Whenever I attend a large conference, I try to take some time afterwards to consider the most important takeaways. Having just returned from the 53rd Annual Heckerling Institute of Estate Planning which was held from January 14-19, 2019, I spent the last week reviewing the conference materials and my notes. From this, I have compiled my list of what I believe to be the top five takeaways from the conference.
1. Tax Basis Planning
The conference started with a presentation by Howard M. Zaritsky and Lester B. Law on tax basis planning after the 2017 tax act. I have given at least three presentations about this topic to professional groups over the past year. Given the significant increase in the estate tax exemption which phases many people out of any possibility of a taxable estate, maximizing basis step-up potential for assets has become a much more important tax planning consideration. Combining this with the fairly recent increase in capital gains rates, imposition of the new net investment income tax, permanence of portability (the ability of a surviving spouse to use the first-to-die’s remaining estate tax exemption), exacerbates the need for tax basis planning as part of the estate planning process.
Beyond illustrating the importance of tax basis planning, the speakers went on to discuss a few primary topics:
Planning with Existing Trusts
Many clients have established standard credit shelter trusts for a spouse or have made transfers to trusts for their descendants. Often, those trusts are not needed to keep assets from being subject to estate tax but will prevent the ability to benefit from a step-up in cost basis upon the death of the beneficiary (spouse or descendant). The primary planning tools described to assist with this planning include: (a) granting an independent trustee the power to make broad discretionary distributions in excess of an ascertainable standard, (b) granting a contingent formula general power of appointment to the beneficiary, (c) giving a trust protector or other third party the power to grant a general power of appointment, or (d) triggering the Delaware tax trap.
Upstream Planning
Planning typically has focused on transferring assets downstream, meaning from a parent to their children or further descendants. Given that many clients may have living parents with unused estate tax exemption, it may be important to considering gifting assets “upstream” to a parent. Depending on the structure and whether the Section 1014(e) one year of death rule is met, this allows use of a parent’s unused estate tax exemption to allow for a step-up in cost basis at their death even if the asset ultimately comes back to the child. There are a number of ways to structure these gifts, including by sale to a grantor trust allowing the child to remain the income tax owner of the asset while also receiving payments of cash flow in satisfaction of a promissory note issued on sale.
Planning for a Full Step-Up at a First Death
In community property states, spouses generally get a step-up at the first death for all assets held by either spouse. Spouses in other states do not get this benefit. Therefore, a number of planning tools have been considered so that assets can obtain a full step-up in cost basis at the first death regardless of whether titled to the decedent spouse, titled jointly, or titled to the surviving spouse. Those planning tools include: (a) the joint estate step-up trust (JEST Trust), (b) the step-up personal residence trust (SUPRT), grantor retained interest step-up basis trust (GRISUT), and (c) opt-in community property trusts. Each of these tools has advantages, disadvantages, most appropriate assets, and tax considerations.
2. The Changing American Family
R. Hugh Magill gave a very interesting presentation on what the new American family looks like. While this was not a substantive planning presentation, the information presented by Mr. Magill illustrates that planning must evolve. As planners, we need to understand the new challenges faced in family planning. We cannot continue to rely upon old models to form the basis of the advice we give and how we draft documents. Some of the facts he highlighted include:
- A 20 year old today is more likely to have a living grandmother than a 20 year old was to have a living mother in 1900.
- Millennials (born 1982-2002) are 65% religiously affiliated as opposed to their grandparents who were 89% religiously affiliated.
- The number of US persons who are married has decreased from almost 70% in 1960 to around 50% currently while rates of cohabitating adults has increased 75% over the last 10 years.
- About 40% of millennials believe that marriage is becoming obsolete.
- Married households constituted 80% of all households in the 1950’s. Today this has fallen to lower than 50%.
- The seven most common family structures (in order) are: (1) single person, (2) married couple, (3) married couple with one child, (4) married couple with two children, (5) one parent with one child, (6) two unmarried adults, and (7) married couple with three children. In the 1950’s, the number one most common family structure was a married couple with three children. That is currently number seven.
