Report Part 17 (Wed. 1/16 Q&A)
As we have done in January for the last eleven years, and again with the
permission of the University of Miami School of Law Center for Continuing
Legal Education, we will be posting daily Reports to this list containing
highlights of the proceedings of the 42nd Annual Philip E. Heckerling
Institute on Estate Planning that is being held January 14-18, 2008 at the
Orlando World Center Marriott Resort and Convention Center in Orlando,
Florida, a new venue for the Institute starting in 2007. A complete listing
of the proceedings will be published here and is also available on the
Institute's Web site at http://www.law.miami.edu/heckerling.
We also will be posting the full text of each of these Reports on the ABA
RPPT Section's Web site, as we have since the 2000 Institute. Those Reports
can be found at URL http://www.abanet.org/rppt/meetings_cle/heckerling. In
addition, each Report can also be accessed at any time from the ABA-PTL
Discussion List's Web-based Archive at URL
http://mail.abanet.org/archives/aba-ptl.html.
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This Report covers the always popular Question and Answer session that was
held on Wednesday morning and featured presenters Dennis Belcher, Carol
Harrington and Prof. Jeff Pennell. The next Report will pick up on various
missing reports and on some of the Friday morning sessions.
For those of you who missed picking up a set of the Screen Shots that were
done by Mr. Hodges, Appendix E, during the Technology Special Sessions on
Wednesday and Thursday afternoons (these did not make it into the
materials), you should contact Chad Hill at the Institute at 305-284-4762
or "Hill Chad" and he will see to it that a set is
sent to you.
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Question and Answer Session
Wednesday morning, January 16, 2008
Presenters: Dennis Belcher, Carol Harrington and Prof. Jeff Pennell
Reporter: Bruce Stone
Carol started out the session by stating the panel's answers to the
questions had been determined on a more likely than not basis, with
laughter from the audience.
Jeff discussed some additional materials that had not been discussed during
the Monday afternoon session, starting with the Matter of Martin B case, a
2007 New York Surrogate's Court decision determining whether a posthumously
conceived child was a descendant of the child's deceased genetic father for
purposes of inter vivos trusts which had been created by an ancestor of the
deceased genetic father prior to the child's conception. The deceased
father had deposited a semen sample at a laboratory after learning he had a
serious illness. The court ruled that the posthumously conceived child was
a descendant of the deceased genetic father for all purposes, and because
the trust instruments were silent, the child and the child's issue were
entitled to the same rights under the trusts as any other natural child.
Jeff referred to a New Hampshire case too new for inclusion in the course
materials, Khabbaz v. Commissioner, 930 A.2d 1180, where the question was
whether a child conceived after her father's death via artificial
insemination was eligible to inherit from her father as his surviving issue
under New Hampshire intestacy law. In this case too, the genetic father was
diagnosed with a terminal illness and deposited semen with a sperm bank so
that his wife could conceive a child. The New Hampshire Supreme Court
ruled that the child was not an heir for purposes of intestacy. Until this
case, the cases had ruled in favor of the rights to take benefits (in
whatever context) of posthumously conceived children.
Jeff said that the most challenging aspect is not whether a posthumously
conceived child should take from the child's genetic parents, but whether
such a child should take benefits from plans created by persons other than
the genetic parents. Would you give your son in law or daughter in law the
right to add beneficiaries to your own estate planning far into the future,
after your child to whom they were married has died? Jeff believes that
most people with respect to their own estate planning would answer this
question in the negative. Jeff cautioned that we should address these
issues in documents that we draft for our clients.
Dennis reviewed developments in the patenting of tax strategy
techniques. He discussed the "SOGRAT" patent involving the transfer of
nonqualified stock options to a GRAT. Dr. John Rowe (the past chair of
Aetna) had transferred stock options to a GRAT, made SEC filings as
required, and was then sued for patent infringement. After a year and a
half of litigation, the case was settled. The settlement terms are
confidential, but the consent decree in the case recognizes the validity of
the patent.
A House committee held a hearing in 2006, where the Commissioner of
Internal Revenue, someone from the tax patent office, a tax professor, an
intellectual property law professor, and a practitioner had
testified. (Reporter's note: although Dennis did not say so, the reporter
believes this was the hearing where Dennis testified.) There have been
three bills filed since then. In 2007, Senate Bill 2369 was introduced and
has passed House but not the Senate, and would prohibit patenting tax
strategies. House Bill 2365 takes a different approach, and would give
immunity to practitioners. There is lobbying against this legislation
because of a concern by some that the bills are too broad. Dennis noted
that Ralph Lerner in his Heckerling presentation this week had mentioned
obtaining deductions for gifts of factional interests in art, and Dennis
warned that there is a pending patent dealing with this. Patents can be
obtained for very obvious things.
