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iHQ: Article III

About the Frye, Oaks, Benavidez & O’Neil, PLLC Information Headquarters:

Frye, Oaks, Benavidez & O'Neil, PLLC has a boutique estate planning practice serving the GLBTI community’s unique needs Post-Obergefell and assisting their allies in the broader Texas community as well with family wealth preservation and transfer during life and at death. We work with all individuals and families of all sorts of backgrounds since we know how important it is that we provide for the beloved family, friends, and/or charitable entities we will leave behind.

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  • The Frye, Oaks, Benavidez & O’Neil, PLLC Information Headquarters is not legal advice.
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Original publish date of 11 January 2016

Prepared by Daniel L. O’Neil, Partner

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Article III: Planned Transfers

Listing of topics:

Easy mode

§056: Nonprobate assets

§057: Probate assets

§058: Probate avoidance

§059: Coordination of probate and nonprobate

§060: The basic gifting strategies

§061: Charitable bequest administration

Hard mode

§062: Disclaimer

§063: Power of appointment

§064: Crummey

§065: Income tax considerations

§066: Estate tax

§067: Gift tax

§068: GST tax

Legendary mode

§069: Tax planned trusts

§070: Zeroed out trusts

§071: Supplemental Needs Trust

§072: Other trust scenarios for minors, incapacitated people, and elders

 

ARTICLE III

PLANNED TRANSFERS

 

ARTICLE III topics on EASY MODE

Now that we know what you own, this article addresses your testamentary intention on where your assets should go – both during life, and at death.

§056: Nonprobate assets

Nonprobate assets are not going to pass through Probate Court, except in limited circumstances. As a result, nonprobate assets cannot be validly disposed of through a Will provision, though this certainly doesn’t stop some people from attempting (ineffectively) to dispose of nonprobate assets through their Will. These are assets that are titled externally with beneficiary designation forms such as 401(k)s, Payable On Death (“POD”) bank accounts, property that you hold as a Joint Tenancy with Right of Survivorship (“JTWROS”) if you die first.

A Will can always be contested; so too can these nonprobate beneficiary designations, both in Probate Court as well as risking a criminal prosecution too. The criminal prosecutions run the gamut of white collar crime charges and depend heavily on the facts and circumstances. These are popular cases to prosecute because the perception is that the defendant took advantage of a sweet old lady (or man) and with the alleged “elder abuse” angle, it becomes an uphill battle to demonstrate that no crime occurred.

§057: Probate assets

Probate assets are going to pass through Probate Court and can be validly disposed of through a Will provision. Probate assets are your stuff, the tangible things and your money. This is your art collection, your furniture, your jet ski, your great-grandmother’s heirloom family ring, and the other pieces of property you think about and make you happy.

§058: Probate avoidance

Particularly from people that have lived most of their lives outside of Texas in jurisdictions with different probate systems, they are convinced that all probate systems are bad and they do not want their estate having to go through Probate Court at all. There are a variety of mechanisms for a person to avoid Probate – some are tax advantaged, some are not. Some of these mechanisms contemplate a huge amount of risk, while others have risks minimized as much as possible. As with any sort of estate plan the facts, details, and circumstances matter – and as with most things in life, you get what you pay for, especially if you have read some publications that only tell you what you want to hear, and make promises that seem too good to be true.

§059: Coordinating probate and nonprobate

Coordination of probate and nonprobate assets really contemplates two different things:

  1. Paying the least amount of tax possible
  2. Not doing silly things like trying to dispose of a nonprobate asset in a Will provision

For #1 this means coordinating the unlimited marital deduction (now extended to our friends in the GLBTI community Post-Obergefell) with tax planning taking into account the concept of portability.

For #2 this means knowing what the beneficiary designations are on such things as life insurance, 401(k), POD accounts, JTWROS deeds, and other nonprobate assets. This also means updating beneficiary designations to reflect what you want to happen, if you designated someone 40 years ago that is no longer appropriate to still be a beneficiary (such as an ex-spouse or someone who passed away 20 years ago.)

But #2 folds back in on #1 with tax planned trusts such as the ILIT, where beneficiary designations need to reflect the rest of your estate plan. If you never transfer ownership of your life insurance policy to the Trustee of the ILIT then your estate plan has been frustrated. This can lead to estate tax under #1.

