Tennessee Estate Planning Law

Your Will Does Not Dispose of All of Your Assets

Bryan Howard — Wed, 01 Sep 2010 07:15:48 -0600

Some people mistakenly assume that their Will controls the disposition of all of their assets. There are several ways that your assets pass to someone outside of your Will.

Assets that are owned as tenants by the entirety with your spouse or joint with right of survivorship will pass to the other owner or owners by operation of law.

A large number of assets pass by beneficiary designation. Common examples are bank accounts, retirement accounts such as 401(k) plans and IRAs, and life insurance. See the enclosed article from Fidelity regarding important considerations in your choice of beneficiary designation.

If you transfer ownership of your assets to a trust before you die, the trust will dictate how the assets pass upon your death. A number of my clients have transferred all or a portion of their assets to a revocable trust or an asset protection trust.

Under Tennessee law, your spouse is entitled to elect against your Will and receive a share of your estate, year’s support, exempt property, and homestead. As a general rule, your spouse will elect to receive these benefits when they are better than the Will.

Even if your Will does not direct your Executor to pay your debts, your creditors will file claims against your estate and will be paid prior to the beneficiaries named under your Will.

Even if your Will does not direct your Executor to pay your tax obligations, the IRS and the State of Tennessee have priority over the beneficiaries of your Estate regarding the payment of income, inheritance, estate and generation-skipping transfer taxes, including interest and penalties. They have a “secret” lien against all of the assets of your Estate. If the Executor of your Estate fails to pay your tax obligations, the IRS and the State of Tennessee will be able to collect taxes from your Executor (to the extent that the Executor has distributed assets to the beneficiaries) or from the beneficiaries of your Estate (to the extent that they received assets from your Estate or from other methods such as beneficiary designations).

Because there are so many ways to receive assets that are not dependent on the terms of your Will, it is very important to make sure that you account for all of these potential non-testamentary transfers when planning for the disposition of your assets.

Estate Planning for Second Marriages

Bryan Howard — Mon, 16 Aug 2010 07:54:03 -0600

I came across an interesting article regarding estate planning for second marriages. The article highlights some of the most common issues faced by male business owners who have children from a prior marriage. Women, of course, face many of the same issues.

Disclaimer of Joint Brokerage Account Reduces Looming Estate Tax

Bryan Howard — Wed, 11 Aug 2010 15:23:49 -0600

I currently represent an 88 year old widower whose wife died less than 9 months ago. The wife’s estate is approximately $1.6 million. The husband’s assets, including a $1 million brokerage account that had been owned jointly with his wife, are worth approximately $1.8 million. Because the husband’s estate exceeds $1 million, his estate will owe more than $300,000 of estate taxes if he dies after January 1, 2011 and Congress does not change the tax laws prior to his death.

In an effort to reduce or eliminate his potential federal estate tax liability, I have recommended a disclaimer of the husband’s one-half survivorship interest in the brokerage account. If the husband chooses to file a disclaimer, his children will receive one-half of the brokerage account now, rather than following his death. Under federal law, the disclaimer will not be treated as a gift by the husband. This means that no federal gift or estate taxes will be charged on the $500,000 passing to his children. The disclaimer will reduce his federal estate taxes by more than $200,000.

Tennessee treats a disclaimer of a joint brokerage account as a gift. The husband will have to pay $36,000 of Tennessee gift tax on April 15, 2011. Upon the husband’s death, the inheritance taxes imposed on his estate will be reduced by $36,000 as a result of the disclaimer. Therefore, the net effect of the disclaimer is to accelerate the payment of $36,000 from 9 months after the husband’s death to April 15, 2011.

The husband has a modest lifestyle and feels comfortable that he will have sufficient assets for his remaining lifetime after he executes the disclaimer. He also likes the idea of getting assets to his children sooner.

If we knew that Congress would change the federal estate tax exemption to $2 million or more prior to the husband’s death, it would be unnecessary to make the disclaimer. Unfortunately, the disclaimer must be filed within 9 months after the death of the wife. Congress has been in a stalemate for more than 9 years regarding the “estate tax fix.” Because the 9 month deadline will occur in a few weeks, the husband will have to make the disclaimer decision prior to finding out whether Congress changes the law.