In September of 2007 the IRS proposed regulations which would require
individuals who pay a fee to use a tax patent to report the
transaction. The person who received the patent fee would also have
reporting requirements. There are approximately 50 tax strategy patents
outstanding now, and another 80 or so are pending. A tax force comprised
of members from the ABA RPPT and Tax Sections, ACTEC, and the American
Bankers Association is keeping track of these patents. The ABA Tax Section
has a good website where you can find a list of these patents. Dennis
warned everyone to be very careful.
Jeff then discussed several cases involving in terrorem clauses, all from
California (beginning on page 364 of the materials). One case involved an
interesting and unusual clause which in essence said that if any one of
three particular children brought a contest, all three of those children
(even those not participating in the contest) would be disinherited. The
court said that even if that seems unfair or illogical, that's not the
standard of validity under California law, and the in terrorem provision
was ok. The majority trend is contrary to California law. Jeff noted that
California has a safe harbor in which a party can first ask the court if a
particular proceeding would be a contest that would trigger an in terrorem
clause. Most states do not have such a safe harbor. In most states, in
terrorem clauses are not enforceable unless the action is vexatious or in
bad faith.
The panel then turned to the questions which had been submitted by
registrants at the conference.
Carol answered a question about section 67(e): the 2% floor applies to the
adjusted gross income of a trust.
Dennis then reported that the panel had just been informed by Ron Aucutt
that the Supreme Court today had affirmed the Second Circuit in
Rudkin/Knight by a 9 to 0 decision. So the next question will be what will
happen to the proposed regulations. Dennis said that for returns due in
April of this year (2008), we will need to read this opinion carefully and
comply with it at least for investment advisory fees, which is all this
opinion deals with.
Carol answered a question about split gift elections. They can be made
after the due date of the return as long as no deficiency notice has been
received. Neither spouse can have filed a return already. If both spouses
are late in filing a return, it's ok to make the split gift election at any
time up until a deficiency notice is issued.
Dennis answered another question by affirming that a grantor can lease a
residence at the end of the QPRT term for a seasonal interest, such as six
months.
Dennis was asked if he is recommending taxable gifts now instead of waiting
to see if the gift tax rate is reduced. Dennis replied that he has clients
who are paying gift tax now. They are getting older, their health is
decreasing, and they are worried about the three-year rule that would
otherwise pull gift tax paid back into the gross estate. In addition,
clients want to see the current enjoyment of gifts to their
beneficiaries. Furthermore, we are in a declining economy and clients
might want to make gifts at low values. This is an important time to be
monitoring GRATs, or assets that could be given away or planned for.
Dennis also noted that if we have an S corporation with retained C
corporation earnings from periods prior to conversion to S status, we
should be asking how likely is it that the 15% dividend rate will remain in
effect? Perhaps clients should be declaring dividends now to get a 15% tax
rate in 2008.
Jeff spoke about issues involving pecuniary marital and charitable
formulas. If the fiduciary has pick and choose discretion in funding the
pecuniary amount and chooses to distribute a portion or even the entirety
of an IRD item to fund the amount, does that trigger and accelerate
income? Jeff answered in the affirmative: the distribution is a section
691(a)(2) acceleration event, and triggers so-called "Kenan"
gain. Contrast this situation to one where there are two named
beneficiaries of an IRA, with one beneficiary entitled to $100,000, and the
other entitled to the balance of the IRA. Distribution of the $100,000 to
the first beneficiary does not trigger or accelerate income.
Dennis suggested using IRD items for the payment of charitable pledges at
death, but not for pecuniary bequests. Jeff added that planners should
also use fractional formula bequests instead of pecuniary formulas for
large IRD items. Carol pointed out that you can also direct a pecuniary
bequest to be funded with an IRD item which avoids acceleration of income.
Carol handled a question which presupposes the existence of a discretionary
trust for a granddaughter, to which GST exemption had been allocated to
make the trust exempt. The distribution standards are for health,
education, support, and maintenance, but the granddaughter has a
testamentary general power of appointment. Can the trustee create a new
trust that would eliminate the general power of appointment and last
through the maximum perpetuities period, without jeopardizing the exempt
status? Carol said first of all why would anyone create such a trust with
a general power of appointment, but if you needed the general power
initially for some tax reason, or because that is what the settlor wanted,
then you probably cannot get out of this and do away with the general power
under state law. But can you do so under the GST statutes and
regulations? Carol said that the answer to this is unclear - there is no
authority. Most likely the new or revised trust could not run past lives
in being plus 21 years or the 90 year fixed term rule measured from
original trust date anyway. There are safe harbors in the regulations, but
nothing that deals with this. But remember that if you don't fit in a safe
harbor, you do not necessarily fail: you just don't fit in the safe harbor.
