Automatic Allocation Rules Applied to Trust Transfers Despite Incorrect Reporting on Form 709

Parents made irrevocable gifts to separate trusts for each of their two children.  The terms of each trust provided for distributions of income and principal to the child, as determined necessary by the Trustee for each child’s health, education, maintenance and support.  When the child attained age 30, the Trustee was directed to pay to or apply for the benefit of the child the entire net income of the child’s trust.  The child had a limited testamentary power of appointment, which could be exercised after the child attained 34 years of age.  Further, if distribution of principal from the child’s trust would result in the imposition of GST taxes, the child had a testamentary general power of appointment as to the balance of the child’s trust.  Absent the exercise of a power of appointment, the child’s trust would be divided into separate shares, by representation, among the child’s living issue, and each share would be held as a separate trust.

Although the Form 709s were timely filed, the transfers were incorrectly reported on Schedule A Part 1, instead of on Schedule A, Part 3, Indirect Skips.  Nevertheless, the IRS ruled in Letter 201924016 that the each of the parents’ respective GST exemptions was automatically allocated to the transfers under the automatic allocation rules of § 2632(c).  Code § 2632(c) provides that if an individual makes an indirect skip during that individual’s lifetime, any unused portion of such individual’s GST exemption will be allocated to the property transferred to the extent necessary to make the inclusion ratio for the property zero.

In some circumstances, however, you may prefer not to rely on the automatic allocations rules, but, rather, affirmatively elect, pursuant to Code § 2632(c)(5)(A)(ii), to treat a trust as a GST Trust with respect to all transfers deemed made by the taxpayer to such trust during the year for which the Form 709 is filed, as well as all future transfers to the Trust. Accordingly, the inclusion ratio of the Trust immediately after the automatic GST allocation will be zero.

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Special Purpose Entities May Now Serve as Trust Advisors in Tennessee

Public Chapter 340, recently signed into law by Governor Bill Lee, represents a significant evolution of Tennessee trust law by permitting the creation of special purpose entities, as defined in Tenn. Code Ann. § 35-15-1301(a)(6), to serve as Trust Advisors for trusts for which a Tennessee corporate fiduciary is serving as Trustee.

To read more about these new entities, check out Aaron Flinn’s recent article.

State Court Reformation to Remove Potential General Power of Appointment Not an Exercise or Release of a General Power

In PLRs 201920001, -20002, and -20003, the IRS determined that the reformation of three trusts for the benefit of the grantor’s grandchildren to remove language that could be construed as granting a general power of appointment to each grandchild would not result in adverse tax consequences to the grantor or his grandchildren.

The petition to reform the trusts was supported by three affidavits, one each from the grantor’s accountant, law firm, and trustee of the trusts, providing that the grantor intended for the trusts to be GST exempt, and that the grantor did not realize that the powers of appointment granted to each grandchild under the trust instrument would result in inclusion of the trust’s assets in the grandchild’s gross estate. 

Specifically, the IRS determined that the reformation would not cause corpus of the trust to be included in the grantor’s gross estate; the reformation revising the power of appointment so that it was limited to the grantor’s lineal descendants and excluded the grandchild, the grandchild’s creditors, the grandchild’s estate and the creditors of the grandchild’s estate, wasn’t a release or an exercise of a general power of appointment; and the assets of a deceased grandchild’s trust would not be included in the grandchild’s gross estate under Code § 2041.

The IRS respected this state law reformation respected because there was clear and convincing evidence of a scrivener’s error. 

LISI 60-Second Planner: PLR 201920001 — Trust Reformed to Correct Scrivener’s Error. Leimberg Information Services, Inc. (LISI).

SECURE Act Stalled in Senate

Senate Finance Committee Chair Chuck Grassley said that “as many as six” Senators oppose certain parts of the Setting Every Community Up for Retirement Enhancement (SECURE) Act (H.R. 194).

