|
|
| A
complete listing of the proceedings and speakers is
available on the
Institute's Web site |
Each report can also be accessed at
any time from the ABA-PTL Discussion List's Web-based
Archive |
| The
ABA-PTL List is an outstanding resource for Probate
and Trust Lawyers. Join
Today |
 2004
Index (back)
Report 5
Tuesday, January 6 (Continued)
Reporter: Carol Warnick Esq.
2:45 - 3:30 p.m.
Taming the Tiger: Designing, Implementing and Operating
the FLP to avoid a Successful Section 2036 Attack.
T. Randall Grove
We should select with care the clients with whom we use entity
planning. Many problems arise when entity planning is used
where it does not really fit very well.
We should all ask these types of questions:
Is my client the right kind of client for entity planning?
What is the best strategy for this situation?
What is the right design for the overall entity plan?
What is the right guidance and assistance for the client
with respect to the operation and creation of the entity?
Look at full spectrum in order to counter the substance oriented
arguments.
He believes that the Service is bringing up a sham argument
couched as a 2036 argument.
Reminder: There is NOT a lot of certainty in this area...still
a facts and circumstances issue.
2036 (a)(1) refers to a retained interest argument.
2036 (a)(2) refers to a transfer and then control over who
receives the benefits.
Retention of Benefit by Donor.
First stage of cases looked at commingling, disproportional
distributions, continuation of pre-entity benefit, etc. (Schauerhamer,
Reichart, Harper.)
Second stage of cases focus on the entity having the characteristics
of a testamentary device. (Harper, Thompson, Kimbell,
Strangi II.) Courts discuss the purpose of 2036 to include
transfers that are testamentary in nature. There is no practical
effect of the entity until transferor's death. (Factors include
a transfer of a majority of decedent's assets to the entity,
minimal change in economic benefit of the assets from prior
to the creation of the entity, donor advanced in age and has
serious health conditions.).
Third stage cases such as Stone. Need non tax reasons
for setting up the arrangement to be able to overcome the
implied agreement issues.
Again, ask the question. Is my client the right client for
entity planning. Should include both analyzing the client
and listening to the client.
Will my client be able to make a successful transition from
the sole proprietor mind set to an entity mind set?
This is also important to the client with regard to the long
term satisfaction of the client. (will they be moaning in
the future about the complicated nature of the plan?) What
kind of articles will the client be sending you from the Wall
Street Journal ten years from now?
What is the client's willingness to treat the entity as an
on-going business with an unrelated third party (not family
members). If they can do that, they will probably make the
right decisions with the entity as they go along.
What about client's other relationships, i.e. with the CPA,
etc. Will they help the client deal with the complexities?
What is the relationship with at least one of the children
who may have an easier time understanding the sophistication
required?
Asset transfers are a huge issue. Will client pay to make
sure that the attorney sweats the details on implementation?
Have in writing what is attorney's role and what is the client's
role.
Ethics rule 1.4 Communication with client. We must reasonably
consult with the client to permit the client to make informed
decisions. We need to communicate the material risks and the
reasonable alternatives, as well as the risks of reasonable
alternatives.
When discuss risks and disadvantages, discuss the fact that
to do entity planning you are giving up other types of planning.
Be sure you have a good engagement letter.
Explain the opportunities and risks to the client in writing.
Do not be viewed as the guarantor of the client's expectations
without shaping those expectations.
What is the simplest way to accomplish the client's objectives.
Will divided ownership in the property accomplish the same
thing?
Balance low to high complexity versus high to low tax benefit.
Identify alternatives for client.
DESIGN ISSUES key issues
Look at the situation and build your design around it. Stone
is a good example. The economics in Stone are a lot
like the economics in Strangi, but there were other
good facts in Stone that could be emphasized, i.e.
negotiations among the parties, the kid's being involved in
the terms of the partnership agreement, etc.
Then look to shore up any weaknesses.
Avoiding the implied agreement. There were 3 issues in Strangi
II that sunk their ship.
1. Did not pay rent currently. Whenever personal use assets
go into an entity, must have a high level of documentation
and compliance with agreements. (In Strangi, no rent
for use of personal residence was paid concurrently.)
2. Not retaining sufficient assets for use of donor. Only
transfer assets that fit with the purpose of the entity. Have
non tax reasons for that asset going in.
3. Not sufficient changes from after the entity was set up.
If taxpayer is retaining a major part of the benefit, show
significant changes in investments, how assets are invested,
control, benefit, etc. Consider establishing an irrevocable
trust like Byrum (helps for both 2036(a)(1) and 2036(a)(2)
matters).
