Report No. 8 (Wed. 1/16)
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 International Planning Update and Trusts as
Beneficiaries of Retirement Plan Assets special sessions from the Wednesday
sessions. The next Report will cover the balance of the Tuesday sessions
and more of the Wednesday sessions.
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Special Session 1-C - International Planning Update of Conflicting Estate
Tax, Income Tax and ERISA Laws
Wednesday, January 16, 2008
Presenters: Gideon Rothschild and Henry Christensen
Reporter: Joanne Hindel
Henry C. started the presentation with a review of a recent TAM that he has
been involved in: Technical Advice Memorandum 200733024: The taxation of
passive
foreign investment companies owned through discretionary foreign trusts.
He gave a brief background on passive foreign investment companies.
A "passive foreign investment company" is defined as any foreign
corporation if (1) 75% or more of the gross income of the corporation is
passive income, as defined in Section 954(c) for foreign personal holding
companies; or (2) at least 50% of the assets of the corporation are held
for the production of passive income. A passive foreign investment
company, unlike a controlled foreign corporation, can have any number of
shareholders, and not be controlled, directly or indirectly, by United
States shareholders. Like the rules for accumulation distributions from
trusts, the passive foreign investment company rules are not designed to
impute income for current taxation to United States shareholders, but
rather are designed to impose an interest charge when the items of income
are finally distributed to United States shareholders in a future year,
replicating, in relatively arbitrary terms, the result which would have
obtained had the income been distributed, or taxable, in the year earned by
the foreign investment company, but the tax not paid by the United States
shareholder until the future year.
He then gave a review of the facts involved in the TAM:
In this case, the donors, three cousins (two of whom were brothers) who
were nonresident aliens of the United States purchased from another cousin
his shares in a
series of closely held family companies which conducted active businesses.
The companies were 100% owned by the family, and the family shares were
subject to a
consortium agreement. When one shareholder announced that he wished to sell
his shares, all of the other shareholders had a right to purchase their
proportionate share, at an agreed upon price which was below market. One of
the three cousins elected to keep his portion of the purchased shares for
himself. The other two cousins elected to transfer their portion of the
purchased shares to a new trust which they created for the benefit of their
grandchildren in Bermuda. The shares were purchased in 1981, and were
transferred to the Bermuda trust in 1983, both well before the enactment of
the passive foreign investment company rules. Further, at the time of the
transfer in 1983, no potential beneficiary of the trust yet existed who was
a U.S. taxpayer. In 1997, the family sold the business, and the settlor
dissolved his holding company, distributing its assets ratably to trusts
for the benefit of his grandchildren then living, approximately one-half to
a foreign trust in 1997 and the balance to a United States trust in 1998.
Henry C. went through the issues presented in the TAM:
1. Was the holding company a passive foreign investment company?
Taxpayers took the position that the holding companies here (both the
original company formed by both settlors, and then the company formed in
1995 to hold the
shares allocable to the trust for taxpayers' benefit) should not be treated
as passive foreign investment companies, because they were created by
nonresident aliens of the
United States, there were initially no United States persons who were
shareholders or beneficiaries of the companies, and the statute was
intended by Congress to apply to United States investors who chose to
invest through foreign funds, rather than domestic funds, so as to defer
their income tax.
2. If the holding company was a passive foreign investment company,
was it reasonable to attribute the ownership of the passive foreign
investment company through the foreign trust to the United States
beneficiaries of the trust, based on some proportional or facts and
circumstances analysis?
In the context where the foreign holding company is owned by a
discretionary foreign trust, most commentators have taken the position that
it is not appropriate to
attribute ownership of the shares to the trust beneficiaries, as it is not
possible to determine their relative shareholdings. The National Office
allocated ownership of the shares of the holding company based upon Section
1298(a)(3), which provides that stock in a corporation owned directly or
indirectly by a trust shall be deemed owned proportionately by its
beneficiaries.
3. If it was, was it reasonable to attribute income arising out of
the passive foreign investment company event, when the holding company
owned by the trust was liquidated, in their deemed portion to the United
States beneficiaries, even though they did not, and still have not, receive
a distribution from the trust to enable them to pay any tax?
Attribution of ownership of a passive foreign investment company may lead
logically to imposition of tax, but should it always do so? In the TAM, the
National
Office interprets Section 1298(b)(5) of the Code to provide that in any
case in which a United States person (here, the minor beneficiaries of the
trust who are U.S. citizens) is treated as owning stock in a passive
foreign investment company by reason of subsection (a), any distribution of
property in respect of such stock to the entity holding such stock (here,
the discretionary foreign trust) shall be treated as a distribution to the
United States person, resulting in imposition of the passive foreign
investment company tax, even though no income is in fact distributed from
the trust to the United States person, such that the United States person
has no income or assets from which to pay the tax. While the National
Office admits that no regulations have been adopted under Section
1298(b)(5), it finds authority for its position in the regulations under
Section 958 of the Code for controlled foreign corporations.
