Spring 2012 Newsletter
Creativity in Estate Planning
By C. Arthur Robinson, II
It is often the case that when we do estate planning for our clients we are focused on foundational estate planning which involves creating for our clients the standard will, revocable trust, and accompanying health care and durable powers of attorney.
Even in the case of a pour-over Will, careful attention should be paid to a series of issues that often arise in the fact patterns that we see on a daily basis. Special attention should be paid whenever we encounter complex family situations, there is any period of time when our client lived in a community property state, where the clients are concerned with potential challenges to their estate plans, or whenever the dispositive pattern is slightly unusual.
Advance Medical Directives are also a document to which careful attention should be paid. An extensive discussion is necessary with our clients to determine which provisions of a relatively standard document will need to be specifically tailored to the clients’ intent as to health care decisions. In the case of Durable power of Attorney, even after the recent legislation in Virginia which creates a far easier environment for the discussion with third parties about which powers are included, the provisions of the document should be carefully considered. There may be powers in your standard form which would be problematic if included in some situations. By the same token, making sure that all necessary powers are included is likewise a very necessary step in drafting these documents.
Finally, in the case of the standard Revocable Living Trust, we typically will draft, among other things, to provide for a marital QTIP and family trust as our default drafting option. There is a great deal more that should be included in these trusts even if from a tax avoidance standpoint the design is a relatively standard family/ marital trust design.
It is also true that, in many instances, our clients would be better off if we varied from the routine planning in certain situations and became a bit more creative in doing estate planning. It is likewise the case that some techniques can be blended into the Revocable Living Trust.
There are perhaps several dozen identifiable techniques which can be made part of an estate plan. This article will explore the combination of certain of these techniques with the idea of ratcheting up the effectiveness of a typical estate plan. Whether these techniques are made part of the Revocable Living Trusts or separately dealt with is for each drafter to decide.
Consider the following two fact scenarios:
Hypothetical #1: Our clients, husband and wife, own assets in an estate which totals approximately $8 million dollars. In addition to personal use assets of approximately $2 million and diversified real estate and investment holdings of approximately $4 million, they own a single block of stock which was acquired by husband during his career with a publicly traded corporation. The single block of stock in amount of $2 million dollars has an income tax basis of $200,000 and a fair market value of ten times that amount. The couple is extremely tax averse and requests your assistance in planning their estate. They also are concerned that many of their assets do not produce sufficient income and therefore they are especially concerned about the $2 million dollar block of stock which has been paying dividends at approximately 1.5% of its fair market value in recent years. What might we do?
One suggestion would be to contribute the block of stock to a charitable remainder trust (CRT). The CRT could be designed with a Unitrust amount which would substantially increase the available income to our clients and permit the sale of the stock internal to the CRT because the CRT is income tax exempt in and of itself. IRC §664(c) (1). In our scenario, we will assume that the clients are also concerned with passing the value of the block of stock to their children and our clients have at least one member of the couple who is insurable. As part of the plan, we will use an Irrevocable Life Insurance Trust (ILIT) which will be funded from the Unitrust payments to replace the $2 million block of assets in a vehicle which will not be part of the tax base for purposes of estate and generation skipping tax. Crummey v. Commissioner, 397 F.2d 82 (9th Cir. 1986), IRC §2035.
As a final touch on this estate plan, we suggest they create, via their normal estate planning instruments, a trust which can qualify as a charitable private foundation (a family foundation) and we designate the family foundation as a residual beneficiary of the CRT. By tying these techniques together, we have achieved the following objectives: first, we have permitted our clients to diversify a single block of investable assets which entail considerable investment risk and reduce their exposure to current market volatility without paying long term capital gains tax at the Federal and State level. We have increased their cash flow by, at a minimum, a factor over 300% for the asset transferred to the CRT and have provided available cash flow to fund the insurance. We have reduced the amount of assets subject to the estate tax by $2 million while creating, via the ILIT, a pool of assets which are not part of the tax base and which can flow to the next generation.
Finally, to the extent that our clients are somewhat charitably inclined, we have provided for the funding of a family foundation which will permit their children and grandchildren to exercise philanthropy in their local community for generations to come.