It is important to coordinate the plans for probate and nonprobate assets. For instance, it is not going to be a best practice to start naming off beneficiaries for your 401(k) in a Will provision, considering that it is a nonprobate asset passing to the beneficiary you named on that form. The Will provision has no impact on that nonprobate asset – so it looks bad, since it is a public record, and can potentially upset the beneficiary named in the Will provision since they are getting nothing and the person on the form took the entire amount months ago.

Outside of designated beneficiary forms on certain accounts, an inter vivos conveyance that is a probate avoidance mechanism can have the same impact. If you gift deed “the East Texas ranch” to Son 1 giving away your entire interest, then update your Will to give Son 2 your entire interest in “the East Texas ranch” then Son 2 is not going to be incredibly happy at receiving nothing.

When probate avoidance transfers are being made, it is important to compare against what is in the Will and whether the Will needs to be updated at that time to reflect the lack of ownership in an asset.

§060: The basic gifting strategies

Inter vivos conveyances

If you want to transfer things now while you are still alive and in good health you can do this. For instance, you can execute a gift deed outright to your child. This takes the asset out of your estate (but provides new, separate problems in long term planning for elder people who are contemplating short term eligibility for public benefits) but brings additional risks such as if they evict you through the proper legal process. This can also come with tax consequences if you have a low basis in the property it will be transferred, rather than receive a stepped up basis to the fair market value on your day of death if coming through Probate. There are numerous issues to consider in the context of executing a short two or three page gift deed. It’s not as easy as a signature.

Testamentary trusts

Like your Will, nothing happens until you pass away if you create a testamentary trust. With however you are funding the testamentary trust, it is not funded until after you have passed away. If you want control over your assets now while you are still alive, you should not place them into an irrevocable trust that you fund with an inter vivos conveyance – because once the asset goes into a funded trust now (if it is irrevocable) it is not coming back out.

Funding trusts now

But if you want to remove assets from your estate and give up all control of them (for tax purposes, or for other purposes) then you can fund the trust now while you are still alive – potentially so your beneficiary can enjoy the gift, or the income from the gift now while you can still enjoy them enjoying the gift.

Trusts provide a level of protection that since the gift is not made outright, there are restrictions on control and ownership. Spendthrift trusts provide a layer of protection from your beneficiary “losing it all” in a game of baccarat, or in a darkened street corner buying too much heroin. However, throughout history Trustees have taken advantage of beneficiaries – sometimes it is the people we would have last thought would betray us like that. There are civil causes of action against that Bad Fiduciary and risks of criminal prosecution they might be facing, but it is a case of the cat already being out of the bag, and the damage will already be done in the event a Trustee goes rogue.

Outright gifts

Outright gifts carry a level of risk as well, but there is no oversight of the beneficiary once they have received a large sum of cash. For some people this will change their life drastically with excesses; but for other people it is a nice nest egg for a house in the suburbs to raise children in or send their children to private school and college, which otherwise would have been out of their financial means prior to receiving the gift. No two situations are the same, no two family circumstances are the same. Making outright gifts requires a conversation about the beneficiary and getting to know your family dynamics better. If we know there are storms brewing on the horizon we always strongly recommend not making an outright gift and instead trying to find a trust situation that might fit the bill so your overall testamentary intention is not frustrated by your beneficiary’s life choices you do not agree with.

§061: Charitable Bequest Administration

Something that every Testator and their family should know about, in the event that they are charitably inclined, is the concept of charitable bequest administration.

When a person includes a valid nonprofit in their Will or Living Trust with Pourover Will, they have identified the importance of this nonprofit to be the same as their family, friends, and other loved ones that have passed through their lives. It is extremely important for the nonprofit to tread lightly in a number of different ways both when the Testator is still alive (since they can update their Will) and especially in the difficult time for the family and friends when the Testator has passed and the charitable bequest has become what is called “mature” since the estate is passing through the probate process.

Many nonprofits fail to have an effective bequest administration.

  • Some nonprofits do not appropriately treat bequests, which leads to potential donors changing their minds.
  • Some nonprofits do not demonstrate how valuable the bequests are, which leads to potential donors changing their minds.
  • Some nonprofits hassle family that just lost a loved one, so it looks like the nonprofit is just trying to shake money out of the dead guy. This is not an appropriate way to treat grieving family members.
  • Some nonprofits fail to make good impressions in other ways. In my practice the most memorable “disinheritance” was extremely memorable for all of the details related to me, in the course of updating the couple’s Wills, of how this nonprofit had failed them in numerous and myriad ways and now that nonprofit was losing out on millions. Millions with an ‘m.’

