Tax, Trusts & Estates Law Monitor : Estate Planning Lawyer & Attorney : Cole Schotz Meisel Forman & Leonard Law Firm : NJ, Mid-Atlantic Gift Tax & Trust Issues

As estate planning attorneys, it is not uncommon for us to be confronted with clients who, for whatever reason, make the decision to disinherit a family member.  While a spouse is not legally permitted to completely disinherit a surviving spouse due to elective share statutes, there is no legal restriction from disinheriting children.

Here is a link to an article in last week’s New York Times, which discusses disinheritance from a child’s point of view.  We thought it was interesting and worthwhile to share.

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On August 17, 2011, New York Governor Andrew Cuomo signed legislation that substantially revises New York’s trust decanting statute, NY EPTL 10-6.6.  New York was the first state to enact a decanting law in 1992.  The statute offers one effective method to revise or update otherwise irrevocable trusts.  The revisions to the statute significantly expand its scope, including the following changes:

“Absolute discretion” standard expanded.  Under the old New York law, the trustee had to have “absolute discretion” to invade the trust principal in order to be able to decant the trust.  The new law relaxes this requirement.

Under the new law, if the trustee has “unlimited discretion” to distribute the trust principal, the trustee may decant the trust in favor of one or more of the trust beneficiaries, to the exclusion of others.  Similarly, the remainder beneficiaries of the new trust can be one or more of the remainder beneficiaries of the old trust, to the exclusion of others. 

For example, if a trust permits distributions to any of four children for the “best interests” of any of them, the trustee could decant the entire trust in favor of only one of the children.  The rationale is that such a distribution falls within the trustee’s broad discretion under the terms of the trust. 

If the trustee does not have “unlimited discretion” – for example, the trust only permits principal distributions according to a “health, education, maintenance and support” standard – then the trustee still may decant the trust, but the beneficiaries of the new trust must be the same as the old trust, and the new trust must contain the same standard regarding principal distributions.  

Notification.  The revised New York decanting statute still requires that all interested parties be notified of the changes to the trust.  In addition, the revised statute provides that, unless the beneficiaries consent, the decanting will become effective 30 days after service of notice. 
Feel free to contact us if you have any questions about the pros and cons of decanting a trust, or the application of New York’s decanting statute.

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On June 28, 2011, the Senate introduced Senate Bill 1286 (known as the Trade Adjustment Assistance Extension Act of 2011), which contains the same GRAT restrictions that were introduced in numerous bills in the House of Representatives and Senate in 2010.  The comprehensive 2010 tax act enacted in December 2010 did not include any GRAT restrictions.  Thus, in 2011, the use of GRATs has not been curtailed or restricted.

The new Senate bill provides that (i) GRATs must have a minimum 10 year term and (ii) the remainder interest of the beneficiaries of a GRAT at the time of the transfer must have a value greater than zero.  If enacted, the bill would prohibit “zeroed-out GRATs,” that is, GRATs where the full value of the assets contributed by the Grantor will be paid back to the Grantor in the form of an annuity so that the remainder interest will have a value of zero.  No guidance has been offered to provide what the minimum value of the remainder interest must be.  One other restriction of note:  the annuity payment itself cannot be reduced year-to-year during the 10 year term.  Without this restriction, it may have been possible to create the economic equivalent of a short term GRAT.

For those people who are interested in short term GRATs, now may be the time to accelerate the implementation of them if you believe the GRAT restrictions will become law.

It is unclear what the effective date of Senate Bill 1286 would be.  The bill provides that amendments made under the section of the bill restricting GRATS would apply retroactively to transfers made after December 31, 2010 but the same GRAT restrictions set forth in the Administration’s 2012 revenue proposals provide that the proposal would apply to trusts created after the date of the enactment of the bill.

We will keep you apprised of the developments of this legislation.

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Gifting is an integral part of estate planning and the incredible rise of education costs has made gifting to fund educational expenses an important consideration for many families.