- Based on the U.S. Census Bureau summary of 2013, 31% of households have no children, 35% of households are traditional households with children (heterosexual married couple with children), and 35% of households are not traditional households (blended, multi-generational, same sex, or single parent).
- One-sixth of children today are raised in blended families and 40% of Americans have one or more step-relatives.
These and other important facts illustrate how the typical American family is changing. With more people living in blended families, more of our client’s descendants dying without children, larger age differences between spouses, and increasing rates of incapacity, our planning needs to consider how to prepare for our clients’ descendants living much different lives, in a different family setting, than those of our clients. The law has largely made drafting flexible trust documents, and amending irrevocable trusts, much easier. We have to be more careful than ever in balancing that flexibility with the needs to preserve the client’s intent. Likewise, as will be discussed below, thinking through family conflicts and selection of fiduciaries upon a death or incapacity will become more important.
3. Fiduciary Selection and Incapacity Planning
During the conference, there were number of presentations that highlighted fiduciary selection and planning. Those presentations included presentations by Stuart C. Bear, R. Hugh Magill, Elizabeth C. Henry, Mary F. Radford, Francis J. Rondoni, Dana G. Fitzsimons, Jr., Bernard A. Krooks, Craig C. Reaves, Margaret G. Lodise, and Sarah Moore Johnson. Clearly, given the amount of time dedicated to this topic at the conference, it is an area getting a lot of attention from the planning community. My previous takeaway, the changing nature of the American family, only serves to underscore how much more important proper fiduciary selection and incapacity planning is becoming. Failure to consider the facts illustrated in that presentation when planning fiduciary selection for a client’s death and incapacity can cause serious disputes among the persons interested in a client’s estate.
Fiduciaries in the estate planning context generally serve in a few different capacities: (a) attorney-in-fact under a power of attorney, (b) executor, administrator, or personal representative, and (c) trustee. In those capacities, fiduciaries have significant duties. Within those roles, fiduciaries can be given broad powers such as:
- The power to make broad, discretionary distributions to beneficiaries, including to the grantor under a revocable trust.
- The power to make gifts under a durable power or attorney and/or revocable trust. This power may be restricted as to a permissible class of beneficiaries, the amount which may be gifted (i.e. annual exclusion), and the purpose of the gifts. Specific care must be taken when allowing the fiduciary to make gifts to himself or herself to avoid an unrestricted ability to make such gifts which could be used to the detriment of intended beneficiaries. Can this be essentially a license to steal?
- The power to consider other resources available to beneficiaries and/or to prefer certain beneficiaries over others.
- The power to form and fund trust and/or the power to amend trusts.
Any one of these powers are often used to provide for flexibility in planning. However, any of them also could be a minefield for disputes and litigation. Of course, there is the possibility for blatant breaches of fiduciary duty. The more common problem the presenters noted were unintended breaches resulting from divergent interests of the interested parties. As mentioned above, the changing nature of the typical American family causes divergence of interests to be greater than in the past.
Imagine a situation where a wealthy child is appointed as agent under a power of attorney with authority to dispose of funds for a parent’s benefit. Acting under a power of attorney, that child engages counsel to establish a revocable trust for the parent, funds the trust, and establishes testamentary trusts for the children at the parent’s death. While the parent is still living, the child spends a significant amount of the parent’s wealth providing top-tier care. Then, after the parent’s death, the agent-child funds trust over which he or she is trustee. Could the less wealthy child allege that assets were dissipated to his or her disadvantage? Could that child argue that creation of a testamentary trust over which the wealthier child is trustee was against the parent’s intended estate plan? Of course, this merely a simple example used which illustrates how steps undertaken by a fiduciary intended to benefit the family cause problems. Similar issues can arise under any number of fact patterns when the surviving spouse is not the parent of the principal’s children, for example.
Likewise, consideration must be given to how fiduciaries act upon incapacity. How is incapacity defined? Who has a right to trigger a determination of incapacity? Many documents allow for an interested party to demand a HIPAA waiver, for example. Failure to give the waiver is often triggers an automatic determination of incapacity. Can conflicting parties use this power as a way to demand sensitive, confidential information to remove an agent/trustee who does not want this information available? Does this language also apply to the principal/grantor? Presentations discussed inclusion of language limiting when these types of powers may be used by requiring some good faith reason to suspect incapacity and/or allowing use only a certain number of times. Likewise, perhaps there should be different provisions applicable to the principal/grantor.