Issue of transfer: Whether any gratuitous transfer is needed
or if you get into (a)(1) simply by funding the entity?
At this point, look at a "full and adequate consideration"
design. He thinks that is the safest right now.
He provides in the outline eight design guidelines which
will keep you on the right path both with implied agreement
issues and full and adequate consideration issues.
1. Clarify the specific business (nontax) purpose.
2. Negotiate the decisions regarding design, implementation,
and operation of entity between the donor and other parties.
3. Develop a business plan and pool the property and services
from each of the partners.
4. Transfer to the entity only those asset6s that are appropriate
to achieve the economic objectives and to satisfy other nontax
goals. The donor should keep sufficient assets to comfortably
provide for his/her personal needs and desires, including
gifting.
5. Implement and operate the entity in a business-like manner
as a joint enterprise for profit.
6. Utilize an active investment approach to accomplish the
economic objectives of the entity.
7. Make significant changes in the benefit to be received
from assets and in the management of assets (in order to avoid
"implied agreement").
8. Continue to operate the entity after the death of the
donor and invest assets according to economic objectives (rather
than primarily using assets to pay estate taxes or liquidating
the entity.)
There are two major design pitfalls dealing with 2036(a)(2).
They are (1) joint action and (2) constraints on right to
designate
1. Joint action - occurs only in situation where taxpayer
does not already have the authority to make those kinds of
decisions. In Byrum, joint action did not come up.
There was an independent trustee utilized. Mr. Byrum could
flood the trust with dividends because he supposedly could
control the directors, but did not have control to get the
dividends all the way to the beneficiaries.
Mr. Gulig in Strangi had two fiduciary roles, manager
of the entity and attorney in fact for Mr. Strangi under the
power of attorney. The attorney in fact role helped create
the joint action problem. Court did not believe he would exercise
fiduciary duties to other shareholders if it conflicted with
his fiduciary duties as attorney in fact for Mr. Strangi.
2. Constraints on right to designate, not just fiduciary
constraints. But Byrum is a bit more involved than
that. Mr. Byrum had tremendous management control. He could
replace independent trustee, etc. But also had to deal with
certain "realities of corporate life"(words used
by opinion).
He thinks that utilizing an irrevocable trust with an independent
trustee, as in Byrum, is very important.
Have an organization meeting that involves the key advisors.
The appendix includes a checklist of various issues to address
at that meeting.
Do not gift too much. (Look at gifting checklist, also in
appendix.)
Key issues for annual review. (Exhibits 12 and 13 in appendix
go through summary of operation of entity.)
3:45 - 4:30 p.m.
Defined Value Clauses: How Much Do I Love Thee? This
Much No More, No Less.
A. Christopher Sega
Mr. Sega discussed that much of our clients' property is
not subject to easy valuation, therefore lawyers have come
up with two types of formula clauses, which he discusses at
length.
1. Price adjustment clause I'm giving you Black acre, but
if I'm wrong on value, you give part back to me or else pay
me more. The price adjustment formula adjusts the amount transferred
based upon the occurrence of a subsequent event (a "condition
subsequent.") The subsequent event is typically a valuation
redetermination. These formulas undo a portion of the gift
and either return this portion to the donor, or increase the
compensation paid to the transferor for this portion. These
clauses do not work because of the Procter case.
In Procter, the Fourth Circuit ruled on four articulated
public policy grounds.
1. If respected, the clause would inhibit efficient collection
of tax by discouraging audits. (A successful challenge would
not increase the amount of tax collected but would restore
the property to the donor.)
2. The effect of the condition would be to requir4e the court
to pass on a moot case. If the condition was valid and the
gift held taxable, the only result would be to defeat the
gift so that it would not be subject to tax. Thus the proceeding
would become one of seeking the court's "declaratory
judgment" that no gift occurred.
3. The provision should not be permitted to defeat a judgment
of the court..
4. Because the trust beneficiaries were not party to the
tax litigation between the donor and the Service, the beneficiaries
might later seek to enforce the gift after the tax litigation
concluded, even though the gift of the excess value was determined
to have never been made.
In his analysis, Procter ignores the fact that the
clause would return a portion of the transferred property
to the settlor's estate, where it would be subject to estate
tax. Furthermore, the Tax Court now has the authority to make
a declaratory judgment as to the value of the gift. Procter
also suffered from being an unsympathetic plaintiff.
Rev. Ruling 86-41 confirms that price adjustment clauses
do not work.
2. Defined value clauses I'm giving you $5 worth of Black
acre. It defines the amount transferred from the outset. Some
consider this formula as involving a "condition precedent"
or "condition concurrent." You cannot ignore the
defined value formula, because you need the formula to determine
the property transferred. Ignore the formula, and no property
changes hands. What the Service may later do is irrelevant.