Types of gifts:

General or Pecuniary – “$40,000 to Nonprofit A”

This is the simplest gift possible. It is money and there are no strings on it. As long as you have this money in your estate and the Will is not contested, it is good to go. If you don’t have the money or if there is a Will contest, then it is not good to go.

Specific - “$100,000 to Nonprofit B to be used only on construction of the new wing of the nonprofit’s business office” or “100 shares of Yahoo stock to Nonprofit C”

This places strings on the use of the money in the first example; while the second example refers to specific property. If that specific property is no longer there because it was sold 20 years ago and the Testator never updated their Will, then the gift fails. In the event the restrictions on the money are too bold, the nonprofit can disclaim the gift. Specific bequests will usually come with a few cautions from the estate planning lawyer to annually review the estate plan (in case of specific property mentioned like the Yahoo stocks) to ensure the property is still there and still valuable enough it will not be disclaimed immediately. “Bad gifts” are things like real estate located near Superfund sites – these gifts will do more harm than good to the nonprofit, so in the event the nonprofit has a “gift acceptance panel” it is their job to catch the bad gifts and disclaim them immediately.

Residual – “Half of the residue of my estate to Nonprofit D”

This sort of gift is considered the most problematic just because there might not be anything in the residue. It will also take the longest to figure out exactly what is in the residue and valuation-wise, what half of it is. Residual gifts are often the “I can’t think of anyone else to give this to” gifts. If the intention is to make a better sort of gift, typically an arrangement can be worked out with the estate planning lawyer to structure a better gift.

Effective bequest administration is important for the Testators, their family in grieving, the lawyers and professional advisers surrounding the family, and the nonprofit themselves.

Bequest administration on the nonprofit side should not be viewed as the task nobody wants; because the person stuck with the thankless task usually does end up giving the impression to grieving families that the nonprofit only cares about shaking a few quarters out of a dead guy.

Effective bequest administration will maximize the value of gifts received, potentially increase the number of donors and improve the types of gifts they might wish to leave (general and specific rather than residual) – and most importantly, certain nonprofits will not continue receiving such a bad reputation in the estate planning and probate lawyer community for how they treat grieving families along with their lawyers and other professional advisers.

It is well worth it for nonprofits to have effective bequest administration in place.

 

 

ARTICLE III topics on HARD MODE

This section takes a closer look at some of the tax topics that arise in Estate Planning.

§062: Disclaimer

When you are crafting your estate plan and figuring out where your property should go, you need to be concerned about the intended beneficiary disclaiming the property. This will frustrate your testamentary intent. Most Testators need to discuss gifts in advance of their demise with the intended beneficiary, especially if they are uncertain of their tax situation and other factors that can lead to a disclaimer.

There are two sorts of disclaimers:

  1. The Plain Denial – this is a bad gift, I do not want it (e.g. real estate near a Superfund site)
  2. The tax advantaged or otherwise Planned Denial – this will adversely my tax situation this year (or create other reporting obligations I don’t want) and/or this gift should go to my child instead since they can use it more.
  3. Limited – you designate your share of that trust/estate goes to a class of possible beneficiaries such as your children or charitable entities. With a limited power of appointment you cannot designate this share goes to you, your estate, or your creditors/the creditors of your estate. This is the spendthrift version.
  4. General – much broader than the limited power of appointment, you have freedom on exercising designations or not.

Plain denial is pretty simple – you properly disclaim timely and no ownership is ever attributed to you. If you don’t do it properly or timely then you will have problems. Once you have met the requirements under state and federal law demonstrating you don’t want to touch the gift with a ten foot pole, your worries are over with respect to that gift. You cannot properly disclaim if you accept the property, income from the property, or direct where it should go when you change your mind and attempt to disclaim.

The planned denial will depend on the exact wording contained in the Will or Trust Document that the gift was generated from. In many circumstances a disclaimer is going to be treated like you predeceased the Testator/Settlor and the gift will pass to your children that “survived” you.

With the tax advantaged denial you will likely avoid gift and estate taxes entirely on that gift-shifting to your child; but there is the potential of GST tax for some transfers

§063: Power of Appointment

Focusing on the first word, this is a power you give to your intended beneficiary: the power to direct where their share of a trust/estate they have received should go when they pass away.