The SECURE Act passed the House on May 23rd with a vote of 417-3, and was expected to pass in the Senate through unanimous consent.  Grassley indicated that Senate Majority Leader Mitch McConnell is unlikely to take up the SECURE Act unless it is through unanimous consent.

Senator Ted Cruz is one of the opponents to the bill because of the elimination of a provision allowing certain distributions for home-schooling and elementary and secondary education expenses.

Chamseddine, Jad. Retirement Bill with ‘Kiddie’ Tax Fix Faces Further Opposition. Tax Notes Today. Taxnotes.com. June 4, 2019.

Lost Will Admitted to Probate

On April 25, 2012, Mr. Gayle Franklin Cook (the “Decedent”) executed a valid will at his attorney’s office.  The Decedent’s brother, Mr. Cook, who had accompanied the Decedent to the office, but was not present during the will signing, took the Decedent’s original will home and placed it in his drawer with other items of importance.  The Decedent died in February 2017, but Mr. Cook could not find the original will.

The Decedent’s niece, Ms. Jenkins, filed a petition in December 2017, alleging that the Decedent’s original will had been lost.  She attached a copy of the will to her petition and asked that it be admitted to probate.  Although the Decedent had two heirs at law, there were three beneficiaries under the Decedent’s will, including Ms. Jenkins.

The following elements must be established by the proponents of a lost will (1) that the testator made and executed a valid will in accordance with the forms of law; (2) that the will had not been revoked and is lost or destroyed or cannot be found after due and proper search; and (3) the substance and contents of the will.  The only question remaining for the court was whether the Decedent revoked his will prior to his death.

Despite the heavy burden faced by the proponents of a lost will, a proponent is not required to prove absolutely that the Decedent did not revoke the will; rather, the proof must establish that it is “highly probable” that the April 25, 2012 will was not revoked by the Decedent.

The Decedent’s brother, Mr. Cook, received possession of the will immediately following its execution.  Mr. Cook testified that the Decedent never had possession of the will.  Although there was evidence that the Decedent visited Mr. Cook’s home, there is no evidence that the Decedent knew of the will’s location.  Ms. Jenkins testified that her mother, Mr. Cook’s wife, suffered from dementia and “had a tendency to move things around, misplace things.”

Based on the uncontradicted testimony presented at trial, the court found that it was “highly probable” that the April 25, 2012 will was not revoked by the Decedent.

In re Estate of Gayle Franklin Cook, No. W2018-01766-COA-R3-CV. (Tenn. Ct. App. Apr. 10, 2019).

Dealing with Digital Assets

Steve Akers’ ACTEC 2019 Annual Meeting Musings suggests the following four planning steps for dealing with digital property:

(1) Prepare a list of digital property, how to access it (list of passwords and let someone know where the list is maintained), and what to do with it;

(2) Back up important data;

(3) Protect valuable data with a strong password and strong encryption; and

(4) Update estate planning documents with provisions giving lawful consent to disclose the contents of electronic communications to fiduciaries.

Estate Planning with Qualified Opportunity Fund Interests

The most recent proposed regulations released in April 2019 [REG-120186-18] (the “New Proposed Regulations”) provide guidance as to the treatment of gifts of Opportunity Zone interests through Qualified Opportunity Funds (“QOF Interests”) to grantor trusts and the implications of transfers at death.

Transfers at Death:

The New Proposed Regulations clarify that the death of a taxpayer owning a QOF Interest is not an inclusion event.  Further, neither the transfer of the qualifying investment to the decedent’s estate, nor the distribution of the qualifying investment to heirs or beneficiaries would be an inclusion event.  But, note that because the transfer to an estate or a beneficiary is not a disposition, there would be income with respect to the decedent.  Because death is not a taxable event, the deferred gains carry over to the successor in interest so that there is no step up in basis at death.  Therefore, the deferred gain continues to be deferred gain in the hands of the beneficiary.  And, for purposes of the qualified opportunity zone (“QOZ”) statute, the decedent’s holding period tacks, and the beneficiary steps into the decedent’s shoes.