Wife Receives Joint Assets Upon Divorce Due to Prenuptial Agreement

Bryan Howard — Fri, 06 Aug 2010 07:23:25 -0600

In recent years, I have seen a tremendous increase in the use of prenuptial agreements. I attribute this to high divorce rates, as well as increased awareness of the potential benefits of prenuptial agreements.

Death and divorce are the two primary circumstances governed by prenuptial agreements. Generally, the agreement details the provisions that will be made for the surviving spouse upon the death of the first spouse. The agreement also details the division of the couples’ assets upon divorce.

A recent case decided by the Tennessee Court of Appeals demonstrates the divorce protection provided by a prenuptial agreement. Mrs. Cummins spent more than $2 million buying two separate homes which were titled jointly in the names of Mr. and Mrs. Cummins. Due to the wording of the prenuptial agreement, Mrs. Cummins was awarded both homes.

Mr. Cummins claimed that he was entitled to 50% of the appreciation of the homes. The Court awarded all of the appreciation to Mrs. Cummins since she had paid all of the property taxes, insurance, and maintenance expenses associated with the homes.

Mrs. Cummins was very fortunate to receive 100% of the homes. Even when there is a prenuptial agreement, both spouses generally share in the value of homes that are titled jointly in the names of the couple. Mrs. Cummins could have saved the aggravation and expense of this lawsuit if she had titled the homes solely in her name.

Hawaii Joins States That Allow Self-Settled Asset Protection Trusts

Bryan Howard — Thu, 29 Jul 2010 15:18:27 -0600

Hawaii has become the 13th state to allow an individual to set up a trust for his or her benefit which is protected from the individual’s creditors. Unlike Tennessee, Hawaii’s law has limits on how much you can transfer to the trust and what kind of assets you can place in the trust. In addition to these restrictions, anyone who establishes such a trust must pay a tax to the state equal to 1% of the assets transferred to the trust. Hawaii is the only state that charges a tax to establish such a trust.

Because of this tax, it is unlikely that anyone other than a resident of Hawaii would use a Hawaii trust rather than a trust in one of the other 12 states. Tennessee’s asset protection trust law compares very favorably to the other asset protection trust states. The Tennessee legislature made several improvements to our law this spring in order to keep our law at the forefront. Tennessee is still the only Southeastern state that permits self-settled asset protection trusts. See the enclosed map for the other states.

Estate Tax Fix Remains Elusive Due to Revenue Concerns

Bryan Howard — Thu, 22 Jul 2010 09:09:11 -0600

In less than 6 months, federal estate taxes are scheduled to return with an exemption of $1 million and a maximum rate of 55%. Numerous bills have been submitted to provide relief from these taxes. Most of the bills would increase the exemption to $3.5 million or more and decrease the top rate to 45% or less.

These bills have not passed because they would significantly decrease tax revenues. The latest such failure was an amendment offered to a Jobs Bill by Senators Jon Kyl of Arizona and Blanche Lincoln of Arkansas. Apparently the Senate decided against combining a large tax decrease with a bill that proposes to increase spending by $33.9 billion.

A lot of Senators are hesitant to pass another large spending bill. Many of these same Senators believe that taxes, including estate taxes, should be reduced. In the enclosed LA Times article, Tennessee’s Lamar Alexander explained why it is logical to support decreasing taxes while at the same time fighting increasing spending as follows: “If you’re going to spend more, you have to have a revenue source or you run up the debt.” Reducing taxes "reduces the amount of revenue we have to spend, and we should reduce spending by the same amount.”

What Lamar says by implication is that the national debt will increase if you reduce taxes without reducing spending. There appears to be a lot of support for reducing taxes. There does not appear to be a lot of support for spending less. It will be very difficult to solve the estate tax dilemna if the fix requires a commitment to decrease spending. I am counseling my clients to be prepared for the return of federal estate taxes in 2011 with the $1 million exemption and 55% top rate.

Who Will Pay Your Mortgage After You Die?

