2011 - 2012 estate planning update

2011 – 2012 ESTATE

PLANNING UPDATE

Yanowitz & Associates, PLLC

www.yanowitzlaw.com

507-252-8997

Overview

Inherited Retirement Plan Benefits –Possible Minimum Distribution Rule Changes

Committee Update - Uniform Trust Code in Minnesota

Portability

Proposals for Fiscal Year 2012 Federal Legislation

Drafting for Qualified Small Business and Farming Deduction

Planning for Income Tax Basis Step Up In The Bypass Trust

INHERITED PLAN

BENEFITS- ARE THE TAX

RULES ABOUT TO

CHANGE?

Inherited retirement plans –

minimum distributions

Proposal by Sen. Max Baucus of the Senate

Finance Committee

5 year rule is the general rule for all

distributions after death for all plans and all

IRA’s.

Exceptions for the following beneficiaries:

spouse, disabled and “chronically ill

persons”, persons less than 10 years younger

than the deceased person, minor children of the

deceased plan participant.

Effective date proposed: death’s occurring after

2012.

Inherited retirement plans –

minimum distributions

Planning Considerations:

Roth Conversions

Funding of Bypass Trusts

Conduit Trusts

Accumulation Trusts

Charitable Remainder Trusts

WILL THE UTC COME TO

MINNESOTA?

Uniform Trust Code

Committee

Decanting

Trust Protectors

Required Notices to Beneficiaries

Spendthrift Provisions

HEMS powers

Lapsed Crummey Powers

Spousal Lifetime Access Trusts (SLAT Trusts)

PORTABILIT

Y

Portability: Requirements

Surviving spouse can use deceased spouse’s

unused unified credit for gift and estate tax

purposes (NOT GST)

deceased spousal unused exclusion amount

(DSUEA)

1st Spouse dies in 2011 or later

2nd Spouse dies before 2013

Not allowed for noncitizen and nonresident

alien spouses.

Basic Example

H dies in 2011 with a $3 million estate which

passes to his children

W’s exclusion becomes $7 million

$5 million from her own exemption

$2 million from her husband’s unused unified

credit

Electing Portability

Elected: file timely and complete Form 706

Statute of Limitations

Cannot increase tax due for predeceased spouse

Service can review predeceased spouse’s return

anytime for purposes of determining DSUEA

Electing out

Following instructions on Form 706

Do not file Form 706

Multiple Spouses

Can only claim DSUEA of last deceased

spouse

H1 and W married. H1 dies. H2 and W married.

H2 dies.

W has DSUEA from H2 IF H2 made election.

Multiple Spouse: Divorce

Divorce revives DSUEA of first deceased

spouse

H1 and W married. H1 dies. H2 and W married.

H2 and W divorce. H2 dies.

W has DSUEA from H1

Recapture with Reduced

Exemption?

Exemption is $5M

H1 dies with $2M estate

W receives $3M in DSUEA

Exemption is reduced to $1M

W dies

Does W have exemption of $2M or $4M?

$2M: Section 2010(c)(4)(A) limits DSUEA to the

basic exclusion amount

Recapture with Gifts?

W gets $5M DSUEA from H1.

W makes $10M in gifts

W remarries H2

H2 dies leaving W with $0 DESUEA

W has no assets at death

W’s taxable estate of $5M ($10M lifetime gifts -$5M exemption)

Result: will create estate tax that exceeds decedent’s estate (who pays the tax?)

Advantages of Credit Shelter

Trusts

Asset protection during surviving spouse’s life

Can protect children’s inheritance

Shelter appreciation and income from estate

tax, DSUEA not indexed for inflation

Preservation of predeceased spouse’s

exemption if exemption is reduced

Minnesota’s estate tax has no portability

Advantages of Credit Shelter

Trust

Use of predeceased spouse’s GST Exemption

Avoid filing estate tax return if estate is not so

large

Portability lost if surviving spouse remarries

and outlives second spouse

Less risk of audit at second death if trust is

funded with non-publicly traded assets that are

difficult to value

Portability may sunset in 2013

Advantages of Portability

Simplicity (no segregation of assets)

Property depreciates after first spouse’s death

(like retirement assets)

Second step-up in basis for appreciated

assets

Acts as back up if couple fails to fully

implement asset retitling

Predictions

No significant modifications of estate plans currently needed

Gift planning using DSUEA

Could have direction in estate plans to file a Form 706

Wealthy spouses should treat DSUEA like basic exclusion and use as soon as possible so assets begin appreciating outside of estate

Premarital agreements

Require surviving spouse’s estate to file an estate tax return and elect portability.

