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Now that the presidential election is over, estate planning attorneys are increasingly nervous about the future of the estate tax regime and whether they will be employable in coming years if President Bush is successful in convincing Congress to repeal the estate tax permanently. While it is true that a great deal of the estate planner’s practice is tax driven, a stronger emphasis on wealth preservation for current and future generations will provide plenty of work to keep estate planning attorneys off the unemployment lines. This article discusses the use of various trusts and other tools of estate planning, many of which are utilized for reasons other than tax savings. In addition, even if the federal estate tax is repealed, the likelihood is that the gift tax will be retained to avoid gaming the income tax and for the possibility in the future that the repealed estate tax will be reinstated. The tools discussed here also have gift and generation-skipping transfer (GST) tax advantages. (Although the focus of the article is on nontax incentives for estate planning, readers are reminded that many states have retained their estate tax structure and should therefore consult with their advisors and revisit their existing plans.) Individuals utilize lifetime trusts (also known as revocable living trusts) as will substitutes, and their use is becoming increasingly popular, especially in states that have stringent probate formalities. With a lifetime trust, an individual (the settlor) is able to transfer his or her assets into the trust for the settlor’s own benefit (a self-settled trust) during the settlor’s lifetime, and then direct distribution of the balance of the trust assets upon the settlor’s death. The settlor may serve as sole trustee during his or her lifetime, naming a successor to serve when the settlor dies, resigns or becomes incapacitated, or the settlor may choose to have someone else (an individual or corporate trustee) serve independently or as co-trustee with the settlor. Although there are no estate tax advantages to a lifetime trust, since the revocability of the trust would cause the assets to be included in the settlor’s gross estate, there are several nontax advantages. The use of a lifetime trust that provides for disposition of the property after the settlor’s death creates continuity in the management of the trust assets, without interruption from the settlor’s death. This feature is very favorable in situations where assets consist of volatile securities or where an asset must be sold to raise cash for the administration of the settlor’s estate. Such continuity is also achieved if the settlor becomes incapacitated, since the trust alleviates the need for a proceeding to have a guardian appointed for the settlor. Although a self-settled lifetime trust does not shield the trust assets from the settlor’s creditors, the assets are protected from the subsequent beneficiaries’ creditors, so long as the settlor provides that the assets are to continue to be held in trust. Lifetime trusts also provide privacy for the settlor’s post-death disposition of his or her property, since, in most cases, the use of a lifetime trust will avoid probate and, consequently, will prevent the scrutiny of court records by “inquiring minds.” Many states have probate laws that provide rights to certain heirs of a decedent, even if those heirs are not named in the deceased’s will. For example, a father may choose to disinherit his child. That child would be entitled to notice of the probate of his father’s will and have the opportunity to object to it. Or an individual may have no living relatives save for some first cousins, many of whose whereabouts are unknown. Those cousins would also be entitled to notice of the probate proceeding, even though the testator hasn’t had contact with them. Often, the court requires the executor of the estate to search diligently for the relatives whose whereabouts are unknown before the will may be admitted to probate. Generally, a lifetime trust avoids these situations because there is nothing to probate, but the individual must be extremely diligent in transferring all of his or her assets to the trust in order to prevent the necessity for a court proceeding. Not all situations warrant the use of lifetime trusts, however, regardless of their advantages. From a cost perspective, lifetime trusts often generate higher legal fees, resulting from preparation of additional documents incidental to the transfer of the settlor’s assets into the trust. In many circumstances, an individual’s goals can be achieved through a will at a lower cost. Individuals considering the use of lifetime trusts should consult with their legal advisor to determine which method is more appropriate and efficient to achieve their goals. Dynasty trusts A dynasty trust is an excellent tool for keeping wealth in the family through multiple generations while providing protection to the beneficiaries against their creditors and against claims of divorcing spouses. The dynasty trust also provides the settlor with the opportunity to control the disposition of assets long after he or she has passed away, or the settlor may choose to allow the beneficiaries