Understanding & Drafting Irrevocable Trusts

1. Understanding & Drafting Irrevocable Trusts Presented By: WealthCounsel, LLC Bill Conway www.wealthcounsel.com

2. Good Morning! • Introductions • Name? • From? • Practice experience? • Hobbies/Interests? • Why EP 203?

3. Good Morning! • EP 203 significantly overhauled • Overview • WealthDocx IRT Module • Insurance-Related IRT Issues • Sale Transactions with Defective IRTs • Asset Protection & Self-Settled Trusts • Split-Interest Trusts

4. WealthDocx IRT Module Bill Conway www.wealthcounsel.com

5. WealthDocx IRT Module

6. Irrevocable Trusts Generally • Gifts are completed • Trust assets are removed from estate • Grantor trust? • Maybe • Maybe not

7. Selecting the Type of IRT (Page 4)

8. Selecting the Type of IRT (Page 4) • 2503(c) Trust • FBO Minor • Outright at 21 • Included in estate • Alternative to UGMA/UTMA • Asset Protection • Self-Settled Trust • Delaware • Distribution advisor suggested

9. Selecting the Type of IRT (Page 5) • Family Bank Trust / BERT Trust • Inter Vivos Bypass Trust • Gifting Trust • Receptacle for lifetime gifts • HEET Trust • Health and Education Exclusion Trust • Appropriate where no GST exemption left • Intentionally Defective Grantor Trust • Grantor trust set to yes • Warning re: Crummey

10. Selecting the Type of IRT (Page 5) • Inheritor’s Trust • Settled by non-beneficiary • Only one beneficiary allowed • Life Insurance Trust (Single) • Doesn’t ask if insurance is appropriate investment • Life Insurance (2nd to Die) • Crummey rights automatically included

11. Other IRTs in WealthDocx • Charitable Trusts • CRTs, CLTs, Foundations • Split-Interest Trusts • GRATs, QPRTs, QTIPs (Later) • Special Needs Trusts (3rd Party) • Retirement Trusts

12. Grantor as Trustee (Page 6) • Maybe, but why?

13. Distribution Adviser/Trustee (Page 7) • Personal touch

14. Other Trust Helpers (Page 7) • Segregating functions • More on Protectors in a moment

15. UTC Provisions (Page 8) • Be familiar with your state law! • Affects accountings, notice, etc.

16. Crummey Withdrawal Rights (Page 8)

17. Crummey Withdrawal Rights (Page 8) • Annual Gift Tax Exclusion • Saves $5 million lifetime credit • Future Interest Rule • Crummey Solution

18. Gifting to Irrevocable Trust • Crummey Solution (Page 9) • No notice required or given • Tax Court - withdrawal rights were illusory • 9th Circuit reversed – present interest as long as the withdrawal right is enforceable • IRS acquiesced in Rev Rul 81-7; Reasonable notice required

19. Crummey Issues • Minor Beneficiaries (Page 9) • Guardian may exercise • Should not be donor/parent • Inconsistent positions by IRS • WD precludes donor/parent from exercising • Non-guardian nominee??

20. Crummey Issues • Grantor’s Control Over Withdrawal Rights (Page 10) • WD defaults • Withdrawal rights exist • Pro rata among all benes • Invert defaults?

21. Crummey Issues • Contingent Beneficiaries (Page 12) • Cristofani(Tax Court) • 2 children as current benes • 5 grandchildren as contingent benes • Tax Ct said no vested interest required

22. Crummey Issues • Contingent Beneficiaries (Page 12) • Cristofani(Tax Court) • Kholsaat(Tax Court) • 16 contingent benes • No withdrawal rights exercised • IRS argued implicit understanding • Tax Court said no evidence of an understanding and none would be inferred

23. Crummey Issues • Contingent Beneficiaries (Page 13) • Cristofani(Tax Court) • Kholsaat(Tax Court) • Holland (Tax Court) • Family meeting to discuss not exercising • IRS argued implicit understanding • Tax Court said meeting evidenced knowledge of rights and conscious decision not to exercise

24. Crummey Issues • Notice of Withdrawal Right (Page 13) • Oral vs. Written

25. Crummey Issues • Notice of Withdrawal Right (Page 14) • Oral vs. Written • Frequency • “Current” notice • Schedule of contributions sufficient • WD requires notice upon each contribution

26. Crummey Issues • Notice of Withdrawal Right (Page 14) • Oral vs. Written • Frequency • Duration • Reasonable period of time • Cristofani was 15 days • 4 days has been approved; 3 days disapproved • ETIP if spouse has withdrawal right

27. Crummey Issues • Notice of Withdrawal Right (Page 16) • Oral vs. Written • Frequency • Duration • Accuracy • Waiver

28. Crummey Issues • Maintaining Sufficient Assets (Page 16) • Satisfy from other trust assets • Distribute fractional portion of policy (if applicable) • WD provides for grant of line of credit from grantor