Bryan Howard — Mon, 12 Jul 2010 09:32:26 -0600

It is very typical for a Will to direct the Executor to pay the Decedent’s valid debts. When my clients own real estate encumbered by a mortgage, they often want the successor owner of the real estate to continue paying the mortgage. For these clients, I place a provision in their Wills giving the Executor the discretion to continue paying the mortgage until the successor owner takes over the payments.

When the successor owner of the real estate is also the residuary beneficiary of your estate, it may not matter whether your estate or the successor owner pays the mortgage. If your estate pays the mortgage, the residuary estate passing to the successor owner will be less. Nevertheless, it provides more flexibility for the successor owner if you allow the mortgage to remain in place. The successor beneficiary can pay off the mortgage early if there is not a need to maintain the mortgage.

Things are not as easy when the successor owner of the real estate is not the residuary beneficiary of your estate. Now it makes a big difference as to whether your estate or the successor owner pays the mortgage.

If you decide that you want the successor owner to pay the mortgage, there is another consideration. The bank may file a claim against your estate and require the Executor to pay the mortgage. Depending upon whether the successor owner was jointly liable on the debt, your estate may have a claim against the successor owner to pay at least a portion of the debt. If you do not want your Executor to be in the position of having to sue the successor owner of the house, you should condition any bequest to the successor owner on their agreement to assume the mortgage. If you take this approach, the bequest to the successor owner will be reduced to the extent, if any, that your estate is required to make payments on the mortgage.

There are 2 methods by which the successor owner can acquire the property.

First, when you own the property, your Will simply devises the property to the successor owner. You can make the devise conditional on the devisee’s assumption of the mortgage.

Alternatively, when you own the property as tenants by the entirety with your spouse or jointly with right of survivorship, the successor owner will acquire the property by operation of law. Your Will cannot require the successor owner to assume the mortgage. However, if your Will makes a bequest of other assets to the successor owner, this bequest can be conditioned upon the successor owner’s assumption of the mortgage. If the bequest is less valuable than the mortgage, the successor owner might forfeit the bequest rather than assume the mortgage.

In summary, you need to decide who you want to pay your mortgage and draft your Will accordingly.

Estate Planning in 2010 for Married Client with Terminal Illness

Bryan Howard — Wed, 07 Jul 2010 09:21:22 -0600

One of my clients has been diagnosed with a rare disease that will very likely end her life in 2010. Due to the peculiar estate tax laws that apply to decedents dying in 2010, there are some unusual planning steps that my client and her husband are taking.

As a general rule, you want to make sure that the first spouse to die has sufficient assets titled in their name so that they can take maximum advantage of federal and Tennessee estate and inheritance tax exemptions. In 2009, the magic number was $3,500,000. This year, the amount is unlimited.

We previously split assets between the husband and the wife with each of them owning assets worth approximately $6 million. The husband is in the process of transferring most of his assets to his wife.

Another change that we are making is to create a revocable trust for the wife that will replace her will. The wife’s revocable trust will own her assets so that it will be unnecessary to probate her will. The revocable trust will transfer $1 million to a typical credit shelter trust of which the husband and children are beneficiaries. The remaining $11 million of assets will be transferred to a marital trust for the husband’s sole benefit during his lifetime. Assuming the wife dies when there is no federal estate tax, it will not be necessary to claim a marital deduction for the marital trust for federal estate tax purposes. We will elect to qualify for the marital deduction for Tennessee inheritance tax purposes so that no Tennessee taxes will be owed.

The overall result of this plan is that all of the couple's assets are eligible for a basis step up. Since the combined built-in appreciation of their assets is $4 million and there is $4.3 million of basis step up available, they will receive a full basis increase. Since they own some significant rental properties, the higher basis will increase the husband’s depreciation deductions.

More importantly, the $11 million marital trust will not be subject to federal estate taxes upon the husband’s subsequent death. This will be a tremendous advantage to the family if they do not ever have to worry about paying federal estate taxes.

In summary, simple planning steps are needed to take full advantage of the absence of federal estate taxes in 2010.