FISCAL YEAR 2012

PROPOSALS

Administration’s Fiscal Year 2012

Budget Proposals

Federal Exemptions:

3.5 Million Estate and GST Tax Exemptions

45% top tax rate

2013 proposal would limit gift tax exemption to

$1 Million

Continuing Portability: potentially costing

$3.681 billion over the next 10 years


Budget Proposals

Consistency in Value for Transfer Tax and

Income Tax Purposes:

New subsections 1014(f)(1) & 1015(f)(1)

New Section 6035 Basis Information Sheet

Could add authorization for Treasury to issue

regulations requiring reporting basis even where

Forms 706 and 709 are not required

Could raise $2.095 billion in revenue over 10

years


Budget Proposals

Grantor Retained Annuity Trust regulations

10 year minimum terms

Remainder interest (the gift) must have value >

0

Annuity amounts not to decrease in any year of

the annuity term


years


Budget Proposals

Limiting GST dynasty trusts to 90 years tax

free

The GST inclusion ratio is increased to 1 on the

90th anniversary of the date of the trust’s

creation

Would impact trusts created after the date of

enactment plus the portion of pre-existing trusts

with contributions after the date of enactment


Budget Proposals

Valuation Discount Modifications

Attacking discounts primarily related to family

transactions, potentially including minority and

marketability discounts


years


Budget Proposal

Grantor Trust Coordination of Income and

Transfer Tax Rules

To the extent that income tax rules treat a grantor as

the owner of the trust, the proposal:

1. Includes the assets of the trust in the gross

estate of the grantor for estate tax purposes;

2. Subjects distributions from the trust to gift tax

during the grantor’s life; and

3. Subjects remaining assets to gift tax during the

grantor’s life if the grantor ceases to be an

owner.

DRAFTING FOR THE NEW

MINNESOTA QUALIFIED

SMALL BUSINESS AND

FARMING DEDUCTION

Drafting for Qualified Small Business

and Farming Deduction – MS 291.03

Statutory Requirements – For A Deduction Of Up To $4 Million

Death after 6/30/2011

Decedent must own “Qualified Property”:Qualified Small Business Property or

Qualified Farm Property

The Qualified Property must pass to a Qualified Heir The statute does not address whether the ownership

interest by the deceased person or his/her family members can be in a trust and if so, which beneficiaries of the trust (current, future, contingent, all of the above) must be qualified heirs.

Drafting for Qualified Small Business and

Farming Deduction – MS 291.03

Definition of a Qualified Small Business

The value of the property was included in the

federal adjusted taxable estate.

There is no minimum percentage of the estate that

must be comprised of the Qualified Small Business

(i.e. no 25% or 50% test as is the case for IRC Section

2032A)

The reference to the adjusted taxable estate prevents

the deduction from applying in the case of property

qualifying for the estate tax marital deduction.




The property consists of the assets of a trade or

business or shares of stock or other ownership

interests in a corporation or other entity engaged

in a trade or business.

There is no requirement that the qualified small

business property be real estate.

Equipment, inventory and other personal property

would appear to qualify.

There is no requirement that the qualified small

business be located in Minnesota.




The decedent or the decedent's spouse must

have materially participated in the trade or

business within the meaning of section 469 of the

Internal Revenue Code during the taxable year

that ended before the date of the decedent's

death.

See Treasury Regulation 1.469-5T. Material

participation requires satisfaction of one of 7 tests.

The test which is most likely to apply requires the

decedent or spouse to have participated in the activity

for more than 500 hours during the taxable year.



This is a stricter test than the material

participation test under IRC Section

2032A, which adopts the IRC Section 1402

standard for determining if an activity is

sufficiently active to be subject to tax as net

earnings for self-employment.

There is no provision which permits the

satisfaction of the material participation

requirement for a retired or disabled individual.



Shares of stock in a corporation or an ownership interest in another type of entity do not qualify under this subdivision if the shares or ownership interests are traded on a public stock exchange at any time during the three-year period ending on the decedent's date of death.

The gross annual sales of the trade or business were $10,000,000 or less for the last taxable year that ended before the date of the death of the decedent.

The property does not consist of cash or cash equivalents. For property consisting of shares of stock or other ownership interests in an entity, the amount of cash or cash equivalents held by the corporation or other entity must be deducted from the value of the property qualifying under this subdivision in proportion to the decedent's share of ownership of the entity on the date of death.



The decedent continuously owned the property for the three-year period ending on the date of death of the decedent.

A family member “continuously uses” the property in the operation of the trade or business for three years following the date of death of the decedent. What is the standard for the measurement of continuous

use?

Unlike IRC Section 2032A, this seems to require that the family member who inherits the property must be the same family member who continuously uses it.

The estate and the qualified heir elect to treat the property as qualified small business property and agree, in the form prescribed by the Commissioner, to pay the recapture tax under subdivision 11, if applicable.