29. Crummey Issues • Estate Tax Treatment (Page 16) • Withdrawal Right = GPOA • GPOA included in power holder’s estate

30. Gift-Over Problem (Page 17) • Lapse of Withdrawal Right • IRC 2514 (vs. 2503) • Lapse over 5/5 = Release • Release = transfer to other beneficiaries (if any) • Transfer is of a future interest

31. Gift-Over Problem • Gift-Over Solutions (Page 18) • Limit withdrawal right to 5/5 • Separate trusts • Common trust with hanging powers • Contribute assets so that 5/5 = $12,000 • Loans in lieu of contributions

32. Gift-Over Problem

33. Gift-Over Solutions • Common Trust (Page 19) • Limits withdrawal right to 5/5 • No lapse greater than 5/5 • Donee has to aggregate gifts for 5/5

34. $2,500 $2,500 Dad Mom 2514(e) lapse of $2,500 each(no gift) Gift-Over Solutions • Common Trust (Page 19) Annual Premium:$5,000 Beneficiaries:2-Son & Daughter No Giftover Problem $5,000

35. $26,000 $26,000 Dad Mom Deemed gift of $21,000 from each beneficiary to the other 2514(e) lapse of $5,000 each(no gift) Gift-Over Solutions • Common Trust (Page 19) Annual Premium:$52,000 Beneficiaries:2-Son & Daughter $52,000

36. Gift-Over Solutions • Separate Subtrusts(Page 19) • Allows for full utilization of annual exclusion • Lapse in excess of 5/5 gifts over to no one • Beneficiary becomes grantor for GST purposes over released portion • Separate accounts must be funded

37. $26,000 $26,000 Dad Mom Lapse to Separate Trust for Son of $26,000 Lapse to Separate Trust for Daughter of $26,000 Gift-Over Solutions • Separate Subtrusts(Page 19) Annual Premium:$52,000 Beneficiaries:2-Son & Daughter $52,000 No Giftover because no other beneficiaries to whom to gift over

38. Gift-Over Solutions • Hanging Powers (Page 21) • Allows for full utilization of annual exclusion • Amounts in excess of 5/5 continue to be withdrawable • Estate inclusion in event power holder predeceases • Best of both worlds

39. $26,000 $26,000 Dad Mom Remaining $42,000 continues to “hang,” therefore no gift over 2514(e) lapse of $5,000 each(no gift) Gift-Over Solutions • Hanging Powers (Page 21) Annual Premium:$52,000 Beneficiaries:2-Son & Daughter $52,000

40. $26,000 $26,000 Dad Mom Balance of $177,200 “hangs” Year 1 $10,000 lapse Year 2 $10,400 lapse Year 3 $15,600 lapse Year 4 $20,800 lapse Year 5 $26,000 lapse Gift-Over Solutions • Hanging Powers (Page 21) Beneficiaries:2-Son & Daughter Year 5:Aggregate Contributions of $260,000 $260,000

41. Incomplete Gifts (Page 23) • “dominion and control” retained • But can’t get it back

42. Grantor Trust Provisions (Page 23)

43. Grantor Trust Provisions (Page 23) • Overview & History • IRC 671-679 • Created to eliminate income tax abuses involving (then-lower) trusts brackets • Grantor trust as to: • Income • Principal • Both

44. Grantor Trust Opportunities (Page 24) • Tax free sale of appreciated assets • Tax burn as non-taxable contributions • Removal of assets from estate • Tax free distribution to trust beneficiaries • Permissible transferee of life insurance policy outside of transfer for value rules

45. Achieving Grantor Trust Status • 672 Definitions (Page 24) • Adverse = beneficial interest that is substantial and whose interest is adversely affected by exercise or nonexercise • Nonadverse = Not adverse • Related or Subordinate = Nonadverse + parent/issue/sibling/employee/corp • Spousal Attribution

46. Achieving Grantor Trust Status • 672 Definitions (Page 24) • Adverse = beneficial interest that is substantial and whose interest is adversely affected by exercise or nonexercise • Nonadverse = Not adverse • Related or Subordinate = Nonadverse + parent/issue/sibling/employee/corp • Spousal Attribution

47. Achieving Grantor Trust Status • Know your defect • One vs. More than One • Certainty • Ease of Toggling

48. Achieving Grantor Trust Status • 674 Power to Affect Beneficial Enjoyment • 674(c) – Power to Distribute Income or Principal, or to add beneficiaries • Grantor holding power = inclusion

49. Achieving Grantor Trust Status • 674 Power to Affect Beneficial Enjoyment • 674(d) – Power to allocate income • Power granted to someone other than grantor or “spouse living with grantor” to distribute, apportion or accumulate income to or for beneficiaries if limited by reasonably definite external standard • Power creates grantor trust as to income only • Possible to switch grantor trust status on and off merely by spouse moving out and back in?

50. Achieving Grantor Trust Status • 675 Administrative Powers (Page 28) • 675(2) – Power given to nonadverse party to make loans to grantor without adequate interest or security • N/A if trustee has authority to make loans to anyone without regard to interest or security • Power alone will cause grantor trust status, even if no loan is made