Deathbed Estate Planning

Bryan Howard — Tue, 29 Jun 2010 13:22:28 -0600

One of the sad things about my profession is that my clients eventually die. Some deaths are sudden and unexpected, but most deaths occur after an accident or illness that makes death imminent within a few days or perhaps a few weeks. Though I am sensitive to the feelings of grief and stress that my clients and their families are experiencing, I have the unpleasant task of explaining to my clients and their families the heavy penalties they will pay to the federal and Tennessee governments if they decline to take advantage of “last minute” tax reduction opportunities.

I am currently working with one of my clients who has been given a life expectancy of 2 months or less. Because my client is likely to die in 2010, some of the planning issues are unique. However, some of the planning opportunities are the same as they would be for a death in a different year. Some of the major issues we have considered:

Make sure all assets are owned by the Revocable Trust so that probate can be avoided. My client has done an excellent job of funding her revocable trust. However, she recently loaned some money to a friend and the Note is payable to her rather than her trust. We are doing a simple assignment of the Note to make sure that it is owned by her trust.
Make annual exclusion gifts of $13,000. My client is making gifts of $13,000 to all of her children and grandchildren, as well as to spouses of her children. At a minimum, this will reduce Tennesse inheritance taxes. If federal estate taxes are reinstated with an effective date prior to the date of my client’s death, or, if she survives until 2011, the gifts will also reduce federal estate taxes.
My client is converting her IRA to a Roth IRA.
My client’s revocable trust makes charitable bequests totaling $500,000. My client trusts her children to make these gifts. Therefore, she is amending her trust to give the money to her children. The children will pay Tennessee inheritance taxes on this bequest at the rate of 9.5%. However, they will receive charitable income tax deductions which will reduce their federal income taxes by approximately 35%. Furthermore, two of the children live in states with state income taxes. The charitable bequests will also reduce state income taxes. This plan will backfire if federal estate taxes are reinstated retroactively. If this were to happen, federal estate taxes would be higher than the income tax savings. In order to account for this possibility, the revocable trust will provide that if the children disclaim the bequest, then the bequest will go to the charities. This will allow the children to see what happens over the next nine months before they must decide whether to disclaim.
Should appreciated assets be sold to avoid losing the benefit of a capital loss carryover? Fortunately, no sales are necessary, because the carryover basis law that applies for decedents dying in 2010 allows the unused capital loss carryover to be added to the $1.3 million basis increase. My client’s executor will have more flexibility to avoid future capital gains if the capital loss carryover is preserved.
Finally, my client is researching her records regarding her income tax basis for several assets. She can find this information much more easily than her Executor.

Estate planning when death is imminent can reduce taxes and other problems. Even though the circumstances are unpleasant, the potential benefits are substantial. I have been told by some of my former clients and/or their families that they took comfort in their final days from the knowledge that financial matters were in good shape.

Inter Vivos Marital Trusts Provide Creditor Protection for Both Spouses

Bryan Howard — Mon, 14 Jun 2010 08:01:24 -0600

A recent article discussed the use of Inter Vivos Marital Trusts to reduce estate taxes. These trusts can also be used to provide asset protection from future creditors. When the objective is asset protection, the trust is designed differently.

One spouse transfers property to a trust for the benefit of the other spouse. If the donee spouse predeceases the donor spouse, the donor spouse becomes the beneficiary of the trust. The donor spouse’s retention of a successor beneficial interest in the trust represents the key distinction of a marital trust that is used for asset protection rather than reducing estate taxes.

This type of trust has always been exempt from future creditors during the donee spouse’s lifetime because it is a third party created spendthrift trust. When the donor spouse becomes the beneficiary, the trust has traditionally been available to all creditors of the donor spouse since the transfer was made to a trust of which the donor is a beneficiary.

A new Tennessee law will make these trusts exempt from the donor spouse’s future creditors after July 1, 2010. This means that one spouse can transfer substantially all of his or her assets to a trust and protect the assets from future creditors of both spouses.

Inter Vivos Marital Trusts may not be used to avoid the donor’s obligations to creditors that already exist at the time of the transfer to the trust. If the donor spouse does not retain sufficient assets to pay existing creditors, the preexisting creditors can attack the trust as a fraudulent conveyance.

Another potential benefit of an Inter Vivos Marital Trust is to make sure that the donee spouse has sufficient assets to utilize his or her federal estate tax exemption and Tennessee inheritance tax exemption. This will reduce estate taxes upon the surviving spouse’s death. No gift taxes will be payable if the donor spouse files timely federal and Tennessee gift tax returns which make a QTIP election.