A Tale of Two Technical Advices. TAM 86-11-004 (November
15, 1985) the Service upheld a defined value formula gift
and made no mention of Procter.
Fast forward to TAM 2002-45-053 (July 31, 2002). Service
declined to give the defined value formula effect.
But Service does sanction the use of formulas in certain
"Congressionally sanctioned" situations, i.e. marital
deduction formulas, QTIP formulas, GRATSs, CRTs, formula disclaimers,
etc.
We as practitioners use many non-congressionally sanctioned
formulas such as savings clauses.
Less aggressive taxpayers may wish to limit their formula
transfers to those types of gifts that Congress has "sanctioned".
How can we creatively use these safe harbors in our planning?
If the principal abuse perceived by the Service is the excess
value (either in kind or additional consideration) going back
to the donor, one might seek to avoid this result by transferring
the excess value to a third party (the "gift over").
This third party might be a tax-advantaged donee, such as
a charity, a marital deduction trust, a zeroed-out GRAT, or
an incomplete gift trust, so that there is little or no transfer
tax consequences to a revaluation.
He goes on to discuss at length the McCord case.
This case involved a formula with the excess (the "gift
over") going to a congressionally sanctioned beneficiary.
A majority of the Tax Court would have respected the defined
value clause it if had provided that the amounts allocated
to each donee were to be determined using "fair market
value of the gifted interest as finally determined for
Federal gift tax purposes." This language was absent
and the Tax Court found nothing in the formula or assignment
that the gifted interests allocated among the donees would
not be ascertained until the "final" determination
was made. It is significant that the majority opinion did
not mention Procter even though both parties briefed
it extensively.
Consider having "gift over" go to an incomplete
gift trust over which the donor retains a special power of
appointment. (Any amt that may be subject to tax goes to a
2nd tier donee, an incomplete trust.
Example: If $1M gift intended, but upon valuation is valued
at $2M, the first million still goes to the 1st tier trust
and second million goes to the incomplete gift trust. Also
discussed other potential "gift-over" donees such
as a marital deduction trust or a zeroed out GRAT, (more leverage
with the GRAT).
He also discussed that one common issue with the donor's
deciding to gift is the lack of a step-up in basis with gifting.
Caryln McCaffrey has previously discussed using a formula
to return a gift to the donor's estate in the event the donee's
income tax cost on a subsequent sale exceeds the donor's estate
tax savings. (He calls his a Hedge Formula.) This might occur
when low basis property is gifted, but fails to appreciate
or declines in value. In that event, the donor may have saved
estate taxes by having the property included in her estate
at the lower value, with a basis adjustment at death. The
donee could then dispose of the gift without incurring a capital
gain. He indicated that such a formula should have no 2036
issues. What about 2038? No, because appreciation (or lack
thereof) causes it to return to donor's estate. The donor
cannot control the appreciation.
Steps he suggests to take if using a defined value clause.
(More are discussed in the outline.)
1. Get a good appraisal up front. Do not do a quick and dirty
appraisal up front and then call in the big guns if you get
audited.
2. Know what the appraisal says before you make the gift.
3. Do not transfer all the donor's partnership interest
4. If using a hedge formula, make sure you have an independent
trustee...
5. If it has a trigger provision, make sure that you pull
it. Adjust the books based on the formula.
6. Report it as a dollar amount gift on the tax return, not
a percentage of partnership interests.
7. Engage in similar transactions with nonfamily members
8. Include in your agreement that anytime within the gift
tax statute of limitations, either party can request a third
party appraisal to revalue the gift.
9. If you do a "gift-over" transaction, have part
of the property go so that some tax will be paid, but do not
make it just a "sliver." That takes away the public
policy issue in Procter.
10. If doing a redemption by second tier donee, make sure
second tier donee does an appraisal to determine what they
got. Should be a separate appraisal.
4:30 - 5:15 p.m.
Funding Formulas Fail on Flexibility: Variations on
Traditional Marital/Credit Shelter Funding Techniques.
Barbara A. Sloan
Ms. Sloan described 2 types of clients
1. The client who, absent tax planning, would leave entire
estate to surviving spouse, outright. (sweetheart client).
This client seeks to build in flexibility with a disclaimer.
2. Type of client who, absent tax planning, would leave entire
estate to surviving spouse in trust. (all-in-trust client).
This client seeks to build in flexibility with a partial QTIP
election
In reality, most moderate to high net worth clients will
use formula credit shelter bequests rather than the above.
