Rupe S. Gill

1. Taxation of TrustsPresented by:Rupe S. Gill and Jennifer E. DalmanAttorneys at LawWalker Lambe Rhudy Costley & Gill, PLLCFor the Business of Your Life & the Life of Your Business

2. Rupe S. Gill • Attorney at Law since 1993 • University of North Carolina, Chapel Hill, BA • Juris Doctorate, Cleveland State University School of Law • Judge Advocate (JAG) • Retired Lieutenant Colonel - US Air Force • Durham-Orange Estate Planning Council • American Academy of Estate Planning Attorneys • North Carolina Bar & Pennsylvania Bar • Durham County Bar Association & US and AF Court of Military Appeals • National Academy of Elder Law Attorneys • Board of Directors, Durham Center for Senior Life • Board of Directors, NC National Academy of Elder Law Attorneys

3. Jennifer E. Dalman • Duke University, BA • Juris Doctorate with Honors, UNC Chapel Hill School of Law • Highest grades in law school class in Estate and Gift Taxation, Partnership Taxation, and Family Wealth Management • Gressman-Pollitt Best Overall Oral Argument Award • Holderness Moot Court Client Counseling and Middle Temple Appellate Advocacy Teams • North Carolina Bar • North Carolina Bar Association and Durham County Bar Association • Durham-Orange Estate Planning Council • American Academy of Estate Planning Attorneys • North Carolina Association of Women Attorneys • Board of Directors, COPE Eldercare

4. Overview • Definition of a Trust • Parties to a Trust • Reasons to Establish a Trust • Different Types of Trusts • Tax Treatment of Trusts

5. What is a Trust? A Trust is a legal entity that can hold title to property for the benefit of one or more persons or entities

6. Parties to a Trust • Grantor, Trustor, or Settlor: the person who creates the Trust • Trustee: the person (or institution) who manages the trust assets and carries out the instructions of the Trust • Beneficiary: the person (or entity) that benefits from the Trust

7. Why Establish a Trust? • Avoid guardianship • Avoid probate • Maintain privacy • Impose restrictions on how and when beneficiaries receive assets • Make challenges to your wishes for distribution of your property more difficult • Estate and gift tax planning • Medicaid and VA Aid & Attendance planning

8. Types of Trusts • Basic distinctions: • Testamentary or Non-Testamentary • Testamentary: Created under a Will • Non-Testamentary: Not Created under a Will • Revocable or Irrevocable • Revocable: Trust can be amended or revoked by the grantor • Irrevocable: Trust cannot be amended or revoked • Grantor or Non-Grantor • Grantor: Trust Property is treated for income tax purposes as being owned by the grantor of the Trust • Non-Grantor: Trust is independent from the grantor for income tax purposes

9. Revocable Trust • Typically, the same individual occupies all three roles – grantor, trustee, and beneficiary • Becomes irrevocable when the grantor dies • The grantor/trustee has complete access to and control over trust assets during his or her lifetime • Used as a management tool during life and provides for the efficient (and private) administration of affairs at death

10. Supplemental Needs Trust • Used to protect government benefits (especially Medicaid and Supplemental Security Income (SSI)) for disabled beneficiaries • Imposes restrictions on use of trust assets – can be used only for goods and services that the beneficiary cannot receive from public support • Can be set up by a third party or self-settled • If set up by a third party, the grantor specifies who receives the balance of the trust at the death of the beneficiary • If self-settled, the balance of the trust goes to the state at the death of the beneficiary

11. Medicaid Planning Trust • Grantor transfers assets to the Trust in advance of need for long-term care – starts the clock running on the five-year look-back period for gifts under the Medicaid rules. • Typically, the grantor retains the right to receive income and also the right to change beneficiaries at the grantor’s death. • Because the grantor has no right to access the trust principal for himself, the principal will not be a countable asset when determining Medicaid eligibility.

12. Common Tax Planning Trusts • Credit Shelter Trust (also called a Family Trust or Bypass Trust) • Used by a married couple to fully utilize the estate tax exemption of both spouses • Grantor Retained Annuity Trust • Grantor gets an annuity payment for a term of years, then the balance of the Trust goes to the remainder beneficiaries (usually the grantor’s children) • Qualified Personal Residence Trust • Grantor transfers primary or vacation residence into the Trust but retains the right to live there for a term of years • Intentionally Defective Grantor Trust • Treated as a grantor trust for income tax purposes but the assets are not treated as being owned by the grantor for estate tax purposes • Charitable Remainder Unitrust • Grantor gets a unitrust payment for a term of years, then the balance goes to charity • Charitable Lead Annuity Trust • Charity gets an annuity payment for a term of years, then the balance of the Trust goes back to the grantor’s family

13. Grantor Trusts • Trust is owned by the grantor for income tax purposes • Note that the Trust isn’t necessarily owned by the grantor for transfer tax (gift, estate, and generation-skipping) purposes • Federal income tax purposes: Internal Revenue Code Sections 671-678 • NC income tax purposes: If the Trust is treated as a grantor trust for federal income tax purposes, it will similarly be treated as a grantor trust for state income tax purposes and a separate tax return need not be filed. http://www.dor.state.nc.us/taxes/estates_trusts/grantortrust.html

14. Grantor Trusts – Code § 671 • The grantor of the trust (§ 673-677) or another individual (§678) will be treated as the owner if the trust contains any of the features set forth in those code sections. • If the grantor (or other individual) is treated as the owner, then income from the Trust will be taxed to the grantor (or other individual) as if the Trust never existed.

