The Strings that Bind

1. The Strings that Bind Presented by Steve Hartnett Associate Director of Education American Academy of Estate Planning Attorneys

2. The Strings that Bind • Grantor Issues – Gift Tax • Gift Completion • “parted with dominion and control” • Treas. Reg. 25.2511-2(b) • If grantor retains rights • Incomplete to that extent • If permissible beneficiary • Depends if creditors can reach • Paolozzi v. Comm’r • PLR 9837007 (Alaska Trust)

3. The Strings that Bind • Grantor Issues – Gift Tax • Gift Completion • If grantor has no interest, see if grantor retained control • Sprinkling power • Add or remove beneficiaries • Power to accumulate (if that might shift assets to different beneficiary)

4. The Strings that Bind • Grantor Issues – Gift Tax • Powers not “dominion and control” IF • Exercisable only w/ adverse party • Subject to ascertainable standard • Question is whether creates enforceable rights in beneficiary under state law – so can differ • Power to affect time and manner only • Power to accumulate if will eventually go to that beneficiary

5. The Strings that Bind • Grantor Issues – Gift Tax • Powers not “dominion and control” • Any power subject to contingency if • Beyond grantor control • Not yet occurred

6. The Strings that Bind • Grantor Issues – Imputation • Estate of Grace reciprocal trust • A sets up trust for B, B sets up trust for A. A is deemed grantor of trust for A, causing 2036 inclusion. • Consider if anyone else could be the deemed grantor

7. The Strings that Bind • Grantor Issues – imputation • Trustee removal • If can replace w/ self, attribution • If can replace w/ someone not related/subordinate, not a problem for 2036/2038. • At first Service allowed, then not, then lost in court, now ok. Rev. Rul. 95-88. • Unclear if 2042 issue --old TAM relied on revk’d RR, but said no

8. The Strings that Bind • Grantor Issues – Imputation • Initial naming of even related party not a problem • So can name kids or spouse as ttee • Service argued in the past that close relationship is de facto control • Courts: no control • Trustee has independent fiduciary duty, i.e. someone can file suit

9. The Strings that Bind • Grantor Issues – 2036 • Estate includes property if • Transfer + • Retained possession, enjoyment, right to income • AND • Period is • D’s life • Not in fact end before D’s death • Ascertainable by ref. to D’s death

10. The Strings that Bind • Grantor Issues – 2036 • Right to receive income or property • Could be implied agreement • Example: John transfers 99% of assets to an Alaska Trust and trustee always distributes upon request • Transfer of residence • No problem if transfer to spouse • Risk if anyone else

11. The Strings that Bind • Grantor Issues – 2036 • Transfer of house • Could give fractional interest and thereby retain right to live there • Note sale/leaseback does not per se avoid 2036 even if for FMV according to Service. • If creditors can reach, it’s included • If distributions satisfy D’s legal obligation of support—inclusion

12. The Strings that Bind • Grantor Issues – 2038 • Transfer (except FMV sale) AND • D had at death • Power to alter amend revoke terminate enjoyment of property • Power alone or in conjunction of anyone that’s not adverse

13. The Strings that Bind • Grantor Issues – 2038 • Powers causing inclusion • Shift income or principal • Add beneficiaries • (independent significance doesn’t count, like power to adopt a child) • Power to accumulate • Alters enjoyment even if doesn’t shift to other beneficiaries • So, completed gift but included

14. The Strings that Bind • Grantor Issues – 2038 • If grantor plus others • Still inclusion • If grantor incapacitated • Still inclusion • Exception • Ascertainable standard

15. The Strings that Bind • Grantor Issues – 2038 • Ascertainable standard • Ok- HEMS • Sickness or other emergency • Standard of living in style to which s/he has become accustomed • Not ok • For best interests • The circumstances so require • Special emergency • pleasure

16. The Strings that Bind • Grantor Issues • Management powers 2036/2038 • If can exercise in non-fiduciary capacity it’s a problem • If in fiduciary capacity • Power to allocate income ok • Investment discretion ok • Power to substitute assets ok • Power to vote stock not ok • 2036(b) and 2036(a)(2)/Strangi

17. The Strings that Bind • Grantor Issues – 2042 • Any incident of ownership causes inclusion • Right to change beneficiary designation, surrender policy, etc.