For federal income tax purposes, the donor spouse will be taxed on all of the taxable income of the trust, including capital gains, during his or her lifetime. The donee spouse will be taxable on the ordinary income of the trust following the death of the donor spouse and may be taxed on some or all of the capital gains of the trust.

Where Is Your Original Will?

Bryan Howard — Wed, 09 Jun 2010 10:03:30 -0600

I recently met with a couple for whom I prepared Wills in 2006. They want to make a change to their Will because a member of their family died unexpectedly. When they went to their lockbox, they were unable to find their original Wills. Fortunately, they still have the ability to sign new Wills.

What would have happened if one of my clients had died and the survivor was unable to find the Will? It is likely that we could have probated a copy of the Will. Tennessee law allows a Court to probate a copy of the Will when there is credible testimony that the Will has been lost and that there was no intention to revoke the Will. I have successfully probated copies of Wills on 6 or 7 occasions. Every time that I have probated a copy, no one objected and a close family member was able to give credible testimony about the Will being lost.

You should assume that your heirs will be unsuccessful in probating a copy of your Will. When the original Will cannot be found, there is a strong presumption under Tennessee law that the Will was revoked. There have been numerous cases where the Court refused to probate a copy of a Will. If the Court refuses to probate the copy, the Court will choose an administrator to manage your estate and distribute your assets according to the intestate succession laws of Tennessee.

Due to the problems caused when your original Will cannot be located, it is very important that you keep your original Will in a lockbox or other safe location. You also need to make sure that one or more trustworthy persons knows the location of your original Will.

Revocable trusts do not have the same problem. The Trustee does not have to produce the original Trust Agreement in order to carry out its duties. This is another potential benefit of a revocable trust.

Sales By 2010 Estates May Be Taxed As Short-Term Capital Gains

Bryan Howard — Wed, 02 Jun 2010 11:26:31 -0600

Short-term capital gains are taxed at a significantly higher rate than long-term capital gains. In 2010, the maximum rates are 35% for short-term capital gains and 15% for long-term capital gains. In 2011, the maximum rates will increase to 39.6% and 20%.

Prior to 2010, gains from sales of assets by an estate were automatically treated as long-term capital gains, regardless of when the decedent bought the asset. For decedents dying in 2010, this rule does not apply. It is now necessary to determine when the decedent bought the asset. If the asset is sold within a year after it was acquired, the gain will be short-term.

Tax on pre-mortem gain can be eliminated by allocating the decedent’s basis increase to the property. Every decedent has $1.3 million of basis increase that may be allocated by the Executor. Married decedents potentially have an additional $3 million of basis increase that can be allocated.

The basis increase can not be used to eliminate post-mortem gains. Assume the decedent bought a stock for $200,000 on November 1, 2009. The decedent died on March 31, 2010 when the stock was worth $260,000. If the Executor sells the stock for $300,000 on October 15, 2010, there will be a short-term capital gain of $100,000. The pre-mortem gain of $60,000 can potentially be eliminated if the Executor chooses to allocate a portion of the decedent’s basis increase to this particular asset. The basis increase cannot be used to wipe out the $40,000 post-mortem gain.

The gain could be converted from short-term capital gain to long-term capital gain if the Executor waits to sell until November 1, 2010.

Inter Vivos Tennessee QTIP Trusts Reduce Estate Taxes

Bryan Howard — Mon, 31 May 2010 12:39:44 -0600

Making a lifetime gift of the $1,000,000 federal gift tax exemption amount can substantially reduce estate taxes. Appreciation and income from the gifted property between the date of the gift and the donor’s death can escape federal transfer taxes. My clients are generally unwilling to make such a gift because it would require the payment of Tennessee gift taxes. A second problem is that the donor loses access to the income from the gift.

A Tennessee QTIP Trust™ provides an opportunity for making a lifetime gift without paying Tennessee gift tax while retaining indirect access to the income through your spouse. A Tennessee QTIP Trust™ is a trust that would qualify for the federal gift tax marital deduction but for which the donor elects not to make a QTIP election on the federal gift tax return. The donor does make the QTIP Trust election on the Tennessee gift tax return.