Carol took a question where a father creates an irrevocable life insurance
trust for his issue, with sprinkling distribution provisions, and then
wants to create a new life insurance trust omitting one of the
children. Can the trustee transfer the life insurance policy from one
trust to another trust without tax consequences? Carol said that first of
all, we must be wary of the fiduciary obligations and limitations. That
is, can the trustee even do it under trust law? If it's just a sale,
probably yes, but is the sale price fair? [Reporter's note: in some
states, if the same person is trustee of both trusts, conflict of interest
rules may be complicate or prohibit the transaction.] But under federal
tax law, it's ok to make the transfer, assuming that a grantor trust is the
transferee of the policy.
Jeff said to look at trust decanting powers as if they were nongeneral
powers of appointment. Giving the trustee of a trust the power to transfer
to another trust omitting one of the children who is a beneficiary of the
first trust is no different than holding a limited power of
appointment. Jeff referred to the article he and Jonathan Blattmachr wrote
in Trust and Estates magazine a number of years ago, which examined whether
having the ability to take away a general power of appointment would be tax
neutral. They felt sufficiently uncomfortable about this that they came up
with the Delaware tax trap as an alternative planning technique. Carol
said that because of the 2007 revenue ruling, there are no transfer for
value issues, but noted that the ruling is only for income tax purposes.
Dennis dealt with a question involving different interests in partnerships
and transferring those interests. Dennis summarized prior planning
techniques (preferred stock freezes) that were used before the enactment of
Chapter 14. Section 2701 causes zero value to be assigned to the retained
preferred stock interest, so that all value remains in the common stock
when it is transferred. Therefore, anytime you have two different equity
classes, you need to consider section 2701.
What if a manager wishes to gift or transfer to a GRAT the manager's
carried interest? The general partnership interest is owned by the fund
manager, which gets a management fee plus also a carried interest. If the
investment fund outperforms a specified benchmark, the carried interest
held by the general partner gets (for example) 20% of the so-called excess
profits. When you plan for a transfer of the general partner's carried
interest, what is its value? The true value is unknown up front but could
become huge in the future. It is a good asset to sell to a grantor trust
on an installment basis. The issues are valuation and whether section 2701
applies. So if section 2701 would apply, you must transfer a vertical
slice of the general partner's interest so that the transfer is of a pro
rata interest.
There was another question involving an investment partnership with
separate interests, one of which vests right away but the other interest is
subject to vesting over time (such as continuing compliance with noncompete
agreements, etc.). The taxpayer wants to sell the vested interest to a
trust. Dennis said that you must go through the specifics and make sure
that section 2701 does not apply. When you are creating different
interests in entities such as LLCs, you can be very creative but you must
be very careful of chapter 14.
Jeff answered a question about the Jelke case. In addition to the discount
for built in gains, can there also be a minority interest discount? Jeff
said yes, you can get both.
Carol took several questions dealing with tax returns. If there is a
transfer without a valuation appraisal, is there adequate disclosure if all
you have is a spreadsheet showing only your calculations and amounts of
discounts but not explaining them? Carol said the answer to this is not
clear. You should give a detailed description of the valuation methods
used, including a description of discounts. If you do not, you are
leaving an opportunity open for the IRS to argue there is not adequate
disclosure. But it is possible to meet the adequate disclosure
requirements without having an appraisal.
What if there is a transfer to a wholly charitable trust and no other
taxable gifts? Must such a gift be reported? Carol said that you are
always required to report gifts of over $12,000 whether tax is owed or
not. Of course, many people do not report such gifts if they are fully
deductible and thus no tax is owed and no unified credit is used. But what
happens if you don't file a return in such a case? Nothing happens if the
transfer actually qualifies for full deductibility, but you don't have a
statute of limitations running on the transfer. We advisers should not
counsel our clients not to file, but we should tell them what the
requirements and consequences of filing and not filing are.
