10 Accommodation Of Special Assets

Transcription

1 10 Accommodation Of Special Assets SUBCHAPTER A: CODE SECTION 2032A 10A.01 THE ISSUE Any property that is to qualify for special use valuation must pass to one or more qualified heirs. Treasury regulations section A-8(a)(2) applies this rule to successive interests by stating that the property must not be able, in any event or under any circumstance, to pass to or for any person who is not a qualified heir, before the property passes to a qualified heir or is subject to inclusion in the gross estate for estate tax purposes of a qualified heir. See Code 2032A (b) (1) (A)(ii), 2032A (b)(1) (B) and 2032A(g), Treas. Reg A-8(a)(2), Rev. Rul , C.B. 175, Rev. Rul , C.B. 208, Ltr. Rul , Ltr. Rul and Ltr. Rul Cf. Treas. Reg A-3(c) and Ltr. Rul However, a number of cases have held Treasury regulations section A-8(a)(2) invalid. Generally, they enunciate a wait-and-see approach according to which a mere possibility of passage of a successive interest to other than a qualified heir before the property is included in the gross estate of a qualified heir does not preclude eligibility but actual passage within the period during which tax savings are subject to recapture does trigger recapture. Smoot v. United States, 892 F.2d 597 (7th Cir. 1989), Estate of Thompson v. Commissioner, 864 F. 2d 1128 (4th Cir. 1989), Kunze v. United States, 1988 U.S. Dist. LEXIS (D. Kan.), Estate of Clinard v. Commis sioner, 86 T.C (1986), Estate of Davis v. Commissioner, 86 T.C (1986), and Pliske v. Commissioner, T.C. Memo (1986). The Internal Revenue Service never has acquiesced in these decisions. Although it did not find the regulation invalid, TAM held that the mere remote possibility of passage to other than a qualified heir did not preclude eligibility. As a practical matter, current law possibly consists of the wait-and-see approach. The wait-and-see approach is workable and supports the policy that underlies the statute. 10A.02 PROBLEMS AND SOLUTIONS Usually, a nonmarital trust that is well-drafted will not vest any interest unless and until the interest becomes possessory. Therefore, the orthodox nonmarital trust usually will present at least some possibility that the property will pass to a person who is not a qualified heir. Form 10.1 Section Code Sections 2032A and Special Prop erty shall mean all property that, if the property were Special Property to which subsections (A) and (B) of this Section would apply, would be eligible for application of either or each of Section 2032A of the Code and Section 2057 of the Code for purposes of determining the United States estate tax payable because of my death or the death of my wife. Notwithstanding any provision of this instrument to the contrary, a [if (but only if), before the filing of the return of United States estate tax payable because of my death (or, as the case may be, the death of my wife), legal counsel (other than any person who is not an Independent Person) for my personal representative (or, in the case of the death of my wife, the personal

2 representative of my wife) so directs, subsections (A) and (B) (or, in the case of the death of my wife, only (A) and (B)(2)) of this Section shall apply.] (A) No power of appointment granted in this in strument shall be exercisable, directly or indirectly, to appoint Special Property in any manner that could permit the property to benefit any person who is not a qualified heir with respect to the property, as defined in Section 2032A(e)(1) of the Code, before the property passes to or otherwise is subject to inclusion in the gross estate (for estate tax purposes) of a qualified heir with respect to the property. (B) b bi [[(1)] If my wife survives me and either my wife survives all of my descendants or there is no sufficient evidence that my wife and the survivor of my descendants died other than simultaneously, upon the death of the survivor of my descendants (or upon my death if no descendant of mine survives me) the Trustee shall distribute all Special Property to my wife.] c ci [[(2)] Any of the Special Property that is not distributable according to the prior provisions of this instrument, cii [including subsection (1) of this subsection (B) but] excluding Section 4.03, shall be distributed to the estate of my lastsurviving descendant who is living after my death or, if no descendant of mine is living after my death, according to Section 4.03.] 10A.02(a) First Problem Assume the existence of a trust that mandates the current payment of all income to the surviving spouse of the testator during the life of the surviving spouse, remainder either (i) to the descendants, per stirpes, of the testator who survive the survivor of the testator and the spouse of the testator or (ii) as provided in the Second Problem. If no descendant survives the spouse, the property might pass to other than a qualified heir. 10A.02(b) Possible Solution If the client is unwilling to risk the existence of the wait-and-see test, a possible solution to the First Problem is to provide that the property shall pass outright to the spouse if no descendant survives the spouse. This solution will permit the spouse to enjoy outright ownership of the property during any time that no descendant is living. After the death of the survivor of the testator and the last-surviving descendant of the testator, usually no overwhelming reason will exist to avoid including the property in the gross estate of the spouse of the testator. This solution will permit the spouse, rather than, for example (as in the Second Problem), a last-surviving descendant (probably a child), to dispose of the property. The spouse might dispose of the property similarly to how the testator might have disposed of it. A deceased descendant, on the other hand, probably will leave the property to his or her spouse, and the spouse of the descendant probably will dispose of it randomly (as far as the testator is concerned). 10A.02(c) Second Problem Assume that upon the death of the testator or upon the termination of the trust for the benefit of the surviving spouse described in the First Problem, the testator allocates the property with respect to the descendants of the testator then living, per stirpes, with a separate trust for each child until the child attains a stated age or sooner dies, with the share of any deceased child to pass to the descendants of the child then living, per stirpes, or, if none, to the descendants of the testator then living, per stirpes, or, if none, to some person or charity that is not a qualified heir. If any child survives the testator or, as the case may be, the survivor of the testator and the spouse of the testator but no descendant of the testator survives the termination of a trust for a child, the property