But then along comes EGTRRA and we do not know what to do.
But even with EGTRRA, the likelihood of repeal seems so low
and so far away, many practitioners have adopted a "wait
and see" approach.
However, we want to provide as much flexibility as possible,
and want to defer as many decisions to the death of first
spouse to die since we do not have all the answers now due
to the uncertainties of the tax code. Now is the time to consider
taking the new tax law more seriously. We not only have the
potential repeal of the estate tax, we have the possible advent
of carry-over basis issues, etc.
She presented several ideas to consider.
1. Consider capping the exemption at some predetermined amount.
The problem is that it does not increase flexibility, but
it does increase certainty. This is especially helpful in
jurisdictions where the state estate tax exemption amount
now does not track the federal estate tax exemption amount.
In doing this, be sure to consider where expenses should be
paid from.
2. Use disclaimers. They are trickier than they appear to
be, or else we would not continue to have cases on them. Especially
tricky is the acceptance of benefits issue. Be sure to give
a cash bequest to spouse so spouse will not be as apt to accept
benefits of what is supposed to be disclaimed. Also look at
successive disclaimers.
Remember, money in trust is not the same as money in hand.
3. Partial QTIPs. Provide a lot of flexibility...
4. Clayton (contingent income) trust - less well-known technique.
Named for the case which established its viability.
Starts as a trust for which a QTIP election could be make,
but nonQTIP-elected portion flows to a completely different
trust and does not even have to meet the requirements of the
QTIP trust. The 6th and 8th Circuits and the Tax Court have
all gone along, and now we even have a regulation. Reg. 20.2056(b)-7(d)(3).
.
She calls it a powerhouse technique. A Clayton trust can
include other family members as beneficiaries. She defines
it as follows:
"A Clayton trust is a trust which starts life as a qualified
trust for which a QTIP election could be made, but to the
extent that the executor does not make the QTIP election,
the non-elected portion flows to a separate trust which is
not required to have terms identical to the QTIP trust and
is not required to meet the definition of a QTIP trust."
In essence, it is a trust that can mutate from being a QTIPable
trust (one than can be QTIPed) into a completely different
trust that doesn't have to contain the requirements necessary
to qualify as a QTIP.
She discussed making the Clayton election, which is really
the absence of an affirmative QTIP election. It is not the
same as making a disclaimer from a QTIP. In a QTIP, the spousal
interest is a vested interest. In a Clayton trust, the spouses'
portion remains contingent until election is made.
This is not easy drafting. We are really drafting for a non-event,
i.e. the failure or refusal of the executor to make a QTIP
election within the applicable time frame. She discussed several
ways to draft such a clause.
One disadvantage of the nonmarital portion of Clayton trust
is that you can not take advantage of the previously taxed
property deduction as you can with a partial QTIP.
Another major unanswered question looming is whether the
surviving spouse, who is the sole executor of the estate,
will have adverse gift tax consequences in making the election.
She suggests that you should not allow the surviving spouse
to be the sole executor (have co-executors with the other
executor designated to make the Clayton decisions) or use
an independent executor to make those decisions and the QTIP
election.
She spent a lot of time dealing with the Clayton trust, and
her outline contains a good discussion of the main concept
as well as its variations.
__________________________________________
GENERAL INFORMATION ABOUT INSTITUTE:
Inquiries/Registration:
University of Miami School of Law
P.O. Box 248087
Coral Gables, FL 33124-8087
Telephone: 305-284-4762 / FAX: 305-284-6752
Web site: www.law.miami.edu/heckerling
E-mail: heckerling@law.miami.edu
===========================================
Headquarters Hotel - Fontainebleau Hilton
4441 Collins Avenue
Miami Beach, FL 33140
Telephone (305) 538-2000, FAX (305) 674-4607
==================================================
NOTICE: Although audio tapes of all of the substantive session
at the Miami Institute currently are only made available to
Institute
registrants for purchase, the entire proceeding of the Institute
are published annually by Lexis/Nexis. For further information,
go to
their Web site at http://www.lexisnexis.com/productsandservices.
The text of these proceedings is also available on CD ROM
from
Authority On-Demand by LexisNexis Matthew Bender. For further
information, contact your sales representative, or call (800)
833-
9844, or fax (518) 487-3584, or go to http://www.bender.com,
or write to Matthew Bender & Co., Inc., Attn: Order Fulfillment
Dept.,
1275 Broadway, Albany, NY 12204.
______________________________________________________
Brought to you by the ABA-PTL Discussion List Moderators
URL for ABA-PTL searchable Web-based Archives:
http://mail.abanet.org/archives/aba-ptl.html
|