There are two sorts of powers:

A limited power, especially if not exercised, is likely not going to subject the holder to estate and gift tax. There needs to be specific wording utilized to ensure the power really is a limited power though.

A general power on the other hand, even if not exercised, exposes the holder to gift or estate tax. But in the event the holder of a general power designates a charity to receive the share, their estate will be entitled to the charitable deduction.

Powers of appointment provide flexibility decades down the line since nobody has a crystal ball to know which child might develop a drug, drink, or gambling problem; or which child becomes a billionaire and will designate someone more needy to receive an inheritance due to them.

Powers of appointment are an advanced tax topic and estate planning document drafting topic. You will not find powers of appointment included in holographic Wills or Wills you buy for cheap online.

§064: Crummey

It has the ‘e’ so it’s not Holden Caulfield’s crummy, nor is it good bread that is crumby.

A “Crummey” power is an annual notification to a beneficiary of a trust that within a certain time period they can withdraw a portion of the trust res, or if not withdrawn then it will become a fixed portion of the trust res. This is usually in connection with an annual gifting program, that the annual gift exclusion amount contributed to the trust can be withdrawn. This power makes the gift a completed gift since it is a present interest.

However this arrangement creates a problem since it is deemed a general power of appointment. This problem can be solved with a “five or five” solution – the beneficiary is restricted to withdraw no more than $5,000 or 5% of the value of the assets. But this creates a problem since the excess beyond the $5,000 (assuming annual gift exclusion amount was maxed out at $14,000 for a single parent or $28,000 for a gift splitting married couple) no longer has a present interest, and is thus not a completed gift. This problem led to the creation of another solution, which inevitably creates more potential issues.

§065: Income tax

When gifting a large asset through an inter vivos conveyance one of the most important considerations is the transferred basis, rather than waiting to take the stepped-up basis to fair market value on date of death of the decedent. This matters for capital gains tax to the transferee – which is a major consideration for middle class families who can be negatively impacted (as in the ability to put bread on the dinner table) by a large unexpected tax bill.

Depending on what the rest of the Testator’s financial picture is there could be issues to plan for with partnership capital accounts along with inside and outside basis; transfers of interest by gift, sale, or otherwise; 754 elections in response; possible S Corp qualified shareholder issues with the transfer; Qualified S Corp Trust issues; life insurance issues; buy-sell agreement issues; and other issues specific to the owner of a closely-held business interest.

With Family Limited Partnerships the most common issues are that they are not run as “legitimate” businesses which creates new and additional problems that would not have existed if an alternate vehicle had been chosen.

With Grantor trusts, income is taxed to you. Depending on your bracket this could be a big problem or not such a big problem.

There are too many other issues to say anything more generally than, there are probably income tax consequences related to whatever you are thinking about. Talk to your CPA.

§066: Estate tax

Income taxes focus on tax year to tax year. Meanwhile, estate tax only matters the day you die. The current exemption amount in 2015 is $5,430,000. You only pay estate tax on the assets you own in excess of the $5,430,000.

If you are married, the amount of the exemption that the spouse dying first does not use (more lawyerly called the “deceased spouse’s unused exemption” or “DSUE” for short) goes to the second spouse to utilize in addition to their own exemption amount; this is a concept called portability which was not permanent until 2013. A married couple can exclude $10,860,000 altogether from the estate tax in 2015; the spouse dying first can utilize the unlimited marital deduction though. In addition to spousal transfers, a person married or not can also give away plenty to charity tax free. So the estate tax hits very few Americans at the moment, far fewer than it did when the amount was $600,000 with no portability.

For the average guy walking out on the street the amount of money in his estate on day of death includes life insurance, retirement plans, and all of his other assets are counted at their fair market value. With tax planning, large assets can be removed from the estate with fancy lawyering to get the amount of money in his estate down below $5.43mm so no estate tax will be owed.

The estate tax exclusion amount is a credit that is unified with the gift tax exemption. Estate and gift tax work very close together – since you use lifetime gifts to reduce the size of your estate, and the estate tax captures everything else that you failed to dispose of entirely when you were alive.

§067: Gift tax

The most important thing starting out, is whether the gift is a taxable gift or not. There are some gifts that are nontaxable gifts such as payments incident to divorce or contributions to political organizations; and there is the annual exclusion amount to take into consideration.

The next item of importance is whether the gift is a completed gift or not. A gift is not completed if it is revocable, as one example. There are other circumstances that make a gift incomplete. The gift must also be of a present interest, not a future interest.