Hypothetical #2: A retired physician and her husband, both in their late 60s, have accumulated substantial assets in retirement plans which have now been rolled to a rollover IRA in the name of the wife who was a successful physician for many years. In addition to the substantial IRA balance in the amount of $5 million, the couple owns a principal residence valued at $2 million, a vacation home valued at $1 million, and a portfolio outside of the IRA account valued at $1 million. Their total estate of $9 million has very substantial income tax exposure in that the real estate is highly appreciated in addition to the IRA being fully income taxable at distribution. What might we suggest over and above the standard estate planning instruments for these clients?
First, with respect to the vacation home, we should consider suggesting the transfer of the vacation home into a family-owned LLC and beginning a gifting program with respect to that residence. Our physician and her husband can remain in control of the family LLC while making gifts of interest to their children and thereby reduce their potential exposure to estate taxes. The biggest planning conundrum in this scenario, however, is the very large IRA account in the name of the wife. It is important from the clients’ standpoint that income be available to them or the survivor of the couple, and they wish to pass this asset to their children, but now understand by virtue of your estate planning work, that the potential marginal rate of tax with respect to this asset, which is potentially both estate taxable and will be income taxable, is a minimum of 70%. In this scenario, rather than relying on spousal rollovers in conjunction with qualifying language in their trust, another potential technique is available. That technique would be to use a charitable remainder trust (CRT) as a conduit for the account. IRC §664(c)(1); PLRs 200335017 (May 27, 2003) , 200302048 (Oct. 5, 2002), 200215032 (Jan. 10, 2002) 200202078 (Oct. 19, 2001), 200038050 (June 26, 2000) and 199919039 (Feb. 16, 1999).
Our physician wife, in conjunction with a spousal waiver, would designate the CRT as the primary beneficiary of the account. The CRT would provide that at the death of the wife, the Unitrust amount would be payable to her surviving spouse, amount, which would typically be in the amount of 5% in order for this long CRT term to qualify under the minimum charitable benefit regulations, would provide for a 5% Unitrust payout during the lives of the surviving spouse and children.
What we have accomplished by this technique is to transmute the IRA account into essentially non-taxable funds by making the CRT the recipient of the IRA distribution. Because the IRA distribution is not income taxable within the CRT, and only the Unitrust payments made thereafter to the husband’s surviving spouse and the children will be taxable when received, there is significant investment growth which is permitted internal to the CRT during their lifetimes. It would again be possible to couple the CRT and, previously to its creation, IRA minimum distributions with an Irrevocable Life Insurance Trust as well as creating a family foundation to catch the charitable remainder.
Both of these hypothetical examples represent situations in which income tax considerations are significant to the overall planning engagement. In addition, because of clients’ quite understandable aversion to paying income taxes on a voluntary basis, it is highly likely in each case that substantial assets which have not yet passed through the filter of income taxes will have to be dealt with in the administration of the estate. In addition, at least in Hypothetical #1, unacceptable concentrations of investment risks are present and can be avoided.
The two hypothetical situations analyzed in this article and their suggested solutions demonstrate creative use of charitable remainder trusts. As is typically the case, while there are details that need to be worked out in the case of both of these plans, there are substantial advantages to coupling these techniques to achieve significant leveraging via income tax deferrals. Charitable remainder trusts, which we often think of in the context of charitable planning, can offer fairly significant income and estate tax advantages, and as a consequence, can enable planning which achieves vastly better results provided we as planners are willing to be creative. It behooves us to use all the tools and techniques in our arsenal in order to assist our clients and to consider how combining several techniques can increase the tax effectiveness of an estate plan and permit our clients to achieve their objectives.
C. Arthur Robinson, II is a partner at Wolcott Rivers Gates. He received his B.A. from Vanderbilt University, his MBA from the College of William & Mary, and his J.D. from the College of William & Mary – Marshall Wythe School of Law. Mr. Robinson is a member of the Virginia State Bar as well as numerous other professional associations. He is also a Certified Public Accountant.