Beth Kaufman Talks to Tax Notes on Tailoring Estate Planning Techniques to Client Needs
Estate planners eager to help their clients make the most of the temporarily doubled estate and gift tax exemption have a daunting array of planning techniques to pick from with no one-size-fits-all solutions.
"We've got a whole bunch of options and it's not possible to say, ‘Oh, this is the best estate plan, this is clearly what you want to do,' because there are pros and cons to all of these options," Beth Shapiro Kaufman of Caplin & Drysdale Chtd. said June 25.
One of the most pressing questions for estate planners is how to ensure their clients can benefit from the doubled exemption before it expires. But all except the ultra wealthy would have to relinquish everything they own to exceed the $ 11.2 million cap for individuals and $ 22.4 million cap for couples, Kaufman said at the American Law Institute Continuing Legal Education estate planning conference in Madison, Wisconsin. "They don't want to impoverish themselves just because Congress gave them bonus exclusion," she said.
Kaufman's first recommendation was to create spousal lifetime access trusts (2018 TNT 113-3) (SLATs), which enables the taxpayer to "give the money away without really giving it away" by making the surviving spouse one of the beneficiaries of the SLAT.
Another way donors can use up the estate and gift tax exemption amount without fully relinquishing access to assets is through a qualified terminable interest property (QTIP) trust. Under section 2519, a gift of any part of a QTIP trust triggers a gift tax on the entire trust, Kaufman explained, and while that's usually an outcome that estate planners want to avoid, when used this way, it allows the client to make a gift equal to the full value of the trust, so that the bonus exemption amount is locked in. Then, because the actual gift consisted of only a small percentage of the trust's assets to the donor's children, the rest of the trust's assets remain in place and the surviving spouse still receives all the income from the trust.
Kaufman said the theory behind this technique is that the QTIP trust's assets are included in the surviving spouse's estate under section 2036, and that section 2036 has an offsetting provision that allows any gift tax paid on the assets to be subtracted. "You get to exclude what you already made a gift of during life, thereby locking down use of your bonus exclusion in 2018, even though you're dying after 2026, and the only part that you actually pay tax on after 2026 is the appreciation on the property," she explained.
This method is "a little iffier" than the SLAT approach, according to Kaufman. She also said that it's "not terribly efficient" because it fails to get appreciation on assets out of the estate. But because it can be used by a surviving spouse who is already the beneficiary of a QTIP trust, it's "nice to have a technique in our quiver for that person."
Some taxpayers may prefer to go the simple route and rely on portability of the deceased spouse's unused exclusion amount to give everything to the spouse when planning around death.
"From a tax perspective, it works," Kaufman said, explaining that this allows for a step-up in basis on the transferred assets. But she added that planning with portability alone wastes the generation-skipping transfer tax exemption because that exemption is not portable, misses the opportunity to get some creditor protection on those assets, and sacrifices future control of them-factors that can become messy if the surviving spouse remarries.
Kaufman suggested combining the portability approach with a QTIP, which keeps the same benefits of using portability alone and adds both creditor protection for the surviving spouse and protection of the inheritance for the children of the deceased spouse, "because in the QTIP, the first to die controls the ultimate disposition of those assets."
Estate planners may also want to consider a "Clayton QTIP" - named after the 1992 Fifth Circuit Court case Estate of Clayton v. Commissioner (92 TNT 233-16), 876 F.2d 1486 (1992) Kaufman said. That case "established the concept that you could have different provisions apply, depending on whether the QTIP election is actually made or not," she said, which means that the decision over which assets to put into a credit shelter trust and which to put into a QTIP trust can be delayed up to 15 months after the person has died. That allows a substantial amount of time to determine which technique works better depending on the law in effect at the time of death.
"So it's a very flexible technique, and flexibility is key under the current law, because we don't know what's going to happen," Kaufman said.
Another flexible approach is to follow the disclaimer method, in which the surviving spouse disclaims some assets being passed on, and can make arrangements so that anything disclaimed goes into a credit shelter trust, Kaufman said. Unlike a QTIP, in which the deceased spouse was able to direct where assets would go after her death, the disclaimer method allows the surviving spouse to proactively disclaim the assets from the marital bequest.
"You're relying on somebody actually doing something that they may not be willing to do when the time comes, or they may not be competent when the time comes," Kaufman said.
Falling Into Traps . . . On Purpose
For wealthy clients who have parents or other older relatives that aren't as well off and have plenty of unused exemption amount, upstream planning techniques (2018 TNT 57-5) can be particularly attractive.
One such technique involves intentionally triggering the "Delaware tax trap" under section 2041. That has always been something to watch out for and avoid, but "now because everything has been turned on its head, the Delaware tax trap is a planning opportunity," Kaufman said.
She explained that what's needed is a trust that's subject to the rule against perpetuities, and then the elder recipient can exercise general power "in a way that blows that rule against perpetuities," which would make the trust's assets includable in their estate.
Kaufman cautioned that this may not work in states that have passed laws specifically to protect taxpayers from falling into the Delaware tax trap, and many practitioners have designed trusts with language preventing that from happening. But she said her firm has now started drafting language to keep that option in their trusts.
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Excerpt taken from the article “Down the Rabbit Hole: Estate Planners Hunt for New Techniques” by Jonathan Curry for Tax Notes.