Then fair market value of the gift matters. Since some gifts can be harder to determine valuation than cash gifts. The value of the taxable gift, in excess of the annual exclusion amount, matters since it will produce a dollar for dollar reduction in the lifetime credit.

Gift tax applies to the donor, the guy giving away the money or property. The donor pays the gift tax (or reduces the exemption) separately from the transfer of property to the donee, so the donee receives the full value of the gift. But here’s the maybe/it depends … the donee might be liable for gift tax if the donor did not pay it.

Gift tax is combined with estate tax, which is never explained very well to people trying to get their tax advice from googling at 4am. The $5,430,000 estate tax exemption can be utilized solely for gifts during your lifetime but then you have no estate tax exemption left.

In 2015 you can gift $14,000 to anyone (child, mistress, or other) without creating a gift tax problem. This is the annual exclusion amount. If you gift your son $15,000 in a way that does not shield it from gift tax (such as a 2503(e) indirect transfer) then this is what it looks like:

$15,000 gift - $14,000 annual exclusion for this person = $1,000 amount is subject to gift tax.

You claim the $1,000 on a gift tax return so now your combined annual exclusion of $5,430,000 is now reduced to $5,429,000. This is the most basic explanation of the unified credit possible.

If you are married, you can gift someone $14,000 and your spouse can gift that same person $14,000 and it will be gift tax free to you both, which is termed “gift splitting.” So as spouses you can give someone $28,000 in 2015 without creating a gift tax problem.

Annual gifting programs are highly recommended for reducing assets in your estate in a tax advantaged way. Especially if the asset you are gifting is going to significantly appreciate, you do not want it in your estate if it will push you over the limit. You can remove the asset from your estate now and it is fixed with the fair market value on the transfer date, not the large increase in worth it will see over time.

Main advantages of gifting are tax savings (especially if it is a gift that will appreciate in value considerably) and the ability for a child or someone else to enjoy the gift now. But the main disadvantages of gifting are losing control over the assets, potentially exposing the asset to the donee’s creditors, and affecting your eligibility for Medicaid.

§068: GST tax

GST is by far the most confusing of the three horsemen of estate planning taxes. GST was put into service as a response to long term and dynasty trusts that were going to avoid tax altogether.

Basics:

  • GST includes outright gifts and transfers into trust, so it is different than estate tax.
  • GST includes unrelated persons more than 37.5 years younger than the donor and related people more than one generation younger than the donor (grandchildren and great-grandchildren as examples)
  • GST catches transfers that slip through the cracks on estate and gift tax at each generation level
  • The $5,430,000 exemption amount for GST is allocated automatically or by election
  • GST is a major concern for a grandparent or other elder person that is intending on giving away more than $5,430,000 to grandchildren, trusts for grandchildren, or other very young people relative to their own age.

This already sounds confusing so let’s do an example to clear up the basics

James is the grandfather and the donor.

Harry is the only son of James.

Albus is the only son of Harry and the only grandson of James.

James throws a lot of money into a trust for Harry (James’ son) and Harry’s children (James’ grandchildren) with the intention that income-only is distributed to the beneficiaries for their health, support, education, and maintenance (“HSEM”) and when Harry dies, the principal will be distributed outright to Albus. The trust res is likely not going to be included in Harry’s estate (let’s pretend the rare circumstances that could lead to that do not happen) so Harry is effectively skipped – so GST tax would be imposed when Harry dies.

More advanced:

There are three scenarios that will cause GST tax:

  1. Direct skip – a transfer is made to a skip person without an intervening benefit to a nonskip person
  2. Taxable termination – the last nonskip person holding an interest dies
  3. Taxable distribution – a distribution is made from a trust to a skip person where this distribution cannot be classified as a direct skip or taxable termination

And the inclusion ratio determines the portion that reach future distribution or termination will expose to GST tax. An inclusion ratio of zero means total exemption from GST tax all along the spectrum to a ratio of one meaning full exposure to GST tax. To calculate the ratio you look at the portion of the transfer NOT covered by the GST exemption/exclusion, and divide this by the value of the entire transfer being made.

 

 

ARTICLE III topics on LEGENDARY MODE

This section takes a closer look at some of the other advanced topics that arise in Estate Planning.