One common technique implementing this planning is the creation of a 529 Plan for a benefit of a child or grandchild.  After-tax dollars are contributed to these accounts which then grow federal income tax free for the benefit of the beneficiary of the account.  The funds must be used for college tuition and related expenses.  If the beneficiary does not use all the funds, the beneficiary can be changed to another child.  To the extent funds are used for non-educational purposes, they are subject to income tax and a 10% penalty on the earnings of the account.  The penalty can be avoided if the beneficiary dies, becomes disabled or receives a scholarship.

529 Plans are limited in that they only can provide for higher education expenses.  An alternative to a 529 Plan is the creation of an irrevocable gifting trust to be the recipient of gifts for your beneficiaries.  The gifting trust can permit the trustee to make distributions to the beneficiary (i.e. a child or grandchild) not only for college, but for other educational needs, health, maintenance, support or any other legitimate reasons, such as a down payment on a house or to start a business.  The trust could extend out for a term of years (i.e., until the beneficiary attains age 35), or can even be for the lifetime of the beneficiary.  While the trust is irrevocable so that it is not included in the donor’s estate, it can be drafted in a very flexible manner to permit distributions over a longer period of time.  In this way, the donor (through the trustee) maintains control over the distribution of the assets

The major disadvantage to the gifting trust when compared to the 529 Plan is that the funds in the trust do not grow income tax free.  Each year, to the extent income is not distributed, the trust will be required to pay income tax on its earnings.  

Lastly, it is also important to note that a donor can pay for a child or grandchild’s educational expenses directly as a tax-free gift, which is in addition to (and not limited by) the $13,000 per donee per year gift tax annual exclusion.

When considering gifts to minors and other beneficiaries for educational purposes, it is important to consider 529 Plans and their tax benefits and compare this to the advantages of a gifting trust and its flexibility to make a wider range of distributions to make an informed decision as to which approach is more appropriate.

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As estate planners, we routinely prepare health care directives. But how many of us have detailed discussions with clients about their burial wishes? Perhaps we should.

A recent New Jersey Appellate Division case involving a conflict over a decedent’s remains highlights the importance of clearly expressed burial wishes. The case – In the Matter of Peggy Z. Puder (unpublished opinion, decided 1/14/2011) – involved Peggy Puder, of Greek Orthodox descent, who married Arthur Puder in a Jewish wedding ceremony in 1982. In 1989, Peggy and Arthur executed reciprocal Wills. Peggy’s Will left everything to Arthur and named him as executor. Peggy also specifically excluded her mother and twin brother from her Will.

In 2006, Peggy was diagnosed with terminal cancer and she died in May, 2007. Her remains were interred in a mausoleum in the Greek Orthodox section of a Paramus, New Jersey cemetery, with the apparent consent of her husband and brother. However, in September, 2007, shortly after being named executor of Peggy’s estate, Arthur authorized the disinterment of the remains and their reinterment in a marital burial plot in the Jewish section of the cemetery.

Peggy’s mother filed suit, seeking to prevent Arthur’s action. The trial court thus had to interpret the provisions of New Jersey’s disinterment statute. The court found that the husband/executor had the sole authority over the handling of his wife’s remains and the decedent’s mother had no standing. The Appellate Division affirmed.

The situation in the Puder case is an unfortunate example of how bad blood among family members may turn into a court battle. It clearly could have been avoided if the decedent had expressed her burial wishes in a writing such as an advance directive.

If a client wishes to be an organ donor, be cremated, have a “green burial” (ie, a burial with minimal environmental impact, for example, by not using embalming fluid or metal), if available, or have some other unique treatment or disposition of his or her remains, then these wishes should be included in the client’s health care directive. These wishes should not be included in a Will which may not be found or read in time. Such planning will not be captured in ordinary health care directive forms, but can be handled by a competent estate planning attorney, and may very well prevent a post-mortem family feud.
 

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Louise Macool, a resident of New Jersey, had a 1995 Will and a 2007 Codicil. She met with her attorney about preparing a new Will. She had written that, among other things, she wanted to add her niece as a beneficiary and keep the house in the family.

Macool’s attorney dictated the Will and his secretary typed a rough draft while his client was in the office. Unfortunately, however, Macool left the office and died one hour after the appointment.