Can a claim for refund of estate tax be filed without opening the entire
estate up to audit if an asset was overvalued? Carol assumed either that
there had been an audit and a closing letter received, or that there was no
audit and a closing letter had been received. Later on, you realize that a
particular asset was overvalued. If the statute of limitations on the
estate tax return is still open for some relatively long period of time,
such as a year, the IRS can easily open an audit proceeding into all
matters concerning that estate. All the closing letter does is to allow
the fiduciary to make distributions without fear of personal
liability. But what if the statute is about to expire in one week? If the
refund claim is filed within the deadline, it's ok, even if it is too late
for practical purposes for the IRS to reopen the return. But even if the
IRS cannot reopen the return itself, it can raise unrelated issues when
dealing with the claim for refund itself - but you wouldn't be at risk for
any more than the amount of the refund itself. Dennis reminded the
audience that there is also transferee liability. Carol agreed but said
that if you're careful you can eliminate that if you don't make any
distributions until the three year statute on the return has run. There is
transferee liability only if a distribution is made while the statutory
period is still open. If only small distributions are made during the
statutory period, transferee liability is limited to the amount that was
actually distributed. As a general observation, Carol said you should
consider getting a new appraiser rather than dealing with bad appraiser
from the first time around.
Can a new preparer (one who has not worked for the client previously) file
a gift tax return for that client ignoring prior transfers from prior
years? Carol said no. Preparers are always required to file in good
faith, which requires you to take into account prior transfers. Dennis
admonished that we should never let our clients' problems become our
problems. It's only money, and even more, it's not our money.
Dennis discussed a question concerning vacation property owned by a husband
and wife as tenants by the entirety. The parents add their two children on
the title as joint tenants with right of survivorship, so there are now
four owners. One parent dies. What are the estate tax
consequences? Dennis answered: they are not good. There is a taxable gift
at time the deed is delivered. When the first parent dies, what is
includible in that parent's gross estate is measured under section
2040. The test is based on consideration furnished by that parent, so 50%
of the value is includible. But there are fractional minority interest
discounts. You should get a marital deduction for the 8.33% increase in
the surviving spouse's interest (because the interest of the surviving
spouse increases from one-fourth to one-third). Jeff said that on the
death of the surviving spouse, 100% of the property value will be included
in the surviving spouse's gross estate, minus any consideration furnished
by the other owners, and consideration acquired by gift doesn't count.
Jeff said that in his opinion, tenancy in common is better than joint
ownership even between spouses, in large part because of the valuation
discounts as tenants in common.
Jeff took a question which asked whether you can merge a nongrantor trust
into a grantor trust. Are all assets now subject to the grantor trust
rules? Jeff said probably not. What you would wind up with would be a
partial grantor trust and a partial nongrantor trust. This will create
complicated administrative issues.
Carol took a question which supposes that a personal representative has
multiple parcels of real estate appraised by two different appraisers for
each parcel. The property values are reported at the higher of the two
appraised values. Then a property is sold at a much higher value. Carol
said that if the return was filed in good faith, there is no duty to go
back and amend or supplement the return. Actually you only supplement an
estate tax return, not amend it. And there would be no duty to disclose a
subsequent sale absent an inquiry. But if there is an inquiry asking
whether a sale has occurred, it must be disclosed.
Carol mused about why is the sale price so much higher? Was the appraisal
wrong? Subsequent changes in value after the valuation date are
immaterial. But was the appraisal wrong?
Dennis went over the course materials that deal with material participation
by trustees for Section 469 purposes. Suppose that there is a subchapter S
trust which holds investments treated as a passive activity. Under Section
469 losses are suspended until a taxable disposition occurs. Death is not
a taxable disposition, and so the losses are added to basis. Dennis noted
that Byrle Abbin covers this in his book.
Jeff referred to John Porter's presentation, and the possibility of being
left with phantom value as a result of distribution of minority interests
to fund marital or charitable gifts. Assume that the IRS succeeds in
increasing value of a family limited partnership. Then you distribute the
interests to the surviving spouse. You are creating a possibility of
underfunding the marital bequest because of the discount arguments that
might apply.
Carol took two GST tax questions. If a grandfather adopts a grandchild for
the sole purpose of avoiding the GST tax, the adoption will not change the
status of the grandchild as a skip person. Adoption does not trump the
family generation assignment rules. There are relationships by blood,
marriage, and adoption. In general, under the rules, if you are assigned
to two different generation assignments, you will be assigned to the
younger generation level. So in this case the child would be treated as a
child under adoption rules, but as a grandchild under the blood
rules. Next suppose that the grandfather adopts an unrelated person who is
more than 37.5 years younger than the grandfather. The age assignment
rules do not apply here at all if you are assigned to a generation level
under the family rules, and so the adopted person is a child under the
adoption rules. If the grandfather adopts grandchild because the child (who
is the parent) abandons the grandchild, the adopted grandchild will be
treated as a child for generation assignment purposes if adopted under age
18. If a client exercises a general power of appointment under a
grandfathered GST exempt trust, Carol recommended reporting the transfer
and including a copy of the trust and explaining that it is grandfathered
in order to preserve grandfathering in the future, even if this is not
required.
