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