to have varying degrees of control and/or access to their trust assets. Since dynasty trusts are typically funded with substantial, appreciating assets, there is the potential for significant estate, gift and GST tax savings when the assets pass to grandchildren or lower generations. If a settlor funds an irrevocable dynasty trust with his or her $1 million gift tax exemption, the trust assets are free from gift tax when the trust is created and from estate tax on the death of the settlor. Additional tax savings occur later on, when the settlor’s children (the presumed beneficiaries) die, because the trust assets are excluded from their estates for estate tax purposes. If the settlor allocated his or her GST exemption to the trust, the transfer of trust assets to the settlor’s grandchildren will also be free from GST tax. It may be beneficial for the settlor to fund the trust with assets worth $1.5 million in order to fully utilize the current GST exemption. Although a gift tax would be generated on $500,000 (the amount beyond the current gift tax exemption), the trust assets could grow substantially over the course of two generations and the assets, as well as the growth, could pass to the grandchildren free of transfer taxes. Of course, extreme caution must be exercised when advising a client to incur a gift tax in the face of possible repeal. An added potential benefit of a dynasty trust is the ability to extend the term of the trust in perpetuity, in states that have eliminated or eroded the infamous Rule Against Perpetuities, which provides that a trust can only last 21 years beyond the death of the last beneficiary that was alive at the time the trust was created. Several states (Alaska, Arizona, Delaware, Idaho, Illinois, Maine, Maryland, New Jersey, Ohio, Rhode Island, South Dakota and Wisconsin) have abolished that rule, while others have extended the term of years that a trust may exist (Florida: 360 years; Utah and Wyoming: 1,000 years; and Washington: 150 years) and some states have opt-out provisions from the rule, which permit the settlor to extend a trust well beyond the grandchild generation. Asset protection trusts Under traditional trust doctrine, an individual may not create a trust for his or her benefit (i.e., where the settlor may receive distributions of income and/or principal) that also acts to protect the assets transferred to the trust from claims of the settlor’s creditors. As American society grows more and more litigious, however, a number of states are changing their public policy to some degree in order to permit the creation of what is commonly known as an asset protection trust (or self-settled spendthrift trust). Asset protection trusts are primarily intended to protect assets from the reach of the settlor’s creditor claims; they can be tailored to provide favorable income tax treatment and serve as an effective adjunct to reducing estate, gift and GST taxes. An added feature is the ability to provide asset protection for beneficiaries in subsequent generations, in perpetuity, in states that have eliminated restrictions on the duration of a trust, as discussed above. Alaska was the first state to enact a statute (in 1997) that permitted a self-settled trust that shields assets transferred to the trust from the settlor’s creditors, followed by Delaware, Nevada, Rhode Island and Utah with similar statutes. Asset protection trusts are attractive to individuals who have accumulated substantial wealth, as well as to certain professionals who, by virtue of their profession, could be exposed to claims that exceed the limits of their liability or malpractice insurance. Each statute has its own nuances and limitations, so individuals considering such trusts should obtain proper legal counsel to advise them of the advantages and risks involved in creating an asset protection trust. For example, any transfers to a trust that are deemed fraudulent will be invalid. It is possible under a particular state’s law that a transfer is deemed fraudulent even if the settlor had no underlying intent to hinder, delay or defraud his or her creditors. Accordingly, anyone considering an asset protection trust should be advised on applicable laws concerning fraudulent transfers and creditors’ rights. However, under the right set of circumstances, asset protection trusts can operate to provide the client with a restful night’s sleep and added tax benefits. Special needs trusts Special needs trusts (also known as supplemental needs trusts) are traditionally used to provide for a disabled beneficiary without jeopardizing the beneficiary’s eligibility for governmental benefits. Essentially, the assets in a properly drafted special needs trust are not included in available resources or income of the disabled beneficiary when determining Medicaid or Social Security Income (SSI) eligibility. The primary purpose of a special needs trust is to supplement, not to replace or substitute, benefits that are provided to the beneficiary by government programs. A special needs trust may be established with funds from a third party, such as a testamentary or inter vivos trust established by the beneficiary’s parents, or from funds belonging to the beneficiary (commonly known as a first-party trust). A