4. Particular to the facts of this TAM, and not generally
applicable to foreign discretionary trusts, was this trust a grantor trust,
taxable to the settlor, until the enactment of Section 672(f) of the Code
on August 20, 1996?
Under the facts of the case, the trust on its face provided that the
Trustee (an independent, corporate trustee) had discretion to allocate
income to the beneficiaries or withhold it, but it appeared that the
shares of the beneficiaries were fixed on a per stirpital basis, so that
income accumulated for the benefit of a beneficiary would eventually have
to be distributed to that beneficiary.
Taxpayers also contend that Section 675 (4) of the Code applies to this
trust, or applied to it at least until August 20, 1996, because the
holdings of the settlor and the
trust in the family holding companies were "significant from standpoint of
voting control", and the voting power for the trust's shares was held not
by the trustee, but by
the settlor, or his son, the Chairman of the holding company, in a
nonfiduciary capacity. The National Office rejected this claim as well.
5. Also particular to the facts of this case, did the distribution
of half of the assets of the trust in 1997 to foreign beneficiaries
effectively distribute all of the (if any) passive foreign investment
company income, and other distributable net income and undistributed net
income, to them, such that no such income was left to be attributed to the
United States beneficiaries when their share was distributed to a new
trust, for them, in 1998?
The issue here is whether the separate share rule of Section 663(c) of the
Code applied to the trust. If it did apply, the distribution of one-half of
the assets of the trust to the foreign beneficiaries would only have
carried out one-half of the distributable net income of the trust. The
National Office found that the separate share rule did apply to the trust.
Henry C. indicated that this situation remains up in the air and many
people are waiting for the matter to be resolved.
Gideon R. then discussed some recent cases that involve off-shore asset
protection trusts. He mentioned the Reikers trust in which an APT was set
up to protect a doctor's assets from malpractice claims but the assets in
the trust were considered by the court to have been accumulated during the
marriage and in a subsequent divorce proceeding were considered by the
court to be subject to division . He also mentioned the Alvarez case in
which a foreign trust was set up by a third party but the husband had
control over the distributions. Similarly, in Minnwala the husband didn't
intend to respect the trust formalities and the court held that the trust
was a sham and the assets were subject to marital division. Gideon R.
mentioned some basic rules that practitioners should follow when clients
are considering APTs:
1. Avoid creating the trust at the time the marriage is at
risk
2. If parents are setting up a trust, remove any
beneficiaries that are involved in a divorce and give someone else, such as
a trust protector, the ability to add them back later.
3. Make the APT trust discretionary at all times
4. Avoid patters of distributions that can later be used
against the client in a divorce proceeding.
5. Word letters of wishes very carefully.
6. Use domestic APTs rather than offshore trusts.
Next, Henry C. discussed a consultation paper that was published in June
2007 by the Financial Action Task Force on Money Laundering (FATF) in which
it outlined the risk-based approach to combating money laundering.
The Financial Action Task Force on Money Laundering (FATF) is an
intergovernmental body. Its purpose is the development and promotion of
national and international policies to combat money laundering and
terrorist financing. In 2007, China joined the FATF, bringing the number of
member countries to 34. Henry C. pointed out that the majority of these
countries follow civil law that often does not recognize trusts like common
law jurisdictions.
In 1990, one year after it was formed, the FATF issued its Forty
Recommendations to Combat Money Laundering. These were revised in 2003. The
Revised Recommendations set out policies and procedures for countries,
financial institutions and gatekeepers (lawyers, accountants, managers of
financial institutions) to detect and combat money laundering. The
Recommendations focus on transparency, knowing the customer and an
obligation to report to government authorities any suspicion that a
customer may be laundering money.
Recommendations 12 and 16 are of greatest concern to
gatekeepers. Recommendation 12 imposes customer due diligence
requirements: know your client,
know where your client obtained his money, know the purpose of the
transaction, know the ultimate beneficial owners and keep all this
information in your records for at least five years. Recommendation 16
covers the circumstances in which a gatekeeper might be required to report
a client to the authorities on suspicion of money laundering. In its June
consultation paper, the FATF identified the risk-based approach to
combating money laundering as a combined effort by financial institutions and
government authorities. These entities are advised to allocate their
resources to the areas deemed to have the greatest risk of money
laundering, rather than spreading their efforts equally across multiple
areas. Importantly, Section 1.12 of the consultation paper recognizes that
one feature of a risk-based approach "will allow financial institutions to
exercise reasonable business judgment with respect to their customers." The
risk-based approach should allow banks and others to focus their most
intrusive inquiries on customers or transactions that they consider to pose
the greatest risk of money laundering. The June consultation paper suggests
that non-financial businesses and professionals take risk into
consideration when deciding how to comply with Recommendations 12 and 16.