§069: Tax planned trusts

There are a large number of tax planned trusts, all of which do different things for different reasons. Irrevocable trusts will take the assets you transfer into them out of your estate, which helps your estate stay under the current threshold for the estate tax exemption. Revocable trusts are typically taxed as Grantor trusts which can have some additional impacts to be concerned with – though the offsetting benefit to those tax treatments, are that as a revocable trust you still have control over the assets and you can change your mind about things. With an irrevocable trust, once you transfer something into it you can probably never get it out.

These are a few of the more popular trusts people are talking about, with a very basic explanation about them.

Separate Share Trust

This sort of trust is a trust named as a beneficiary of an IRA that, according to the stated terms, will separate into distinct shares for different beneficiaries upon the death of the Grantor.

2503(c) Trust

This is a minor’s trust to hold assets until the child reaches 21 years old. The trustee can use the trust assets to pay such things as college expenses for the child. The trust can also convert to a Crummey trust once the child turns 21.

Bypass Trust

Much more common when the estate tax exemption was lower, this sort of trust bypasses placing assets into the estate of the second-to-die spouse – instead they just receive the income (and potentially some principal) and the assets pass to the Grantor’s intended children when the second-to-die spouse passes away. This method allows the decedent spouse’s estate planning desires to control for a long time after they pass away, especially important if the surviving spouse remarries or gets a different idea about wealth transfer to children – they only have the power to distribute the assets they actually own at that point.

Qualified Personal Residence Trust

A QPRT holds the personal residence, which is typically a person’s largest single financial asset and one that can be greatly appreciating in value.

Irrevocable Life Insurance Trust

An ILIT is a trust funded by life insurance policies and proceeds. An ILIT potentially has gift, estate, and GST tax consequences. Careful attention must be paid to ownership rules and payment of premiums.

Second to Die Life Insurance Trust

A version of an ILIT, this holds a survivorship policy for you and your spouse.

Qualified Terminable Interest Property Trust

QTIPs are used most often in blended families that have children from prior marriages. The QTIP provides flexibility for the Grantor to look after both the current spouse, and children from a prior marriage in a tax advantaged way.

                                                             

Charitable Remainder Annuity Trust

CRATs provide a fixed income stream during life, and upon death of the Grantor the trust assets remaining pass to the charity and escape the Grantor’s estate.

Charitable Remainder Unitrust 

The difference between the CRAT and the CRUT is that with the CRUT the income is variable since the principal is revalued annually.

Charitable Lead Trust                  

The CLT donates trust income to charities (the “lead”) and then after a period of time has elapsed, the remainder of the trust goes to the Grantor’s intended beneficiaries.

                         

Sprinkle Trust        

Also less popularly called a Spray Trust where the trustee is given broad discretion to distribute trust assets to beneficiaries as their needs arise or fluctuate. This is much more flexible than other arrangements that are rigidly tied to certain dates or completion of certain requirements.

                       

Qualified S Corporation Trusts 

QSSTs have a lot of specific rules to qualify. Failure to properly file timely elections jeopardizes the S status, and including a disqualified shareholder leads to losing the S status which creates the dual taxation problem.    

Grandchildren’s Trusts   

These contemplate GST tax consequences because of the age difference. But the annual exclusion and lifetime credit provide some flexibility in funding these trusts initially.

                       

Grantor Retained Unitrust

The GRUT provides a variable income stream that changes with the annual valuation of the principal. When the GRUT ends the trust assets remaining are transferred to the Grantor’s intended beneficiaries.

Grantor Retained Annuity Trust

The GRAT is best utilized when the expected return on trust assets is likely to exceed the 7520 rate and the Grantor is in relatively good health, likely to survive the term of the trust.

§070: Zeroed out trusts

A casual conversation of tax planned trusts is not without the related historical tensions that tax lawyers (and their clients) have had with the IRS, and Congress intervening to term some estate planning techniques “abusive” as they try to close the loopholes from year to year. One such loophole is the zeroed out GRAT made most-popular by the Walton family (of Wal Mart) and a casino billionaire (of Las Vegas.)

The zeroed out concept comes from the world of Grantor Retained Annuity Trusts (“GRATs”) when the annuity is leveraged to return a value to the Grantor equivalent to the value of the property transferred into the GRAT.

There are hazards though, especially if the Grantor dies before the close of the term; the trust property fails to produce enough income to pay the annuity; or the trust assets don’t outperform the 7520 rate. These are hazards in addition to the obvious of giving up all control over trust assets since the GRAT is irrevocable and cannot be later amended.