The Tennessee QTIP Trust must make income available to the donee spouse. Rather than requiring income to be paid to the spouse, the spouse should be given the right to withdraw income. There are two benefits from using the right to withdraw income as opposed to the mandatory payment of income. First, to the extent that income accumulates in the trust, it will escape federal transfer tax. The second benefit is that either the donor spouse or the donee spouse will be required to pay federal income taxes attributable to trust income even though the income remains in the trust. Thus, the trust is able to grow in value on a pre-tax basis.

The donor spouse should not have a successor life estate or discretionary principal interest following the death of the donee spouse. This would cause estate tax inclusion for the donor spouse.

The downside with a Tennessee QTIP Trust occurs when the donee spouse predeceases the donor spouse. If the value of the trust upon the donee spouse’s death exceeds the $1,000,000 Tennessee inheritance tax exemption, the donee spouse’s estate will pay Tennessee inheritance tax. This means that some transfer tax will be paid prior to the death of the survivor. Because the lifetime Tennessee QTIP Trust will exhaust the donee spouse’s Tennessee inheritance tax exemption, the donee spouse’s Will should establish a testamentary Tennessee QTIP Trust (as opposed to a traditional credit shelter trust) for the donee spouse’s federal estate tax exemption amount.

Due to the potential Tennessee inheritance tax upon the death of the donee spouse, and the necessity of the donee spouse’s establishment of a testamentary Tennessee QTIP Trust, it may be advisable for the spouse with the shortest life expectancy to be the one who establishes the lifetime trust. Access to income will also be preserved if the survivor is the donee spouse. Nevertheless, the greatest benefit from accelerating the use of the federal gift tax exemption will occur if the trust is established by the spouse with the longest life expectancy.

A Tennessee QTIP Trust™ can reduce estate taxes while allowing the donee spouse to retain access to the income and corpus of the trust.

Children Born Out of Wedlock Must Act Quickly to Preserve Inheritance Rights

Bryan Howard — Fri, 21 May 2010 13:29:25 -0600

I recently read that 43% of the 91,000 babies born in Tennessee in 2008 were born out of wedlock. Babies with unwed parents are now so common that the social stigma from yesteryear has largely disappeared. Nevertheless, there are still circumstances where the law discriminates against children born out of wedlock.

When someone dies without a Will, the state of Tennessee decides who will inherit the person’s estate. The laws governing this process are known as "Intestate Succession." When the decedent has no surviving spouse or descendants, the property is distributed to the decedent’s parents or descendants of the parents if they are deceased, i.e., brothers, sisters, nieces and nephews. If the parents are deceased and have no then living descendants, then the property is distributed to descendants of the decedent’s grandparents (i.e. aunts, uncles, first cousins, second cousins, third cousins). Children born out of wedlock frequently claim to be a member of the class who inherits from an intestate decedent.

The Cleo Snapp case is the most recent of several Tennessee cases that have treated children born out of wedlock as creditors of the estate. Tennessee law requires creditors to file a claim against the estate within 1 year of the decedent's death if they want to receive a share of the estate. Furthermore, if the executor notifies the creditor that they need to file a claim, they have only 4 months after receiving the notification. If the creditor does not file a timely claim, they forfeit their share of the estate.

The problem presents itself when inheritance rights flow through the potential inheritor's father. There is no requirement for filing a claim when your “blood” relationship to the decedent is through your mother.

When a potential inheritor files a timely claim, he or she must still prove the identity of their father by clear and convincing evidence.

The paternity issue most often arises when there is not a Will, but can also arise when there is a Will which does not clearly specify who inherits the decedent's estate.

Tax Court Approves 17% Discount for Fractional Gifts of Vacation Home

Bryan Howard — Thu, 13 May 2010 08:13:33 -0600

Qualified Personal Residence Trusts significantly reduce estate taxes that will be assessed on a personal residence. For married couples, I often recommend that the husband and wife each transfer a 50% interest in the residence to separate QPRTs. When both spouses establish separate trusts, you hedge the mortality risk associated with QPRTs. The other benefit from separate QPRTs was demonstrated by the recent Ludwick case in which the husband and wife each transferred 50% of their $7 million Hawaiian home to a separate QPRT. The court ruled that the value of each 50% interest was 17% less than 50% of the value of the entire home. The 17% fractional interest discount significantly reduced the gift tax cost of establishing the QPRTs.

