2002 by Sebastian V. Grassi, Jr.

Transcription

1 DRAFTING TRUSTS UNDER THE NEW TAX LAW 2002 by Sebastian V. Grassi, Jr. Grassi & Toering, PLC 888 West Big Beaver Road, Suite 750 Troy, Michigan (248) (248) fax Table of Contents (Click on title to proceed to topic. Press <Ctrl><Home> to return to top.) Termination Clause and Independent Trustee Trust Termination and Limited Power of Appointment by Special Power Holder All to Surviving Spouse in a QTIP Marital Deduction Trust with Clayton Contingent QTIP Election Residue of Trust Estate to QTIP Marital Deduction Trust Subject to Clayton Contingent QTIP Election and Survival of Spouse Death Tax Apportionment Issues Drafting example of disclaimable bequest to spouse Durable Powers of Attorney and Disclaimers Disclaimers and Apportionment of Death Taxes Surviving Spouse as Trustee of Credit Shelter (Disclaimer) Trust Closing Letter to Client Regarding Disclaimer Trust Disclaimer Based GST Planning Introduction 2001 Tax Act Tentative Repeal of the Federal Estate Tax and Generation Skipping Transfer Tax. The Economic Growth and Tax Relief Reconciliation Act of 2001, P.L ( 2001 Tax Act ), provides for a phased in reduction in the federal estate, gift tax and generation skipping transfer tax ( GST ) rates, the phase in of an

2 increase in the estate, gift and generation skipping transfer tax applicable exclusion amounts, and the repeal of the federal estate tax and generation skipping transfer tax for persons dying after December 31, The gift tax, which is a backstop to the income tax, is not repealed. However, on January 1, 2011, the Act s sunset provision automatically repeals all of these changes (including the repeal of the estate and generation skipping transfer taxes) and reinstates the current federal transfer tax regime as of January 1, Absent intervening legislation that makes repeal permanent, the current federal transfer tax system will be in full operation, once again, beginning January 1, The Need To Design Flexible Estate Plans. As a result of the uncertainty of the permanency of estate tax repeal, the 2011 reinstatement of the current transfer tax regimen, and the possibility that future legislation may freeze the phased in applicable exclusion amount in lieu of estate tax repeal, estate planners need to consider drafting flexibility into estate planning documents, especially trusts. Flexibility is important with regard to persons who may die before January 1, 2010 but whose trusts are in existence during the period that federal estate tax and generation skipping transfer tax repeal is permanent. Such flexibility may include: (i) comprehensive trust termination provisions, (ii) appointment of a special power holder with the power to appoint the trust assets to the current trust beneficiaries, (iii) use of a Clayton contingent QTIP trust election, (iv) disclaimer based marital deduction planning, and (v) disclaimer based GST planning. Key changes affecting transfer taxes under the 2001 Tax Act are summarized in the below chart. Year Estate and GST Exemption Amount 2002 $1,000,000 (Estate) $1,100,000 (GST) 2003 $1,000,000(Estate) $1,100,000* (GST) 2004 $1,500,000 (Estate and GST) 2005 $1,500,000 (Estate and GST) Estate, Gift and GST Tax Rates Gift Tax Exemption Amount Other 41%-50% $1,000,000 State Death Tax Credit Reduced 25%. 41%-49% $1,000,000 State Death Tax Credit Reduced 50%. 45%-48% $1,000,000 State Death Tax Credit Reduced 75%. QFOBI deduction repealed. 45%-47% $1,000,000 State Death Tax and GST Credit Repealed. State

3 2006 $2,000,000 Flat 46% $1,000,000 (Estate and GST) 2007 $2,000,000 Flat 45% $1,000,000 (Estate and GST) 2008 $2,000,000 Flat 45% $1,000,000 (Estate and GST) 2009 $3,500,000 Flat 45% $1,000,000 (Estate and GST) 2010 Repealed 0% (Estate and GST) 35% (Gift) 2011 $1,000,000 (Estate) $1,100,000 *(Gift) Death Tax Paid Becomes a Deduction on 706. $1,000,000 Gift tax rate is 35%. Carryover basis is instituted. 37%-55% $1,000,000 Present law returns. QFOBI=$300,000 maximum. * Plus any post 2002 inflation adjustments 1.2 Termination Clause and Independent Trustee. Should estate taxes be permanently repealed or the applicable exclusion amount be significantly increased (in lieu of repeal), trusts that were originally designed to minimize estate taxes may no longer be necessary. If the non-estate tax reasons for a trust no longer justify its existence, consideration should be given to allowing an independent trustee to terminate the trust. (A) General Power of Appointment Issues. The power of a beneficiarytrustee to terminate a trust in his or her sole discretion may be a power to affect the beneficial enjoyment of the trust property or its income, and could constitute a general power of appointment for estate and gift tax purposes. Reg. sections (b)(1) and (b)(1). Therefore, the power to terminate a trust should be held by an independent trustee. (B) Beware the Spendthrift Clause. Under common law, a spendthrift clause prevents a trust from being terminated. Therefore, the trust s spendthrift clause should include language that permits the trust s early termination.