The niece (who was an added beneficiary under the proposed new Will) brought an action to admit the draft Will to probate. The trial court found that the draft Will could not be admitted. New Jersey law requires a Will to be signed and acknowledged by two witnesses in order to be valid (NJSA 3B:3-2), and the document failed that test. New Jersey law also allows a non-compliant document to be admitted as a Will if the proponent can show by clear and convincing evidence that the document was intended to be a Will. NJSA 3B:3-3. The trial court found that, although it was proven that Macool intended to change her Will, there was insufficient evidence to conclude that Macool intended the actual draft document to be her Will. The trial court also held that a Will must be signed in some fashion in order for it to be admitted to probate.

In a September 16, 2010 opinion, the Appellate Division agreed with the trial court that the Will draft was inadmissible as a Will. The Appellate Division also rejected the part of the trial court’s ruling that a Will must bear the testator’s signature. Thus, it appears that in New Jersey, a document which is unsigned may still be admitted to probate as a decedent’s Will.

This case concerns an attempt to have a court accept a non-compliant document as a Will. Obviously, the best practice is to have properly executed documents. Perhaps the lesson is that Will formalities, difficult as they sometimes are, really do matter.

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As many of us know, the Qualified Personal Residence Interest Trust, or “QPRT,” is a common estate planning tool. An individual contributes his or her residence to a trust, but retains the right to live in the residence for a term of years (e.g., 10 or 20 years). The contribution of the residence to the trust is a gift, but the gift is reduced by the value of the individual’s retained interest, so the gift is much less than the actual fair market value of the residence.

The creation of the remainder interest typically constitutes a taxable gift by the grantor of the trust. This can limit the utility of a QPRT if a client already has used his or her $1 million lifetime gift tax exemption, or if the value of the remainder interest would exceed $1 million. For example, a $10 million New York City apartment will generally create a remainder interest of greater than $1 million if transferred to a QPRT (the calculation depends, of course, on the QPRT term of years, the discount rate in effect, the client’s age, etc.). This client may not be able to create a traditional QPRT without triggering a gift tax.

One planning technique that a client at this level might wish to consider is a “zeroed-out QPRT.” With a zeroed-out QPRT, the individual retains certain rights (ie, a limited power of appointment) over the remainder interest so that the initial transfer of the property to the trust is not a gift at all.  In other words, the actuarial value of the remainder interest is not gifted away and remains in the grantor’s estate. But if the individual survives the term of the QPRT, the future appreciation in value of the residence will be removed from the individual’s estate. Only the actuarial value of the remainder interest at the beginning of the trust term should be includible.

Let us return to the above example of a $10 million New York City apartment and assume the client is 65 years old and creates a 15 year QPRT to own the property. The remainder interest is allocated to its own trust, and the client retains a limited power of appointment over it. Based on the current actuarial tables, the grantor’s retained interest will be worth approximately $6 million and the remainder interest will be worth approximately $4 million. There should be no gift at the time of transfer due to the grantor’s limited power of appointment over the remainder.

Now let us assume that the client survives the term, and when the client dies at 81, the property has a value of $17 million. On these numbers, the amount includible in the client’s estate should be only the original $4 million remainder. All of the appreciation in the property has occurred outside of the client’s estate.

One downside to this technique is that the donees will receive the property with a carryover basis and not receive a step-up (assuming the step-up rules apply). Since the estate tax is greater than the capital gains tax, this generally does not present an issue, though it is worth noting that the scheduled increase in capital gains rates will worsen the income tax effects of a sale of the property.

The zeroed-out QPRT is an interesting application that may be a worthwhile consideration for certain clients. Please contact us if you would like to discuss this technique.

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Click here to read about issues that can arise when estate planning involves real estate.

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The IRS recently announced in Revenue Procedure 2009-50 that the gift tax annual exclusion amount available to taxpayers in 2010 will remain unchanged at $13,000. The Tax Reform Act of 1997 tied the then $10,000 gift tax annual exclusion to cost of living adjustments based on increases in the Consumer Price Index. As a result, since 1998, the annual exclusion has increased from $10,000 to $13,000. The annual exclusion permits a taxpayer to gift $13,000 annually to any beneficiary without being required to use his or her $1 million lifetime gift exemption amount.