Both presenters noted that some countries, such as the United Kingdom now
impose duties upon lawyers and others to combat money-laundering by their
clients. They are concerned that the U.S. may impose similar responsibilities.
Gideon R. then discussed Forms 3520 and 3520-A that address the reporting
requirements relating to foreign trusts and foreign gifts. He reviewed the
comments that were sent by the president of ACTEC to the Commissioner of
the Internal Revenue Service. These comments were drafted by a subcommittee
of ACTEC that Gideon R. chaired. The comments related to the following:
A. Penalties for failure to comply with filing requirements in
connection with Forms 3520-A and 3520
B. Due date of Form 3520-A
C. Confusion regarding reporting requirements for a foreign grantor
trust with a non-US. grantor
D. Lack of need for Form 3520-A as a separate form
E. Ambiguity as to 90-day filing requirement for transfers to foreign
trusts
F. Income tax filing requirements for foreign trusts with U.S. grantor
G. Form 1040 "check box" for receipt of foreign gifts/bequests.
He pointed out that the failure to timely file and fully comply with the
reporting requirements imposed by Section 6048 subjects the "responsible
person" to a penalty
pursuant to Section 6677 of up to 35% of the gross reportable amount. Many
professional tax preparers are unaware of the unique filing date of March
15 set forth in the Notice and the instructions to Form 3520-A. Many of the
penalties assessed against taxpayers have been due to the late filing of
Form 3520-A, caused by the failure of both the affected taxpayers and their
tax preparers to realize that the filing deadline, which was formerly April
15, is now March 15.
He said that the IRS has not expressed a willingness to change the due date
to April 15.
He also indicated that the committee recommended that Form 1040 be modified
for a taxpayer "check box" to be added to Part III of Schedule B for
receipt of foreign gifts and bequests.
Henry C. then concluded the presentation with a discussion about the
proposed changes in the United States Tax Treatment of Expatriates. He
started by explaining that for many years, there have been efforts in
Congress to change the manner in which the United States taxes expatriates.
Generally over the past 10 or 15 years, legislation has originated in the
Senate (most often, in the first years, at the instance of Daniel Patrick
Moynihan of New York), but languished in the House. Henry explained that
under the current law the taxation involves a 10-year "shadow period"
during which the expatriate, if the avoidance of United States taxes was a
principal purpose of his giving up United States citizenship or long term
residence, must pay an additional income, gift and estate tax upon U.S.
source income and transfers of U.S. situs assets over the tax which a
nonresident alien would pay.
Under Section 877(a) of the Code, the expatriation tax regime applies, at
present, to any expatriate who (i) paid an average annual net income tax of
$124,000 or more in
each of the 5 years prior to expatriation (with inflation adjustments,
$136,000 as of 2007); or (ii) has a net worth of $2,000,000 or more; or
(iii) fails to submit certifications
and evidence to the Secretary of his compliance with Section 877.
He then discussed the pending House Bill that practitioners should be
familiar with for any clients that are expatriates or are contemplating
becoming expatriates.
In the House bill, the exit tax is imposed as if it were a "regular" tax,
due with the filing of the next Federal income tax return of the
expatriate, as if he or she had disposed of all of his or her assets on the
day of expatriation. The House bill would allow deferral of tax on
retirement and deferred compensation plans administered in the United
States by administrators subject to the jurisdiction of the Internal
Revenue Service (or foreign administrators who so elect). The House bill
allows the expatriate to elect to pay an exit tax based upon the value of
his or her assets on the day he or she became a U.S. taxpayer.
Finally, he discussed some aspects of the proposed bill that would require
an expatriate to waive any treaty benefits as a price of deferring payment
of the exit tax.
The presentation was very interesting and the materials included in the
outline are a valuable reference tool.
