfer more assets to their families and less to the IRS. GRATs, and other similar strategies are particularly important knowing that the federal estate tax, with rates perhaps as high as 45%, will remain long into the future. The Obama Administration and Congress are considering restricting GRATs.

GRATs allow the donor to transfer closely held stock, real estate, or marketable securities to a Trust for a minimum of two years. If the donor receives an annual annuity from the GRAT, the transferred asset or at least its appreciation, will pass to the donor’s family at the end of the GRAT term at a reduced value and is removed from the donor’s estate. The asset value is reduced for gift tax purposes because of the retained annuity. Obviously the greater the annuity amount and the longer the term of the GRAT, the greater the reduction in value of the transferred asset for gift tax purposes. In fact, it is possible to "zero out," meaning eliminate, the gift tax.

One catch: the donor needs to survive the term of the GRAT. Thus, an 80 year old would not choose a 20 year GRAT. In fact, regardless of age, many business owners choose 2 year GRATS to capture any savings possible, and then simply do repeated 2 year GRATS with the same assets (so called "rolling GRATS").

Under the Obama plan, the law would prohibit GRATS less than 10 years in duration, meaning the donor must live 10 years to remove the asset from the donor’s estate. A separate proposal in Congress would not tinker with the length of the GRAT, but would require a minimum gift imposed on the donor, perhaps as much as 10% of the transferred asset (thus eliminating zeroed-out GRATS).

This proposal, if enacted, will likely carry the date of enactment as the effective date. Thus, acting now becomes even more important.

PROTECTING ASSETS

In this economy, creditor protection is an increasing concern for many individuals. In contrast to prior years, when perhaps real estate developers at times or professionals concerned about malpractice, had creditor protection concerns, today's environment and the economy has affected many more people.

Any creditor protection solution is only possible if there is no "fraudulent conveyance." A fraudulent conveyance is any transfer that renders the debtor insolvent or which is done with the intent to delay, hinder, or defraud a creditor. Assuming no fraudulent conveyance, certain assets may be protected depending on state law or bankruptcy protection. Common examples are the following:

1. Many states protect property that is titled with a spouse "tenants by the entirety." Thus if there is a judgment against one spouse, the property would be protected. An example would be a real estate developer who signed a loan. Upon default, if a creditor sought collection from the developer’s real property and accounts that were titled "tenants by the entirety," those assets would be protected as long as his wife did not sign on the note. If his wife then died and the judgment was outstanding, then the protection is lost.
2. ERISA accounts, such as 401(k) plans, enjoy unlimited protection. IRA's, which are not ERISA plans, enjoy limited protection in many states up to $1 million. The IRA protection of $1 million may depend on whether the debtor is in bankruptcy and the 2005 Bankruptcy Act applying. Although assets rolled over from an ERISA plan to an IRA are also protected, it is important to make sure you do not commingle the two different kinds of accounts.

There are a host of other asset protection solutions ranging from charging order protection afforded partnerships and limited liability companies, to domestic asset protection trusts created in states that have favorable protection laws such as Delaware or Alaska, to offshore planning in Countries with even more favorable laws. However, the bottom line is that, for U.S. residents with U.S. assets, proactive asset protection planning will only work if it predates any fraudulent conveyance problems.