There is also a way to take advantage of fractional interest QPRTs when it is not possible or practical to establish separate husband and wife QPRTs. One person can establish two separate QPRTs with different terms, for example, 6 years and 8 years, and transfer a 50% interest to the two separate QPRTs.

My clients seldom establish QPRTs for their Tennessee residences because they do not want to pay Tennessee gift taxes. Therefore, most QPRTs that my clients establish are for vacation homes located in other states. Generally, QPRTS in other states do not generate any federal or state gift taxes.

If you are buying an expensive home in Tennessee or elsewhere, there is a technique called a joint purchase trust that can be used without any gift taxes having to be paid. Joint purchase trusts have a lot in common with QPRTs. However, they must be established prior to purchasing the home.

Tennessee Dynasty Trusts

Bryan Howard — Wed, 12 May 2010 12:01:26 -0600

The term “dynasty trust” refers to a trust that will last for several generations. Since 2007, Tennesseans have been able to establish dynasty trusts that can last for 360 years. Prior to 2007, trusts had to terminate after approximately 100 years.

In order to qualify for the longer duration, the trust must provide a testamentary limited power of appointment to at least one member of each generation of your descendants who dies more than 90 years after the trust is established. A testamentary limited power of appointment provides the beneficiary with the right, through a provision in his or her Will, to terminate the trust in favor of certain beneficiaries or charities or to keep the property in trust with different provisions. Tennessee’s law is unique in requiring this power of appointment in order to qualify for the longer term.

The required power of appointment will be eliminated for trusts established on or after July 1, 2010. Even though the power of appointment will no longer be required, I still recommend that you provide future generations with the ability to modify the trust. Imagine that your great great grandparents had established a trust in 1910 which now benefits you. Could they have possibly anticipated all of the changes that have occurred over the past 100 years and determined a sensible trust design for your descendants? It is much more likely that you can design a better trust to accommodate the specific attributes of your children and grandchildren and numerous changes that have occurred in the world over the last century.

If 360 years is not long enough for you, there are several states that allow trusts to last into perpetuity. Even if you live in Tennessee, you can take advantage of the laws in one of these other states. To date, only one of my clients has not been satisfied with 360 years.

Market Correction Creates Opportunity for Roth IRA Conversions and GRATs

Bryan Howard — Fri, 07 May 2010 14:35:41 -0600

Over the past 6 trading days, the Dow Jones Industrial Average has dropped from 11,167 to 10,380, which is a drop of 7.6%. If you have not already converted your IRA to a Roth IRA, this is a golden opportunity to make the conversion. By converting now, you might lose the opportunity to convert at the bottom if the market drops further. However, if it turns out that this is merely a temporary correction, you will be glad you made the conversion even if you slightly miss the bottom. If this turns out to be the beginning of a bear market, you can recharacterize your Roth IRA to a traditional IRA and try again next year. The recharacterization option lets you “win” if the market rebounds and “break even” if the market goes down further.

A market correction is also a good opportunity for establishing a GRAT. GRATs are similar to Roth IRAs in terms of letting you start over without a penalty if the market declines after you establish the GRAT. This may be your last chance to make a tax-free transfer of wealth to younger generations through the utilization of short-term GRATs. Congress is considering legislation that would eliminate this opportunity.

Beware of Creating a Charitable Remainder Trust in 2010

Bryan Howard — Fri, 07 May 2010 08:02:56 -0600

Charitable remainder trusts (CRTs”) are a popular technique for obtaining income tax benefits and providing money to charity. Due to a law passed in 2001 as part of the Act that repealed estate taxes for this year, there is a significant gift tax risk associated with CRTs established this year.

Many CRTs make payments to the grantor of the trust for lifetime or for a period of years. The unintended effect of the law is to treat the Grantor’s retained interest in a CRT as a taxable gift. The "phantom" taxable gift will cause unnecessary gift taxes to be paid and/or increase estate taxes payable upon the Grantor's death.