4 (C) Crummey Withdrawal Rights. If the trust contains Crummey withdrawal rights, as do most irrevocable life insurance trusts, be sure to include in the trust termination clause a prohibition of termination while a withdrawal right remains outstanding and has not lapsed; otherwise the IRS may argue that the withdrawal right can be unilaterally cut off by the trustee and is therefore illusory (i.e., does not qualify for a present interest gift exclusion under Crummey). (D) Marital and Charitable Deduction Issues. If the trust is a marital deduction trust or a charitable remainder trust, the Trustee should be prohibited from exercising its termination power in a manner that would impair the marital or charitable deduction. (E) Drafting examples: Termination of Trust. If at any time the size of any trust created under this trust agreement is so small that the trust is uneconomical to administer, or if for any other reason in the opinion of the Independent Trustee, the trust is no longer necessary, impractical, or inappropriate to continue for any reason under the current circumstances, including changes in economic and factual circumstances or changes in federal, state or local rules of law (tax or otherwise), including permanent repeal of the federal estate and/or generation skipping transfer tax, or it would not be in the best interests of some or all of the beneficiaries for the trust to continue, such Trustee may, without prior or subsequent court approval, terminate part or all of the trust and distribute part or all of the trust funds, as the case may be: (i) to my spouse if the trust is a marital deduction trust so deducted/elected, (ii) to or for the benefit of the primary beneficiary for whom the trust was established, if there is such a beneficiary, or in the absence of a primary beneficiary to the person(s) to whom Trustee then must or may pay the trust's current income, in proportion to their interest(s) in trust income; however, if there is more than one beneficiary to whom current income could be paid but the interests are indefinite, Trustee shall distribute the trust assets to or for the benefit of the beneficiaries who are my descendants, by right of representation, or if no descendant of mine is a beneficiary, to all then living income and then living residuary beneficiaries of the trust equally, or (iii) in such other manner or amount(s) as a court of competent jurisdiction may direct, in order to carry out my intentions. Upon such termination, the rights of all other persons who

5 might otherwise have an interest as succeeding life tenant or in a remainder, shall cease. Prior to terminating a trust hereunder, Trustee may request and shall be entitled to be held harmless and receive appropriate indemnification from the beneficiaries who are going to receive a terminating distribution. Trustee shall not terminate a trust if it would prevent an existing bequest from qualifying (or continuing to qualify) for the marital or charitable deduction, or impair the status or qualification of a trust that holds shares of stock in a Subchapter S corporation, or would impair a beneficiary s unexercised right of withdrawal that has not yet lapsed or would otherwise impair a qualified family owned business interest deduction taken under IRC section Independent Trustee Defined. An "Independent Trustee" means a person: (i) who is not related or subordinate (within the meaning of IRC section 672 (c)) to any donor or beneficiary (as the case maybe regarding the identity of the appropriate powerholder ) with respect to the trust in question; (ii) who cannot be benefited by the exercise or non-exercise of any power given Trustee by this trust agreement or by law; (iii) who is neither a beneficiary nor a donor of the trust in question; and (iv) if a general power of appointment held by a beneficiary may only be exercised with the consent of an Independent Trustee, the term "Independent Trustee" also means a person who does not have a substantial interest in the property subject to the power which is adverse to the exercise of the power in favor of the beneficiary, the beneficiary's estate, the beneficiary's creditors or the creditors of the beneficiary's estate (as the case may be), within the meaning of IRC section 2041(b) and Reg. section (c)(2). Spendthrift Provisions. To the fullest extent permitted by law, a beneficiary's interest in the trust (including income and principal) shall not be subject to the beneficiary s liabilities or creditor claims or to encumbrance, assignment, sale, transfer (voluntary or involuntary), anticipation or legal process. Moreover, no power of appointment or power of withdrawal shall be subject to involuntary exercise. However, this spendthrift provision shall not restrict the exercise of a disclaimer or the exercise of a power of appointment or withdrawal right granted by this trust agreement, nor shall it prevent or prohibit the complete or partial termination of a trust. 1.3 Special Power Holder. Because a trustee owes a fiduciary duty to all the trust beneficiaries, including the remainder beneficiaries, the independent trustee may be reluctant to unilaterally exercise its trust termination powers. As a precautionary