3 might pass to other than a qualified heir. 10A.02(d) Possible Solution If the client is unwilling to risk the existence of the wait-and-see test, a possible solution to the Second Problem is to provide that, in lieu of the gift to some person or charity that is not a qualified heir, the trust estate of the trust of a deceased child shall pass to the estate of the last-surviving descendant of the testator. 10A.02(e) Third Problem Assume that the spouse of the testator in the First Problem, or the child of the testator in the Second Problem, has a nongeneral power of appointment which permits the donee to appoint to other than a qualified heir. Treas. Reg A-8(a)(2). See Rev. Rul , C.B. 208, and Ltr. Rul However, Smoot v. United States, 892 F.2d 597 (7th Cir. 1989), Estate of Thompson v. Com missioner, 864 F. 2d 1128 (4th Cir. 1989), Kunze v. United States, 1988 U.S. Dist. LEXIS (D. Kan.), and Estate of Clinard v. Com missioner, 86 T.C (1986), have held Treasury regulations section A-8(a)(2) to be invalid to the extent that the mere existence (as opposed to the use) of a nongeneral power of appointment of a qualified heir would prevent special use valuation. 10A.02(f) Drafting If an election according to Code Section 2032A might be at trac tive, consider the necessity of assuring that each contingent re main der will pass to a qualified heir and not to someone who is not a qualified heir. According to Treasury regulations section (b)-7(d)(3), promulgated because of Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992), property that has the format of qualified terminable interest property only if a QTIP election is made can qualify for the marital deduction. By analogy, can Code Section 2032A apply to property that, because of Form 10.1, passes to a qualified heir only if a person so directs after the death of the testator and before the delivery of the election? Variable a is usable only if the answer is affirmative. If the required passage to a qualified heir were conditioned upon an actual election, a beneficially interested person who would possess the power to elect might possess a general power of appointment and, by failing to elect, release the power and make a gift for gift tax purposes. Variable a addresses this issue by conditioning the passage to a qualified heir upon the exercise of discretion to direct and by vesting the discretion in an independent person. Even if the service of an independent person were optional and a beneficiary were able to prevent the service of an independent person, the beneficiary would not possess the power that the independent person, if appointed, would possess. Because only a direction, not a failure to direct, can increase the interest of the beneficiary (by adding a remainder interest), a power to prevent the direction by preventing the service of an independent person, under circumstances in which the beneficiary could not force an independent person to direct, would not seem sensitive. Cf. United States v. Winchell, 289 F.2d 212 (9th Cir. 1961). According to Code Section 2041(b)(1)(C)(ii), a power that a person only can exercise with the concurrence of a person who has an adverse interest is not a general power of appointment. However, even if Form 10.1 were written so that passage to a qualified heir were conditioned upon an actual election, the protection of this rule would seem unavailable. Arguably, the persons who actually sign a 2032A agreement are not adverse. Use variable b to vest in the spouse of the settlor if any marital disposition is not outright and the spouse survives or dies simultaneously with the last-surviving descendant of the settlor. Use variable c to vest in the last-surviving descendant of the settlor if (i) variable b is used and a descendant survives the spouse and otherwise the plan does not provide for outright disposition to a descendant at the death of the spouse or (ii) variable b is