Dennis dealt with a question involving making additions to a testamentary
charitable remainder unitrust. The IRS sample form does prohibit making
additions to the unitrust. But of course a prohibition of additions is not
required for unitrusts. Dennis recommended dealing with this one way or
the other when drafting the trust. But what if you want to add to a
charitable remainder unitrust and the document prohibits additions? What
if everyone signs off approving the addition? Dennis recommended simply
creating a new CRUT instead of getting into a fight over the terms of the
document, unless you have separate representation and agreements binding on
all persons, with all parties in interest represented. Otherwise the lawyer
could be left holding the bag.
Jeff dealt with a question about interested witnesses to wills. Suppose
that a sibling is not a direct beneficiary under the will, but is a
beneficiary of a life insurance policy, and the will contains tax
apportionment provisions waiving the right of reimbursement for estate tax
from life insurance beneficiaries. Is the sibling an indirect beneficiary
under the will? Jeff answered yes most likely. There is very slender
authority for the right of reimbursement being waived via will as being
tantamount to creating a beneficial interest under the will. So if the
sibling is an indirect beneficiary because of the tax clause, is the
sibling an interested witness that affects execution of the will? Jeff
noted that under the Uniform Probate Code, we no longer care about
interested witnesses.
Carol took a question where a donor has prefunded a credit card, given it
to a donee, and told the donee that the donee could only use the card for
medical expenses. Does this qualify as a nontaxable payment of medical
expenses? Carol said probably not. This doesn't work if you make a
transfer into an irrevocable trust which only permits distributions for
medical purposes, because the transfer into the trust itself is the
problem. So if you use a trust, you should set up the trust so that it
becomes a completed gift only when the payments are made. The same thing
happens when funds transferred to a GST trust which only permits
distributions for medical and educational purposes, so you have to do
something to avoid creating a direct skip when you transfer funds into the
trust.
Dennis announced that "the pelican is at the spa." He then read a question
which supposes there is a decedent who was a resident of a US possession
and therefore was a US citizen by virtue of that residency. If the
surviving spouse is also such a resident and citizen for the same reasons,
can the surviving spouse inherit directly and avoid the QDOT rules, obtain
the benefit of the US estate tax marital deduction, and then avoid US
estate tax when the surviving spouse dies while a resident of the US
possession? The questioner said that he or she was reluctant to ask the
question because it might alert Congress to a loophole, and asked Dennis to
answer in code if the answer is yes. Dennis said that the surviving spouse
would still be subject to estate tax under the US possession's laws, but
that the pelican is at the spa. With laughter, the question and answer
session came to an end.
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THE REPORTERS
Our on-site local reporters who are present in Orlando this year are Gene
Zuspann Esq. of Zuspann & Zuspann in Denver, Colorado; Joanne Hindel Esq.
of Fifth Third Bank in Cleveland, Ohio; Jason Havens Esq. of Howard, Mobley
& Havens PLLC in Florida and Tennessee; Kimon Karas Esq. of McCarthy,
Lebit, Crystal and Liffman Co., LPA in Cleveland, Ohio; Bruce Stone Esq. of
Goldman, Felcoski & Stone, PA in Coral Gables, Florida; Craig Dreyer Esq.
of McDonald Hopkins LLC in Cleveland, Ohio; Carol Sobczak Esq. of The Law
Offices of Carol A. Sobczak in St. Helena, California; Ronda Martinez Esq.
of Fifth Third Bank in Southfield, Michigan; and Mike Stiff Esq. of
Hutchins & Stiff LLC in Denver, Colorado. The editor again this year will
be Joseph G. Hodges Jr. Esq, a solo practitioner in Denver, Colorado, who
also is the Chief Moderator of the ABA-PTL List.
_________________________________________
GENERAL INFORMATION ABOUT INSTITUTE:
Inquiries/Registration:
Philip E. Heckerling Institute on Estate Planning
University of Miami School of Law
Center for Continuing Legal Education
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
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8701 World Center Drive
Orlando, FL 32821
Telephone (407) 239-4200, FAX (407) 238-8777
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