practitioner will be faced with drafting the latter type of trust when the beneficiary is the recipient of proceeds from a personal injury action or medical malpractice suit. Knowledge of Medicaid and SSI rules and regulations, as well as specific requirements for trust language (as codified in federal and corresponding state law) is essential in drafting a first-party supplemental needs trust. A family limited partnership (FLP) is a limited partnership where the partners generally consist of members of one family, usually the parents and children. A limited liability company (LLC) is the functional equivalent to the FLP but is utilized in place of a partnership structure, depending on the type of assets involved or on the applicable state law and does not require a general partner. Although these entities have been carefully scrutinized and frequently challenged (some successfully) by the Internal Revenue Service for estate and gift tax purposes, by and large the courts have been friendly to the significant nontax benefits that these entities provide. An FLP (or LLC) is especially attractive for clients who own their own business or commercial or investment real estate because the entity provides liability protection to its partners, while also providing protection from owners’ creditors by limiting creditors’ rights to a charging lien in most states. In most FLP structures, a parent will transfer assets to the entity, which will be eventually owned by the children, but the parent will retain control over the assets or the day-to-day operations of the business as general partner, which is a considerable concern for most clients. The entity also provides a structure for centralized management of assets and can be used as a management company for other business entities or it can be a means by which a number of individuals are able to pool their assets together for greater investment opportunities. Similar to trusts, an FLP provides continuity of life to the entity after its “founder” is deceased. Of course, creation of the FLP or LLC carries with it very desirable tax advantages, which, until recent challenges by the Internal Revenue Service (IRS), has been a favored estate planning technique. Notwithstanding those challenges, if the entity is properly structured and operated, valuation discounts are available for gifts made of interests in the entity (for example, by a parent to a child) and for estate tax purposes. Tax advantaged trusts Keeping in mind that the gift tax is likely to be retained, not to mention that many states have retained their estate tax, the various tax advantages of the estate planning tools discussed above should also be considered when creating an estate plan. Other techniques that are available for reducing wealth transfer taxation include charitable lead or remainder trusts, grantor retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs), sales to intentionally defective grantor trusts, and irrevocable life insurance trusts (ILITs), to name a few. A charitable lead or remainder trust provides an opportunity to pass assets to a charity while also providing for noncharitable beneficiaries (i.e., the settlor, or his children). Depending on the type of trust created, the donor may receive income, gift and/or estate tax charitable deductions. A GRAT is a statutorily sanctioned trust in which the grantor (settlor) transfers assets to the trust and retains an annuity interest (a fixed dollar return each year) during a term of years that the grantor is expected to outlive. At the end of the trust term, the trust assets pass to the remaindermen, who are usually the grantor’s children. The amount of the gift to the remainder beneficiaries is discounted using IRS valuation tables, providing immediate gift tax advantages with the ability to zero-out the gift, and, if the grantor survives the term of the trust, the assets are not includable in his taxable estate. With a QPRT, the settlor transfers his personal residence to a trust and retains the right to live in the residence for a specified term of years. At the end of the term, the residence would pass to the settlor’s children free of estate tax, if the settlor survives the term of the trust. Valuation discounts on the gift of the residence to the trust are also available. Both GRATs and QPRTs can afford substantial transfer tax savings and should always be considered when formulating an estate plan. Despite the distinct possibility of an estate tax repeal, there are several nontax reasons for trust and estate planning, and clients should be encouraged to consider the various use of trusts as a form of wealth preservation and transmission. Reminded by the adage that there is certainty in death and taxes, attorneys should be aware of, and continue to utilize, various tax-driven estate planning techniques to take advantage of gift tax exemptions, to reduce estate taxes at the state level, and to be prepared for the day when the federal estate tax is reinstated after repeal. Herbert Bockstein is a member in the New York office of Philadelphia’s Blank Rome. Barbara L. MacGrady is an associate at the firm. Both attorneys are with the firm’s private client practice group.

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