To assist in mitigating some of the pitfalls, the speakers mentioned the use of a “protector” whether under a trust instrument or power of attorney. This would be someone who is not necessarily appointed as the fiduciary but has the power to remove/replace, determine incapacity, etc. That way, should conflicts arise among the interested parties, there is a neutral third party who can step in to avoid problems. While the use of trust protectors has become somewhat common, power of attorney protectors is less common. However, the issues may be similar. Planners should consider appointing an appropriate third party for these purposes.
The primary takeaway here is that planners need to spend more time on considering whom to appoint as fiduciary, putting into place methods to mitigate against disputes, avoiding the use of incapacity triggers as weapons, and documenting principal/grantor intent. By being more intentional in these areas, a number of disputes may be avoided.
4. Increased Importance of Qualified Small Business Stock
After the 2017 tax act, there is a “permanent” 21% flat income tax rate for C corporations. In light of the 37% top federal income tax rate that would apply to individuals (subject to the potential for a 20% qualified business income deduction), calculating whether increased use of C corporations for clients has become an increasingly common practice. Part of that analysis must include consideration of whether the client may benefit from Section 1202 qualified small business stock (“QSBS”). While Section 1202 has been around since 1993, it has not garnered much attention and the IRS has issued very little interpretations. Depending on when the QSBS was acquired, a selling shareholder may exclude either 50%, 75%, or 100% of the gain. Eligible gain is gain from the sale or exchange of QSBS which has been held by the taxpayer for more than 5 years. Further, during the taxpayer’s holding period the corporation must have satisfied an active business requirement (at least 80% of corp.’s assets are in the active conduct of one or more qualified trades or businesses; certain types of businesses are disqualified). There are additional requirements beyond the scope of this writing.
Paul Lee of Northern Trust gave two separate presentations on this topic. One was during the fundamental sessions. The other was a special session panel discussion presented jointly with Joseph Comeau, Julie M. Kwon, and Syida C. Long. In general, a number of definitions and qualification requirements were discussed by the presenters. Primarily, the following items were considered:
Per-Issuer Limitation
This describes the maximum amount of gain which may be excluded in a taxable year. Generally, this is limited to $10 million per taxpayer or 10 times each taxpayer’s adjusted basis in their QSBS. Strategies to maximize benefit under this requirement include “stacking” and “packing.” “Stacking” refers to multiplying the $10 million per taxpayer limitation by making transfers which will not violate the original issue requirement described below. Gifts are a key method of accomplishing this, including to non-grantor trusts as long as the Section 643(f) anti-abuse rules can be satisfied. If a client can create a separate, non-grantor trust for each of his or her three children, for example, then the client just increased his or her limit to $40 million. “Packing” refers to taking steps to maximize QSBS basis to avoid the 10 times basis rule. This includes contributing assets such as high basis assets, intellectual property, etc. The panel noted that there is some disagreement about whether there a married couple gets two, separate $10 million exemptions or, rather, only one.
Original Issue
In order to qualify for the exclusion, the shareholder must have held the QSBS since “original issue.” To be QSBS, stock must meet certain requirements: (a) it must be stock in a C corp. issued after August, 10, 1993, (b) on the date of issuance, it must be a qualified small business (generally gross assets under $50 million), and (c) the shares must have been acquired by the taxpayer at its original issue in exchange for money, property, or services. Any number of planning transactions could cause the stock to cease to be QSBS due to the new shareholder not holding the shares from “original issue.” Many transfers, however, are exempted such that the transferee continues to be treated as having received the shares at original issue. Such transactions include gifts, bequests, and transfers from a partnership to a partner. However, a number of transactions do not benefit from this treatment such as a transfer from an S corp. to a shareholder or from a partner to a partnership. As such, care must be taken to ensure that planning advice given to clients who own QSBS do not cause loss of “original issue” treatment.
Qualified Small Business
A qualified small business is a domestic C corp. with aggregate gross assets not in excess of $50 million (a) at all times on or after August 10, 1993, (b) before the issuance of stock, and (c) immediately after issuance.