For the recipient beneficiary, this means that unless there is an earlier disposition, come December 31, 2026, the beneficiary holding the QOF interest will be responsible for the deferred tax, possibly without the liquidity to pay it.

Gift Tax Consequences:

Giving away your QOF interest generally subjects the interest to immediate taxation.  One exception to this general rule is a gift of the QOF interest to the taxpayer’s grantor trust.  The New Proposed Regulations do not treat a taxpayer’s gift of a QOF interest to the taxpayer’s grantor trust as an inclusion event that would accelerate the deferred capital gains tax.  The answer goes back to good old Revenue Ruling 85-13 which provides that a transaction between a grantor and the grantor trust does not have tax consequences because the same taxpayer is responsible for the taxes.

Further, termination of grantor trust status due to the grantor’s death would not be treated as an inclusion event.  Note, however, that termination of grantor trust status for other reasons would subject the deferred capital gains to tax.

Perhaps the most attractive treatment of the gift of a QOF interest to a grantor trust is that the trust takes the holding period of the grantor.  Therefore, future appreciation after ten (10) years is excluded from income tax if still held in the grantor trust.

What about the GRAT?

Estate planners love GRATs, and, as grantor trusts, they are excellent vehicles for estate planning with QOF interests.  Remember, however, that the remainder beneficiary of a GRAT funded with a QOF interest should be a grantor trust to avoid an inclusion event that triggers tax on the deferred gain.

Angkatavanish, Todd and David Herzig. INSIGHT: Frozen Ozone (Fr-Ozone) Planning–The Newest Flavored Estate Freeze. Bloomberg Law. May 22, 2019.

SECURE Act Passes House; Held up in Senate by Sen. Cruz

The House of Representatives overwhelmingly approved the “Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019” (H.R. 1994).

Under current law, IRA and Qualified Plan assets can be distributed based on the life expectancy of the beneficiary.  The SECURE Act provides, generally, that all IRAs and Qualified Plans must be distributed within ten (10) years of death.  The proposed effective date is December 31, 2019.

Exceptions to the proposed 10-year rule include: (1) rollovers to a surviving spouse; (2) children under majority take over their life expectancy until the age of majority, and then the 10-year rule applies; (3) “disabled” and “chronically ill” beneficiaries may use a life expectancy payout; and (4) an individual not more than ten (10) years younger than the plan participant may use a life expectancy payout.

Note that while the conduit trust worked well under the life expectancy rules, it might not be your best option under the 10-year rule of the SECURE Act.

The House bill eliminated a provision allowing $10,000 in distributions per beneficiary from section 529 educational savings plans to pay for home-schooling and elementary and secondary school expenses.  Cruz objects to that elimination.

Keebler & Associates, LLP, Setting Every Community Up for Retirement Enhancement Act of 2019. CLE presentation through Leimberg Information Services. May 23, 2019.

Chamseddine, Jad and Stephen K. Cooper. House-Passed Retirement Bill Hits Home-Schooling Snag in Senate. Tax Notes Today. May 24, 2019.

Every Student’s Dream: A Billionaire Offers to Wipe Out Student Debt

Billionaire benefactor Robert Smith announced on May 19th that he and his family would establish a grant to pay off student loans for Morehouse College’s entire 2019 graduating class.

If that sounds too good to be true, it might be.  Smith needs to be particularly cognizant of potential income tax consequences to the students whose debt is paid off.  Since the schooling has already occurred, these payments are not scholarships.

The worst treatment for the students would be treatment as forgiveness of indebtedness while their best treatment is if the payments are treated as gifts.

Alexander L. Reid of Morgan Lewis & Bockius LLP suggests that the gift treatment will prevail.

For the sake of the students, I sure hope so.

Stokeld, Fred. Billionaire’s Gift Could Carry Tax Consequences for Students. Tax Notes Today. May 21, 2019.