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The IRS has released the AFR interest rate for October, reducing the September AFR rate from 3.4% to 3.2%. While this is above the historically low 2% AFR rate in February, it still represents a very low interest rate, making GRATs a very attractive estate planning device to transfer significant wealth to your family members gift and estate tax free. In this environment where there are some proposals in Congress designed to curtail the use of GRATs, it again highlights that now is the time to seriously consider implementing a GRAT if you have a large taxable estate.

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With school in full swing and parents of college-age children becoming empty-nesters again, one important estate planning question comes to mind: can you as a parent get medical information about your college-age child in the event of an emergency? This concern is especially relevant this year as concerns about swine flu (H1N1 virus) are widespread.

Once a child turns 18, parents generally no longer have legal authority over their child’s financial or medical decisions, even though high-school and college-age children usually are still dependent on their parents.

Moreover, the Health Insurance Portability and Accountability Act (“HIPAA”) imposes high standards of patient privacy on hospitals, physicians and other health care providers. Because of this, many medical providers will not provide any medical information to anyone without the authority of the patient.

One solution is for parents to ask their college-age children to sign a power of attorney and health care directive. These routinely prepared estate planning documents authorize the parents to obtain medical information and make medical and financial decisions for a child if the child is unable to make such decisions for himself or herself. By keeping copies (or, better yet, electronic copies) of these documents readily available, parents will be better prepared to respond in case of an emergency involving the child.

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The IRS has issued the Applicable Federal Rate (“AFR”) for September, keeping the AFR rate under Code §7520 unchanged from August at 3.4%. What this means is that GRATs are still very attractive estate planning devices for taxpayers. The AFR rate is the interest rate the IRS requires taxpayers to apply to the amount gifted to the GRAT to value the gift at zero. If the gifted assets appreciate at an amount greater than 3.4%, then notwithstanding any valuation discounts attributable to the gifted assets, the appreciation in excess of 3.4% would pass gift tax-free to the GRAT’s beneficiaries. Thus, the lower the AFR rate, the more attractive GRATs are to taxpayers.

In light of proposed legislation in Congress requiring only long term GRATs and limiting valuation discounts, now may be the time to implement a GRAT.
 

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As online account management becomes more pervasive in our society, and in turn, paper records become obsolete, it is important to consider keeping in a safe place a record of all of your accounts and the attendant identification numbers/codes and passwords so that if something catastrophic occurs, your family members and/or trusted representatives have the ability to access your accounts and information without too much difficulty.

For example, when someone passes away, an estate is created and one of the primary responsibilities of the executor is to inventory the assets of the estate. Prior to this digital age, that typically involved monitoring the mail to review statements of accounts that arrived each month. Online statements have replaced paper statements, and without access to email accounts or direct access to financial institutions, these accounts could be overlooked. If someone becomes disabled, and is unable to communicate his password protected information, it could be unduly burdensome to unlock this critical information.

You should consider (1) checking your Internet service provider’s privacy policy following a death, (2) making sure a trusted family member or representative has access to this protected information to identify and access these accounts, (3) backing up digital records regularly, especially if they have monetary value and (4) providing special instructions to family members or in estate planning documents as to the treatment of your digital property.

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2009 has been an interesting year for estate planners. The arrival of 2009 brought an increase in the applicable exclusion amount to $3.5 million (from $2 million in 2008), meaning taxpayers with proper planning could shield this amount from the imposition of federal estate taxes. 2009 also brought the scheduled estate tax repeal for a one year period beginning on January 1, 2010 that much closer.

Notwithstanding the fact that we are now less than seven months away from a temporary estate tax repeal, there is a prevailing belief among estate planners that Congress will change the law before 2010 preserving some form of the estate tax, especially in light of the economic meltdown and the federal deficit.

In fact, numerous bills have already been introduced in Congress detailing estate tax parameters for 2010 and beyond. With respect to the applicable exclusion amount, three separate House bills have been introduced with exclusion amounts equal to $2 million, $3.5 million and $5 million, respectively.

For the most part, the estate tax rates in these bills are set at the current 45% estate tax rate, and some impose surtaxes on estates in excess of $10 to $25 million.