Several groups have written letters to the IRS requesting relief from the gift tax problem. Treasury officials have informally advised certain attorneys that guidance concerning this issue will be forthcoming in the near future. It is not certain what the guidance will say. Therefore, you should not create a CRT until the guidance is issued.

Increase Your Trust Distributions With A Unitrust Conversion

Bryan Howard — Mon, 26 Apr 2010 08:17:19 -0600

If you are a beneficiary of a trust that requires income to be distributed to you, you may be able to increase your trust distributions by taking advantage of a new Tennessee law that will become effective on July 1, 2010. Section 21 of Public Chapter No. 725 of the Tennessee Public Acts of 2010 authorizes a trustee of a trust that requires mandatory distributions of net income to convert the trust to a total return unitrust.

The effect of a conversion is to change the trust distributions from “income” to a fixed percentage of the value of the trust. Assume that your trust has $1 million of assets and generates net income of $25,000 per year. If the trust is converted to a 4% unitrust, your distributions will increase to $40,000.

The fixed percentage must be between three percent (3%) and five percent (5%). Ideally, the income and remainder beneficiaries of the trust will agree to the percentage in advance. If the beneficiaries fail to agree in advance, the trustee will either not make the conversion or will choose the percentage on its own.

The conversion can be made without a court proceding if certain procedures are followed. If the Trustee is not “disinterested,” the Trustee must appoint a disinterested person to determine the unitrust percentage, the method to be used in determining the fair market value of the trust, and which assets are to be excluded in determining the unitrust amount. The trustee must send written notice of the proposed conversion to all qualified beneficiaries of the trust and not receive an objection within thirty (30) days. If a beneficiary objects, the Trustee can petition the Court to approve the conversion.

The main benefit of making a conversion is to eliminate an inherent conflict of interest between the income and remainder beneficiaries. With an all income trust, the income beneficiaries generally want the trustee to purchase investments that generate a lot of income and remainder beneficiaries want the Trustee to purchase assets that will appreciate in value. As a general rule, high income investments do not appreciate as much in value. When payments to the income beneficiary are dependent on the value of the trust rather than income received, the income beneficiary prefers for the trustee to maintain an investment policy that results in growth of the value of the trust over time. Growth will increase distributions to the income beneficiary and will also benefit the remainder beneficiaries of the trust.

Synthetic Charitable IRA Gift™

Bryan Howard — Mon, 19 Apr 2010 12:50:09 -0600

For the last four years, IRA owners who are over age 70.5 have been able to make charitable gifts from their IRA of up to $100,000 per year. This law has been extended before and Congress is currently working on another extension for 2010. Congress’ willingness to continue extending this law is attributable to the popularity of this technique.

Even if Congress extends the law, there may be a better way to make a gift to charity. Here’s how it works: Step 1: Determine how much you want to give to charity from your IRA. Step 2: Make the gift to charity from your non-IRA assets. For example, you could give highly appreciated securities or real estate. Step 3: Convert the same amount of your IRA to a Roth IRA.

The income from the Roth conversion will be offset by the charitable income tax deduction so that the net effect on your income taxes is neutral. Income tax neutrality is consistent with a direct gift to charity from your IRA. However, the synthetic gift has the additional effect of converting appreciated securities from your taxable portfolio into a Roth IRA where you will never pay taxes on the appreciation or the earnings of the securities.

There are 3 other benefits of the synthetic gift technique. You are not limited to a charitable gift of $100,000 per year. You can make a gift to your private foundation or donor advised fund. This is not possible with a direct gift from the IRA. Finally, if you have not yet attained age 70.5, you are not eligible to make a direct gift from your IRA. The synthetic gift technique has no age limit.

There is a potential pitfall with this technique. There are complicated income tax rules that affect the timing and amount of your charitable income tax deductions. Make sure your CPA examines the consequences before you make a synthetic charitable IRA gift™.

A synthetic charitable IRA gift™ may be a better choice for you than a charitable IRA rollover because it provides money to charity and allows you to convert a portion of your taxable portfolio to a Roth IRA.