15. Grantor Trusts – Code § 672 • Definitions and Rules • Noteworthy: • Adverse and nonadverse party • A party is adverse if he/she has a substantial beneficial interest in the Trust which would be adversely affected by the exercise or nonexercise of the power which he or she possesses • Related or subordinate party • Spouse, parent, issue, sibling, employee, corporation in which the grantor has voting control, subordinate employee of a corporation in which the grantor has voting control

16. Grantor Trusts – Code § 673 • Trust will be treated as a grantor trust if the grantor has a reversionary interest and the value of the reversionary interest exceeds 5% of the trust estate • Example: • I put $500,000 in Trust for my brother for his health, education, maintenance, and support. If my brother dies while I am still living, then the money in the Trust comes back to me. If I’m not living when my brother dies, the money in the Trust will instead be distributed to my descendants. • Because there is a substantial chance that my brother will predecease me, the value of my reversionary interest exceeds 5% and the Trust is treated as a grantor trust.

17. Grantor Trusts – Code § 674 • Trust will be treated as a grantor trust if the grantor is able to direct beneficial enjoyment • Key Exceptions: • Power exercisable only by Will • Power to allocate among charitable beneficiaries • Power limited by an ascertainable standard • Power to withhold income temporarily or during disability of beneficiary • Example: • I put $500,000 in Trust for my son, naming myself as Trustee. I, as Trustee, can distribute income and principal to or for the benefit of my son in my sole discretion. • Because I, as Trustee, have the power to direct beneficial enjoyment, the Trust is treated as a grantor trust. • If, instead, I, as Trustee, could only make distributions for my son’s health, education, maintenance, and support, this is limited by an ascertainable standard and may not be a grantor trust, depending on the other trust terms.

18. Grantor Trusts – Code § 675 • Administrative powers that will make a Trust a grantor trust: • Ability to dispose of trust assets for less than adequate consideration • Power to borrow without adequate interest or security • Power to vote stock, control investments, or substitute property • Example: • I set up a Trust for the benefit of my parents. An independent Trustee is appointed and I have no interest in the Trust. However, I can substitute what assets constitute the trust estate; for instance, I can demand that the Trustee give me the real property in the Trust in exchange for cash. • Because I can demand that the Trustee exchange or substitute trust property, the Trust is treated as a grantor trust.

19. Grantor Trusts – Code § 676 • Trust will be treated as a grantor trust if the grantor has the power to revest in the grantor title to trust property • Example: • I transfer $500,000 into a Trust for my son, naming an independent Trustee. However, I retain the right to take the money back out of the Trust at any time in the future. • Because I can withdraw the trust fund, the Trust is treated as a grantor trust.

20. Grantor Trusts – Code § 677 • Trust will be treated as a grantor trust if the grantor (or a nonadverse party) can direct that trust income be: • Distributed to the grantor or grantor’s spouse • Held or accumulated for future distribution to grantor or grantor’s spouse, or • Applied to the payment of premiums on policies of insurance on the life of grantor or grantor’s spouse • Example: • I I transfer $500,000 into a Trust for my son, naming an independent Trustee. The Trust provides that principal can only be used for the benefit of my son. However, the independent Trustee may distribute income to me. • Because the Trustee is nonadverse and can distribute income to me, the Trust is treated as a grantor trust.

21. Grantor Trusts – Code § 678 • A person other than the grantor can be treated as the owner of trust property for income tax purposes if: • The individual has an unfettered right to distribute the trust corpus or income to himself or herself. • The individual has released the unfettered right to distribute the trust corpus or income to himself or herself, but retains control or rights as described in Code §§ 671 - 677.

22. Transfers to TrustGift & Estate Tax Consequences • A transfer to a Revocable Trust will never be a completed gift. Thus, all property held in a Revocable Trust will be taxable in the estate of the grantor. • A transfer to an Irrevocable Trust may or may not be a completed gift and may or may not be includable in the grantor’s taxable estate. • If gift is completed, donee takes carryover basis. If gift is incomplete, donee gets a step up in basis at death of donor.

23. Transfers to TrustGift & Estate Tax Consequences • When a gift is completed: Treasury Reg. § 25.2511-2(c) and (d) • Grantor retains the power to change beneficiaries (even if the grantor is not a permissible beneficiary): incomplete gift – property included in grantor’s taxable estate. • Grantor retains only the power to change the manner or time of enjoyment – completed gift • Note: property also included in grantor’s taxable estate under Code § 2036 (though double taxation is avoided by Code § 2001) • Inclusion in taxable estate: • Code § 2035: transfers within three years of death • Code § 2036: retained interests (grantor either retains (1) right to income or (2) right to designate beneficiaries) • Code § 2037: transfers geared to grantor’s life (grantor retains >5% reversionary interest or beneficiary only gets possession/enjoyment of property if survives grantor) • Code § 2038: powers to alter, amend, revoke, or terminate

24. Powers of Appointment • Limited Power of Appointment: • Beneficiary may only appoint property to or for the benefit of certain individuals or entities • If exercised during lifetime, no gift tax consequences • Property is not included in beneficiary’s taxable estate • Because the property is not included in beneficiary’s taxable estate, may be subject to generation skipping transfer taxes • General Power of Appointment: • Beneficiary may appoint property himself, his estate, his creditors, or the creditors of his estate • If exercised during lifetime, beneficiary is considered to have made a completed gift • Property is included in beneficiary’s taxable estate

25. Questions? Rupe S. Gill, Esquire RGill@WalkerLambe.com Jennifer E. Dalman, Esquire JDalman@WalkerLambe.com Walker Lambe Rhudy Costley & Gill, PLLC (919) 493-8411 www.walkerlambe.com