6 measure, the independent trustee may seek judicial approval of the contemplated termination. A judge may or may not sanction the proposed termination. Given this possibility, it may be appropriate to also grant the power of termination to a special power holder who owes no fiduciary duty to the trust beneficiaries. Needless to say, this power should only be given to a trusted advisor of the grantor. In addition to holding the power to terminate a trust, the special power holder could also be given the power to appoint the trust s assets to the trust s current beneficiaries in such proportions and manner as the special power holder deems fit. The special power holder should not be the grantor or a beneficiary of the trust, and should meet the definitional requirement of an independent trustee in order to avoid any adverse estate or gift tax consequences as a result of holding these special powers. (A) Crummey Withdrawal Rights. If the trust contains Crummey withdrawal rights, as do most irrevocable life insurance trusts, be sure to include in the special power holder s power of appointment a prohibition of appointment while a withdrawal right remains outstanding and has not yet lapsed; otherwise the IRS may argue that the withdrawal right can be unilaterally cut off by the special power holder and is therefore illusory (i.e., does not qualify for a present interest gift exclusion under Crummey). See, Rev. Rul. 81-7, C.B (B) Marital and Charitable Deduction Issues. Care must be taken to avoid impairing a marital or charitable deduction because of the special power holder s power of appointment. Therefore, the special power holder s power of appointment should be modified with respect to a marital deduction trust so that the class of donees is limited to the surviving spouse. No power of appointment by the special power holder should be granted over a trust that contains a charitable devise, unless the power is carefully drafted to avoid impairing the charitable deduction. (C) Drafting example: Trust Termination and Limited Power of Appointment by Special Power Holder. Each trust may, from time to time, have a special power holder. A special power holder may be appointed: (i) by me, in a writing delivered to the Trustee of the trust in question, (ii) by a majority in interest of the current trust beneficiaries of the trust in question, with one (1) vote

7 being cast by each such beneficiary who is sui juris, one (1) vote being cast for each such minor beneficiary by his or her custodial parent, and one (1) vote being cast by the legal guardian for any such beneficiary having a legal guardian, (iii) by the Trustee then serving of the trust in question, or (iv) by a court of competent jurisdiction. Once appointed, a special power holder may not be removed except by a court of competent jurisdiction and then only for reasonable cause. After my death, the special power holder may terminate a trust, in whole or in part, pursuant to the criteria set forth in the paragraph entitled, Termination of Trust. [See, previous drafting example, immediately above]. Furthermore, after my death, Trustee shall distribute all or any part of the trust estate (other than life insurance on the special power holder s life) as the special power holder (in a non-fiduciary capacity) from time to time appoints in a writing that is delivered to Trustee, to any one or more of the trust s beneficiaries, including contingent remainder beneficiaries (but not to the special power holder, the special power holder s estate, or the creditors of either) and in such proportions (equal or unequal) and in such manner (whether out right or in trust) as the special power holder specifies. Provided, however, that no such distribution may be applied or distributed that would give the special power holder any pecuniary benefit or would discharge or satisfy the special power holder s legal obligations. Any person serving or appointed to serve as a special power holder must not be related or subordinate (within the meaning of IRC section 672 (c)) to me or to any beneficiary of the trust in question. A special power holder (then acting or nominated) may resign at any time by giving written notice, specifying the effective date of resignation to Trustee of the trust in question or to any current income beneficiary of the trust in question. If the special power holder is incapacitated, then he or she will be deemed to have automatically resigned as special power holder. Notwithstanding any other provision of this trust agreement, the special power holder shall not exercise any power or discretion conferred under this trust agreement: (i) for the direct or indirect benefit of the special power holder, the special power holder's estate, or the creditors of either, (ii) that would cause the special power holder to possess a general power of appointment within the meaning of IRC sections 2041 and 2514, (iii) that would impair a beneficiary s outstanding withdrawal right that has not yet lapsed, (iv) that would prevent an existing bequest from qualifying (or continuing to qualify) for the marital or charitable deduction or from enabling an increase in basis (if applicable) under the Internal Revenue Code, (v) that would impair the status or qualification of a trust that holds shares of stock in a Subchapter S corporation, or (vi) that would otherwise impair a qualified family owned business interest deduction taken under IRC section The special power holder, acting in its capacity hereunder, shall have no fiduciary duty to any trust beneficiary and shall be indemnified and held harmless by the trust and the beneficiaries who are benefitted by the exercise of the special power holder s authority hereunder.