Other important items are addressed in these bills as well. For example, there is a mention of unifying the gift and estate exemptions, meaning if this were part of the new law (we believe unlikely at this point), the $1 million lifetime gift exclusion amount would be increased to equal the estate tax exclusion amount. This certainly would expand the ability of a taxpayer to implement more lifetime transfer planning.

Some of the bills include the concept of making the estate tax exclusion portable for couples, meaning for example if a husband does not utilize his full exclusion, his wife could utilize not only her exclusion, but his as well.

Finally, there is language in one bill which would restrict the use of valuation discounts typically applied to the ownership of closely held non-business family entities. These discounts are an integral part in transferring wealth to the next generation.

We will be keeping a close eye on estate tax legislation throughout the year and will report to you the new estate tax law as soon as it is passed.
 

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Intra-family loans offer a conservative way of using interest rate arbitrage to achieve guaranteed estate tax benefits. The technique can be a powerful tool in today’s uncertain economic climate.

Intra-family loans take advantage of the spread between IRS prescribed interest rates and the interest rates available in the capital markets. For example, in July 2009, the “applicable federal rate” prescribed by the IRS for a three year note is 0.82% and a jumbo CD can be found with an interest rate of 4%.

Consider this example: Client creates a new irrevocable, generation-skipping tax exempt grantor trust for the benefit of his family. He makes a gift of $1 million and then loans the trust $9 million in exchange for a three year promissory note bearing interest at the applicable federal rate of 0.82%. The trust takes the $10 million and simply invests it in a jumbo CD as described above. The trust will receive interest income of $400,000 per year and have to pay out $82,000 per year in interest on the promissory note, a net gain of $318,000 per year, which accrues to the trust income, gift and estate tax-free. In three years, the trust will have accumulated $954,000 on a tax-free basis. At that time, the trust can repay (or refinance) the note.

The market downturn of 2008-2009 has wreaked havoc with many estate plans as transferred assets have lost value or failed to meet investment expectations. Intra-family loans are a conservative method for achieving estate tax benefits in today’s economy. Readers who are interested in intra-family loans should contact their tax attorney.
 

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Earlier this month, the New Jersey Appellate Division, in Hadfield v. Lillo, held that a decedent’s ex-spouse was not entitled to the proceeds of a life insurance policy where the decedent, after obtaining a divorce, failed to change the beneficiary designation of a life insurance policy on his life. This case represents a fairly straightforward interpretation of New Jersey’s “revocation on divorce” statute.

NJSA 3B:3-14, amended in 2005, provides that a divorce revokes any revocable dispositions made by a divorced individual to his or her former spouse in a governing instrument (which includes a life insurance policy), except as otherwise expressly provided. Prior to the amendment, the statute simply provided that if after executing a will the testator divorces, the divorce revokes any dispositions of property to the ex-spouse under the decedent’s will only.

The decedent in Hadfield was divorced prior to and died after the 2005 amendment. The ex-spouse argued that the amended version of the statute should not apply because it was not in effect at the time of the divorce. The court rejected this argument and retroactively applied the amended statute after reasoning the ex-spouse had no vested right in the insurance since the decedent could have changed the beneficiary designation at any time.

The law is similar in New York. Under NYEPTL 5-1.4, a divorce revokes the former spouse’s rights not only under a will but also by beneficiary designation of an insurance policy. The statute, by way of recent amendment, specifically references the beneficiary designation of a life insurance policy.

A shortcoming to the statutes is that life insurance frequently is owned by a spouse’s irrevocable insurance trust and the irrevocable trust is designated as the beneficiary. The statutes highlighted above deal with the revocation of revocable dispositions made by a divorced individual. As a result, absent specific language in an irrevocable trust to the contrary, a divorce will not revoke the designation of the irrevocable trust as the beneficiary and will not terminate an ex-spouse’s rights under the trust. It is also important to note that the state level revocation upon divorce statutes do not apply to ERISA governed retirement plans, such as IRAs, 401(k)’s and other employer-provided plans, a rule which adds confusion to this area.

A life changing event such as a divorce should always result in an extensive review of one’s estate plan.
 

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