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Special Session 2-B - Trusts as Beneficiaries of Retirement Plan Assets
Wednesday, January 16, 2008
Presenter: Steven Trytten
Reporter: Joanne Hindel
Steven T. picked up in this session from where he had left off in the
earlier session the day before. He again reviewed a case study involving a
basic stretch-out for a client, 75 years old, widowed with one child, age
34. He showed the audience a series of sensitivity analyses by changing
investment yield, portfolio turnover assumptions, providing for market
fluctuations in yield and by adding or removing investment fees from the
IRA. Steven T. also reviewed an in-depth analysis that Bernstein conducted
using the "Monte Carlo" method and changing market fluctuations in yield
and investment fees. He also showed the audience further sensitivity
analysis with respect to changes in the estate tax by eliminating estate
taxes and by changing income tax rates. He also reviewed changes to the
case study by changing the date of death of the IRA participant and by
changing the beneficiary's age.
He then turned the presentation to the use of trusts as beneficiaries under
the MRD rules.
The MRD Rules effectively impose two steps of analysis to determine the
postdeath MRDs of a trust that has been designated as death beneficiary of
a retirement plan
account:
Step 1 - Does Trust Meet Threshold Requirements to Qualify as a DB Trust.
If the trust satisfies certain threshold requirements, it is referred to in
these materials as a "DB
Trust" and MRDs will be calculated as if certain trust beneficiaries had
been designated individually. These trust beneficiaries are referred to in
these materials as the "DB Trust Beneficiaries."
Step 2 - Determine the DB Trust Beneficiary With the Shortest Life
Expectancy. If the trust is a DB Trust, the next step is to identify the DB
Trust Beneficiary with the
shortest life expectancy.
Generally, the MRD Rules only recognize individuals as "Designated
Beneficiaries." This effectively excludes charities, business entities,
estates, and trusts, but an exception is allowed for any trust that meets
the following threshold requirements: the trust is valid under state law;
the trust is irrevocable or will become irrevocable upon the death of the
Participant; the beneficiaries of the trust are identifiable.
He pointed out that it is very important to make sure documentation is
provided to the plan administrator. In the context of post-death MRDs, the
deadline for providing this
documentation is October 31 of the calendar year following the year of
death (one month after the Determination Date of September 30). The
consequence of failing to meet this deadline is that the trust will not
meet the threshold requirements to be a DB Trust in any year of post-death
distributions.
Since the consequence of failing to comply with the documentation
requirement is that the trust is precluded from qualifying as a DB Trust,
and since there is no known remedial procedure that can be followed if
documentation is not submitted by the prescribed due date, Steven T.
suggested including language in each trust instrument
that reminds the trustee of the documentation requirement.
If a retirement plan asset is passing directly or in trust for several
individuals (e.g. the plan owner's children), all of the individuals must
calculate MRDs using the life expectancy of the oldest individual in the
group, unless the plan by its terms provides "separate accounts" for each
individual, in which case each individual may use his or her own life
expectancy for his or her account. Steven T. suggested certain language in
the beneficiary designation that would provide:
"The IRA shall be divided into three equal separate accounts for the A
subtrust, B subtrust, and C subtrust arising at the IRA Owner's death under
the T Family Trust
established [date]."
He then proceeded with a discussion of several types of trusts that may or
may not be appropriate when retirement plan interests are to be designated
to one or more trust and the trusts are to qualify for "stretched-out" MRDs.
a. Conduit Trusts. The "conduit trust" is the type of trust considered to
be the "default" approach that can be used except when there is a specific
reason to use another approach.
b. Variations on Conduit Trusts. Possible variations on the conduit trust,
including the "grantor" conduit trust, which is designed to provide greater
control and flexibility to the beneficiary.
c. Outright Gifts to "Second Tier" Beneficiaries. The "outright gift to
'second tier' beneficiaries" is a relatively straightforward alternative to
the conduit trust.
d. Recipients Limited By Age Restriction. The "age restriction" approach is
another alternative to the conduit trust that should be used with great
caution. Outright Gift to "Last One Standing." The "last one standing" is
another somewhat specialized alternative to the conduit trust
f. Dynasty Trusts. The term "dynasty trust" is often used to describe a
trust that continues for multiple generations, and is often used in estate
planning as a tool to reduce the aggregate transfer tax cost of passing
assets across multiple generations. Dynasty trusts generally provide the
greatest benefit to the extent that they can be made "exempt" by allocation
of a transferor's generation-skipping transfer tax exemption. The
implications of designating a dynasty trust as beneficiary of retirement
assets, is the most complicated alternative of all.
g. Marital and Bypass Trusts. Special planning issues arise in connection
with marital or bypass trusts that may receive retirement plan assets at
the first spouse's death.
Steven T. spent considerable time on each type of trust explaining how it
worked, how best to draft such a trust and providing sample forms.
The presentation was very well done and the materials are excellent.
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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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NOTICE: Although audio tapes of all of the substantive session at the Miami
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