Section 1045 Rollover
An important planning option was discussed by Mr. Lee. This option is provided under Section 1045. In the event of a sale of QSBS held for at least six months, a taxpayer may elect to roll over gain by reinvesting in another QSBS. The taxpayer must invest in the replacement QSBS within 60 days from the sale of QSBS. To the extent the sales price exceeds the cost of replacement QSBS, gain will be recognized. Deferred gain reduces basis in replacement QSBS.
5. Tax Planning for Divorce
Carlyn S. McCaffrey gave a presentation during the fundamental section on this topic followed by a special session panel discussion with Ms. McCaffrey, Linda J. Ravdin, and Scott L. Rubin. Ms. McCaffrey started her presentation by illustrating the general tax benefits and burdens of marriage. Benefits include: (a) joint filers have lower rates than an individual with the same income, (b) a married individual’s losses can offset the other spouse’s gain, married persons’ contribution base for charitable contributions are combined, (c) married persons (who are not non-resident aliens) can make unlimited tax free gifts to each other, (d) married individuals can split gifts, and (e) a surviving spouse can take advantage of the first-to-die’s unused estate tax exclusion amount. However, there are burdens. Those include: (a) married couples with the same income may pay more tax due to the marriage penalty, (b) limits on deductibility of state income and property taxes is not doubled for married couples, and (c) limits on the deductibility of home mortgage interest are not doubled for married couples.
Given recent changes in the 2017 tax act, planners must reevaluate recommendations they traditionally have made with respect to divorces. There were a number of changes which could impact divorcing spouses. Those include a change in the benefits/burdens discussed above as well as the repeal of miscellaneous itemized deductions such as the ability to deduct attorneys’ fees related to tax advice in a divorce. The changes with the likely biggest impact consist of two items:
Repeal of the Alimony Deduction
Continuously since 1942, alimony has been deductible by the paying spouse. Although the policy reasons for repeal are not certain, there are estimates of an additional $6.9 billion in revenue from repeal which likely answers the reason for repeal. In any event, planners will need to consider methods of achieving the same results. One such alternative is to fund a non-grantor trust immediately after the divorce is completed which will make distributions to the receiving spouse. Such distributions will carry out trust income to the payee spouse, thereby making him or her responsible for income tax on the income received. Given that Section 672(e) attributes rights held by the non-grantor spouse to the grantor spouse for purposes of the grantor trust rules, it will be important that any trust created for this purpose be funded after the divorce is final. Section 2516 provides a gift tax exemption which should allow a gift tax deduction in funding any such trust provided that it is funded within 2 years of the divorce and pursuant to the property settlement agreement. To avoid the IRS arguing that the grantor trust rules are triggered if there is a pre-divorce definitive plan in place, the property settlement agreement may need to contemplate funding the trust as only one alternative to satisfying the payor spouse’s obligations.
Repeal of Section 682
Until 2019, the grantor of a trust ignored for income tax purposes (grantor trust) was given relief to the extent distributions were made to his or her ex-spouse. The statute treated distributions to the ex-spouse as carrying out income attributable to the distribution. It is this repeal that makes it very important that any trust used as described above be funded only after the divorce. A serious problem with the repeal of Section 682 is that it does not apply only to newly formed trusts. Rather, it applies to any preexisting trust. Although comments have been submitted requesting relief, the current status of the law gives no such assistance. As a result, anyone who has created a trust of which his or her spouse is a beneficiary may be at a significant income tax disadvantage by being forced to pay income tax on distributions made to an ex-spouse. Given these issues, Ms. McCaffrey discussed considering restructuring existing trusts through decanting or statutory modifications.
There certainly were many other important topics covered from the U.S. Supreme Court’s grant of certiorari to the Kaestner case out of North Carolina (which I have written about here) to Section 199A to strategic uses of powers of appointment. However, the topics outlined above topped my list as the ones that seemed to gain the most attention at the conference as well as being the items which are of most current relevance. I look forward to finding ways of using what I learned at the conference to help my professional colleagues and clients. Hopefully, this summary helps you.