4 not used and the trust estate does not pass entirely outright to a descendant at the death of the settlor. Use variable cii if variable b is used. SUBCHAPTER B: S CORPORATION STOCK 10B.01 THE TRUST Form 10.2 (3) Remainder Special Assets Trust. Notwithstanding the preceding portion of this subsection (B) concerning the creation and administration of the Remainder Trust, this subsection (3) shall apply to (and only to) any of the trust estate that (according to the preceding portion of this Section) is administrable according to this subsection (B). (a) Creation. The Trustee shall set apart in (or, as the case may be, pay to) a separate trust, to be known as the Remainder Special Assets Trust, so much or all, if any, of the trust estate (or what absent this subsection (3) would be the trust estate) of the Remainder Trust as the Independent Trustee in its sole and absolute discretion determines to be advisable from time to time. (b) Administration. The Remainder Special Assets Trust shall be identical to the Remainder Trust, except that the Trustee shall not pay any of the trust estate to other than my wife during her life and that a [subsection (1)(a) of this subsection (B) shall not apply and instead] the Trustee shall pay the net income to my wife quarter-annually from and after such time (if any) as the Independent Trustee in its sole and absolute discretion determines and until such time (if any) as the In de pen dent Trustee in its sole and absolute discretion determines but (if the Independent Trustee makes the former determination) at least until the end of the calendar year in which the Independent Trustee makes the latter determination. 10B.01(a) Purpose Inclusion of S corporation stock in a trust during more than a brief time requires (i) a vehicle that a single individual is regarded as owning for income tax purposes according to the grantor trust rules (Code Sections ), (ii) a qualified subchapter S trust ( QSST ) according to Code Section 1361(b)(1)(B), (c)(2) and (d) or (iii) an electing small business trust ( ESBT ) according to Code Section 1361(b)(1)(B), (c)(2) and (e). QSST status requires either that the trust require the trustee to distribute all income currently to a single individual or that the trustee in fact distribute all income currently to a single individual. Code 1361(d). Additionally, during the life of the same individual, the trust must not permit any distribution of principal to any other person. Form 10.2 also permits creation of a separate trust as a receptacle for other assets (e.g., residences and any assets that because of valuation difficulties are not appropriate for unitrusts) of which the income or use value should be paid currently. Use variable a in order to omit from the special assets trust any Give-Me-Five, unitrust or annuity interest that is included in the trust to which reference is directed. 10B.02 STUB INCOME Form 10.3 Section Accrued Income; Undistributed Income. Upon the death of any beneficiary of a trust with respect to which an election described in Section 1361(d)(2) of the Code was in effect at any time during the life (or was pending at the death) of the beneficiary, to such extent (if any) as necessary to cause the trust to meet the criteria for a qualified subchapter S trust, the Trustee shall distribute to the estate of the beneficiary any income that was received or accrued, but not distributed, before the death of the beneficiary. Unless otherwise provided in this instrument, the Trustee shall administer any accrued or

5 undistributed in come with respect to any deceased beneficiary as if the in come accrued and the Trustee received it after the death of the beneficiary; provided, the preceding portion of this sentence shall not apply to any income that the Trustee was required to distribute before the death of the beneficiary. 10B.02(a) Purpose The purpose of the first sentence of the form is to afford flexible protection. Use the first sentence if any trust that is not designed to qualify for the marital deduction can be a qualified subchapter S trust because of an election according to Code Section 1361(d) (2). Accord ing to Revenue Ruling 92-64, C.B. 214, income that is undistributed at the death of the deemed owner of the trust can be payable to the estate of the deemed owner or, if (but only if) the successor beneficiary is one individual, to the successor beneficiary. The purpose of the second sentence is to facilitate administration. Consider using the second sentence if any trust that is not designed to qualify for the marital deduction requires current distribution of income. If a marital trust is not QTIP and the surviving spouse has only a general power of appointment exercisable during life, add an exception to the second sentence to require distribution of the stub income to the estate of the surviving spouse. Reg (b)-5(f)(8). SUBCHAPTER C: INTERESTS IN QUALIFIED PLANS AND IRAS Interests in individual retirement accounts ( IRAs ) and qualified plans, and the interface between the interests and private trusts, affect millions of people and perhaps trillions of dollars. Nevertheless, many years after the enactment of the governing statute, the rate at which an interest is distributable to a private trust remains unclear. The last change in the Code which materially affected the rate at which an interest is distributable to a beneficiary was effective as of the beginning of See Code 401(a)(9). The Internal Revenue Service ( IRS ) issued proposed regulations in 1987, modified them slightly at the end of 1997, issued a new set of proposed regulations in January of 2001 and issued final regulations in April of The law, such as it is, remains opaque as it applies in essential respects to trusts as beneficiaries. Unless an interest in a qualified plan or IRA is payable to a designated beneficiary, distribution of the interest cannot extend beyond (i) the life or life expectancy of the participant or owner or (ii) if the participant or owner dies before reaching his or her required beginning date (i.e., usually April 1 of the calendar year after the calendar year in which the participant or owner attains age ), five years after the death. Any longer (i.e., extended) period of distribution is a function of (i) the existence of a designated beneficiary and (ii) if a designated beneficiary exists, the life expectancy of the designated beneficiary who has the shortest life expectancy. Reduced to its essentials, the uncertainty relates to whether, and to what extent, features that are common to private trusts preclude the existence of a designated beneficiary. Virtually all of the features to which the uncertainty relates are central, not peripheral, to why property owners create trusts. Without limitation, the features include (i) the ability of a trustee to use trust property to pay death costs, (ii) the discretion of a trustee to allocate trust property to a disposition, (iii) the ability of a trustee to use trust property to benefit a nonindividual, (iv) the ability of a trustee to distribute trust property to the estate of a beneficiary, (v) the discretion of a trustee to distribute or accumulate income and to distribute principal, (vi) the ability of a donee to appoint trust property and (vii) the ability of a trustee to retain trust property beyond the life expectancies of those who are living at the creation of the trust.