The value of the property was included in the federal adjusted taxable estate.

The property consists of: consists of a farm meeting the requirements of section 500.24.

Note: this is the corporate farming statute which in turn regulates the ownership of trusts owning farm land. The statute excludes timber and poultry operations, and by ruling, the commissioner has exclude land in the CRP program,

was classified for property tax purposes as the homestead of the decedent or the decedent's spouse or both under section 273.124, and

was classified as class 2a property under section 273.13, subdivision 23 [relating to vacant contiguous land].

The definition requires that the qualified property must consist of agricultural land, the farm home and farm buildings. Grain, livestock and equipment and other farm related personal property do not qualify.

https://www.revisor.mn.gov/statutes?id=500.24





The decedent continuously owned the property for the three-year period ending on the date of death of the decedent. There does not appear to be any material participation

requirement during the period before the decedent’s death.

A family member continuously uses the property in the operation of the trade or business for three years following the date of death of the decedent.

The estate and the qualified heir elect to treat the property as qualified farm property and agree, in a form prescribed by the commissioner, to pay the recapture tax under subdivision 11, if applicable.

Recapture Tax

The amount of the additional tax equals the

amount of the exclusion claimed by the estate

under subdivision 8, paragraph (d), multiplied

by 16 percent.

The additional tax under this subdivision is due

on the day which is six months after the date

of the disposition or cessation of the qualifying

use.

Recapture Tax

If, within three years after the decedent's death

and before the death of the qualified heir, the

qualified heir disposes of any interest in the

qualified property, other than by a disposition

to a family member, or a family member

ceases to use the qualified property which was

acquired or passed from the decedent, an

additional estate tax is imposed on the

property.

Drafting Considerations With Respect To

The Qualified Interest Deduction

In the case of married clients, consider potential decrease of Federal exemption to $1 Million on 1/1/2013.

Directing qualified interest to a share that does not qualify for the marital deduction may trigger an unexpected federal estate tax on the first spouse’s death. A gift to the marital share does not qualify for the qualified interest deduction.

Note: if IRC Section 2032A planning is being considered for a married couple, a lead pecuniary marital formula is often selected under which the Section 2032A property is often passed under the marital share so that the valuation reduction may be achieved in both spouse’s estates.

A formula gift could be employed which requires that the transfer occur only to the extent that no federal estate tax is triggered.



Review the tax payment provision. Generally, the tax, including the recapture tax, should be apportioned to the qualified heirs receiving the qualified property.

Consider alternatives to trust ownership by the property owner and the qualified heir until further guidance is received. To avoid probate, consider the use of TOD deeds for real estate, and TOD certification for partnership interests, LLC interests and corporate shares.



Consider requiring each heir who receives an

interest in the qualified property, other than a

surviving spouse, upon the request of the

personal representative, to:

sign the election and recapture agreement

(including any protective elections) before the due

date of the return, as a condition to receiving their

inheritance of the qualified property, and

such signing should also be required with respect

to any further matters required to perfect the

election.



If the qualified property will be transferred into

a trust, consider a provision which requires the

personal representative and trustee to

designate a qualified heir to manage such

property to secure qualification for the

deduction. The fiduciary should be exonerated

from liability for such delegation.

Permit an independent trustee or trust

protector to amend the trust to the extent

necessary to permit qualification for the

deduction.

WAIT & SEE PLANNING –

ELECTING BASIS STEP

UP IN THE BYPASS

TRUST

Planning for Income Tax Basis

Step Up In Bypass Trust

Income tax basis step up at death under IRC

Section 1014.

Directing the independent trustee to consider

IRC Section 1014.

Creation and elimination of general powers by

independent trustees.

Problems with formula general powers.


Step Up In Bypass Trust

Solution: The Delaware Tax Trap

Section 2041(a)(3) provides that an exercise by a

beneficiary of a limited power of appointment will

be taxed as if it were a general power of

appointment if the exercise of the power is to a

further trust which “postpone(s) the vesting of any

… interest in such property, or suspends the

absolute ownership or power of alienation of such

property, for a period ascertainable without regard

to the date of the creation of the first power.”


Step Up In The Bypass Trust

Technique to exercise a power of appointment which transfers property in further trust in a manner which postpones the vesting of an interest in trust:

Problem: the law of most states – including the Minnesota version of the Uniform Statutory Rule Against Perpetuities (USRAP) – generally prohibits an exercise in further trust with a new measuring period.

Solution – Minnesota and all other states with rules against perpetuities permit a transfer in a further trust in which the beneficiary of the appointed trust has a presently exercisable general power of appointment.

2011 - 2012 estate planning update

Economy & Finance