§071: Supplemental Needs Trust

Put most essentially, SNTs provide for supplemental and extra care over and above what the government provides.

The SNT is a specialized vehicle required specialized drafting of the trust document by a lawyer – a spendthrift trust or other sorts of trusts will not accidentally do the same thing a SNT will, so it is inappropriate to try and use another trust when a SNT is what is needed.

SNTs are essential for people whose eligibility for means-tested programs (such as SSI and Medicaid) would be jeopardized by receiving even a small inheritance. SNTs are also important for people living with disabilities to supplement other public benefits they are receiving.

The benefit of SNTs is that they allow a person to retain eligibility for public benefits, while also having a pool of assets that can be utilized to improve the quality of their life. An SNT is about quality of life.

Shielding personal injury settlements

SNTs commonly come up in the personal injury arena where a cash settlement will jeopardize benefits, but will not be enough money to actually cover the medical and other living expenses.

Not counted assets

Funds dropped into SNTs are not considered “counted assets” in the same way that cash in their hand is. Since most SNTs are irrevocable, once the money goes in it is not coming back out – so there is no incident of ownership.

Importance of trustee

However the trustee needs to keep careful records and avoid making any disbursements that will jeopardize the beneficiary’s eligibility for benefits. An individual can serve as trustee or a bank’s trust department can.

First party

A SNT funded with first party funds have money coming from the person attempting to remain eligible for means-tested programs – this is their money, so first party funding is also called self-settled. This money is subject to Medicaid payback – any money remaining in the SNT upon death will pay the State back for any Medicaid money spent on their behalf.

Third party

A SNT funded by other people than that person have third party funds. Third party funds are not subject to Medicaid payback. These are typically funded by close family members such as parents or siblings.

Basic support expenses

Basic support includes such things as food and housing. This basic support affects SSI through ISM and PMV.

Supplemental needs

Supplementary needs cover additional things which will typically not affect SSI. A nonexhaustive list of such things covered include: Health and dental treatment and equipment for which there are not funds otherwise available; rehabilitative and occupational therapy services; medical procedures, even though not medically necessary or lifesaving; medical insurance premiums; supplemental nursing care; supplemental dietary needs; eyeglasses; travel; entertainment; companionship; private case management; cultural experiences; expenses associated with bringing relatives or friends to visit with the beneficiary; vacations; movies; telephone service; television and cable equipment and services; radios; stereos; training and education programs; reading and educational materials; and more.

Even with a SNT in place, there are impacts on SSI and Medicaid.

SNT buying a house

There are likely to be impacts on your benefits under the (“PMV”) Presumed Maximum Value rule by the SSA with respect to (“ISM”) In-kind Support & Maintenance (shelter) received in the new house. The month the house is purchased is deemed to result in that ISM, but it is capped by the PMV. If the trust purchases outright with the trust corpus then you only get hit with the PMV that one month. But if there is a mortgage you get the PMV reduction in that first month and every month the trust makes a monthly mortgage payment. Depending on any reductions you might have already on current ISM in your living situation, you might be looking at a further reduction from that amount up to the PMV amount – but in exchange you would be in your own house.

SNTs can create numerous issues that require careful management by trustee, frequent legal advice, and analysis to ensure that the SNT operates as the Settlor intended.

§072: Other trust scenarios for minors, incapacitated people, and elders

Qualified Income Trust   

Also called a “Miller Trust” this relates to Medicaid eligibility. The trust agreement must be irrevocable; provide that the State of Texas will receive any amount remaining in the trust upon the death of the Medicaid applicant; and designate precisely which sources of income will be deposited into this trust each month.

 

142 Trust

This sort of trust arises when there is a minor or incapacitated person that is due to receive funds in a lawsuit. The court that creates the trust retains continuing jurisdiction and supervisory power over the trust – including the power to construe, amend, revoke, modify, or terminate the trust as needed.

Management Trust

A proper court exercising probate jurisdiction may enter an order that creates a trust for the management of the estate of an alleged incapacitated person who does not have a guardian if the court, after a hearing, finds that: (1) the person is an incapacitated person; and (2) the creation of the trust is in the incapacitated person's best interests.

 

This concludes ARTICLE III.

Thank you for reading ARTICLE III in Frye, Oaks, Benavidez & O'Neil, PLLC’s Information Headquarters.

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