18. The Strings that Bind • Income Tax Issues • Grantor trust status • If grantor is substantial owner • All income/deductions on grantor’s 1040 • Allows trust assets to grow tax-free • Grantor pays the tax • Special co-trustee could toggle grantor trust triggers

19. The Strings that Bind • Income Tax Issues • Grantor trust status • Alter ego of grantor • Transactions between trust/grantor ignored • Look through to grantor for S shareholder issues • Section 121

20. The Strings that Bind • Grantor Trust Status Triggers • IRC 673 reversionary interest 5% • IRC 674 beneficial enjoyment power • Held by grantor OR non-adverse • Unless subject to contingency • Power re charitable beneficiaries • Trustee power over corpus subject to HEMS • Power affects income and HEMS, benef will get eventually, benef LPOA over it, or fixed pattern for what was accumulated

21. The Strings that Bind • Grantor Trust Status Triggers • IRC 674 • Power to add beneficiaries • LPOA over trust assets • If non-adverse is trustee • Not grantor trust under 674 if at least ½ trustees are not subservient (presumed if related or subordinate) to the grantor

22. The Strings that Bind • Grantor Trust Triggers • Section 674- administrative powers • Power for grantor to borrow w/o adequate security or interest • Even if exercisable by non-adverse party—even if only w/ approval of adverse • Loan outstanding to grantor / spouse • Investment decisions in non-fiduc

23. The Strings that Bind • Grantor Trust Triggers • IRC 675 • Power of substitution in non-fiduc • If held by grantor, not 100% clear 2036 not problem. Jordahl dealt w/ power in a fiduciary capacity. • Could be held by any non-fiduc person– but “reacquire” • IRC 676 power to revoke

24. The Strings that Bind • Grantor Trust Triggers • IRC 677 Income for benefit of grantor • If income can be used for benefit of • Grantor or grantor’s spouse • Discretion of grantor or non-adverse party • Alaska trust would be grantor trust • Spouse beneficiary would trigger • May use income to pay premiums on life insurance on grantor or spouse. Power not enough, unless insurance. Actual payment does it

25. The Strings that Bind • Beneficiary Issues • Gift Tax Issues • GPOA [IRC 2514] • Exceptions • Ascertainable standard • Exercise in conjunction w/ grantor • Exercise in conjunction w/ adverse party, i.e. at least 5% interest

26. The Strings that Bind • Beneficiary Issues • GPOA problem can be hidden • Example: Pebbles is trustee and remainder beneficiary. Pebbles makes discretionary distribution to lifetime beneficiary • Could be problem even if holder’s interest is subject to HEMS • Question is whether distribution may reasonable diminish availability for distributions

27. The Strings that Bind • Beneficiary Issues • Non-enforcement of rights is a gift • Dickman v. Comm’r • Example: Oliver sets up trust for Eb, Sam, and Mr. Haney. Sam is trustee. HEMS standard. Sam goes back to school and doesn’t distribute for it. Gift upon expiration of statute of limitations.

28. The Strings that Bind • Beneficiary Issues • Watch for reciprocity causing GPOA • 2 trusts and cross-trustees • Watch whenever beneficiary is trustee • If GPOA contingent and not occurred as of death, no inclusion. • If holder lacks capacity, still included

29. The Strings that Bind • Beneficiary Issues • If client beneficiary has GPOA issue • Maybe rectify with slow lapse • Not release unless over $5k/5% • Beneficiary can disclaim if w/in 9 mos of creation of the power • If beneficiary is co-trustee, problems persist • Unless co-trustee is someone w/ adverse interest b/c of GPOA rules

30. The Strings that Bind • Beneficiary Issues • Watch any power in non-fiduc capacity • Can use independent trustee to avoid GPOA issues • More flexible b/c complete discretion possible • Allows better asset protection • Beneficiary may be more vulnerable

31. The Strings that Bind • Beneficiary Issues • Income Taxes • IRC 678 could be substantial owner • If grantor not substantial owner • Beneficiary has GPOA OR • Beneficiary had GPOA and would be treated as substantial owner if he/she were grantor. • Issue: beneficiary has power to distribute to self based on HEMS is this a “power solely by himself”? DeBonchamps says no

32. The Strings that Bind • Beneficiary Issues • Creditor Protection • Beneficiary creditors of 3rd party trust • Some states allow attachment • Child support • Intentional torts • If ascertainable standard • Creditor can force

33. The Strings that Bind • Beneficiary Issues • Creditor Protection • Possible Solution • Child as trustee w/ ascertainable standard • If problems, child resigns and independent trustee takes over • Only discretionary distributions • Sprinkle among benef and kids/spouse