8 1.4 All to Surviving Spouse in a QTIP Marital Deduction Trust with Clayton Contingent QTIP Election. An alternative to the traditional reduce to zero marital deduction formula is the use of a single marital deduction QTIP trust subject to a Clayton contingent QTIP election. In such instance, the residue of the decedent s estate (to the extent the assets qualify for the marital deduction) is left to a single QTIP marital deduction trust for the benefit of the surviving spouse. Through the use of a Clayton contingent QTIP election the decedent s fiduciary can then determine how much of the QTIP trust property should be qualified for the marital deduction. With a six (6) month extension to file the decedent s federal estate tax return, the decedent s fiduciary will have fifteen (15) months (or longer) to determine the appropriate contingent QTIP election amount. This fifteen (15) month window period affords tremendous post mortem flexibility, as discussed below. The Clayton contingent QTIP election is a more flexible variation of the traditional partial QTIP election. A Clayton contingent QTIP election permits a surviving spouse s income interest in a QTIP marital deduction trust to be contingent on the fiduciary s election to treat the marital trust property as QTIP property under IRC section 2056(b)(7). The property elected for QTIP treatment remains in the QTIP marital deduction trust while the non-elected portion of the QTIP trust property is generally distributed to the surviving spouse or the decedent s descendants, either outright or in further trust, such as a credit shelter trust or a descendants trust. (A) History and Regulatory Authority for Clayton Contingent QTIP Election. In 1997 the IRS, in response to Estate of Arthur M. Clayton, Jr. v. Commissioner, 976 F2d 1486 (5 th Cir., 1992) and its progeny, issued regulations effective with respect to QTIP elections made after February 18, 1997, which allow the surviving spouse s income interest in a trust to qualify for treatment as QTIP although it is contingent on a QTIP election being made by the decedent s executor. That portion of property for which the QTIP election is not made can pass to the surviving spouse and/or other beneficiaries (e.g., a credit shelter trust). Reg. section (b)-7(d)(3), reads as follows:

9 (3) Contingent income interests. (i) An income interest for a term of years, or a life estate subject to termination upon the occurrence of a specified event (e.g., remarriage), is not a qualifying income interest for life. However, a qualifying income interest for life that is contingent upon the executor's election under section 2056(b)(7)(B)(v) will not fail to be a qualifying income interest for life because of such contingency or because the portion of the property for which the election is not made passes to or for the benefit of persons other than the surviving spouse. This paragraph (d)(3)(i) applies with respect to estates of decedents whose estate tax returns are due after February 18, This paragraph (d)(3)(i) also applies to estates of decedents whose estate tax returns were due on or before February 18, 1997, that meet the requirements of paragraph (d)(3)(ii) of this section. Reg. section (b)-7(h) Ex. 6, illustrates the operation of the contingent income interest election: Example (6). Spouse's qualifying income interest for life contingent on executor's election. D's will established a trust providing that S is entitled to receive the income, payable at least annually, from that portion of the trust that the executor elects to treat as qualified terminable interest property. The portion of the trust which the executor does not elect to treat as qualified terminable interest property passes as of D's date of death to a trust for the benefit of C, D's child. Under these facts, the executor is not considered to have a power to appoint any part of the trust property to any person other than S during S's life. (B) Drafting example: Residue of Trust Estate to QTIP Marital Deduction Trust Subject to Clayton Contingent QTIP Election and Survival of Spouse. After first satisfying all of my just debts and approved claims against my estate, the expenses of the administration of my estate, and the payment of any specific devises contained in this trust agreement or under my will, if I am survived by my spouse, Trustee shall distribute the remaining trust property to the QTIP Marital Deduction Trust; provided, however, Trustee shall first distribute to the Family Trust [i.e., credit shelter trust] any trust property: (i) that does not qualify for the federal estate tax marital deduction, or (ii) is excluded from inclusion in my gross estate for federal estate tax purposes, or (iii) is otherwise exempt from federal estate tax in the first instance. Only property that qualifies for the federal estate tax marital deduction shall be distributed to the QTIP Marital Deduction Trust. If an election is made to qualify a fractional or percentile portion (but not all) of the QTIP Marital Trust for the federal estate tax marital deduction under IRC section 2056 (b)(7), I give to the QTIP Marital Deduction Trust only that fractional or percentage

10 share of the QTIP Marital Deduction Trust as to which my fiduciary shall make the QTIP election under IRC section 2056 (b)(7). That portion of the QTIP Marital Deduction Trust as to which my fiduciary shall not make the IRC section 2056 (b)(7) QTIP marital deduction election shall be distributed to the Family Trust [i.e., credit shelter trust] to be administered, distributed and disposed of under the terms of that trust. If I am not survived by my spouse, Trustee shall instead distribute the remaining trust property to the Family Trust. (C) Drafting Point: Because a Clayton contingent QTIP election is a form of partial QTIP election, they should not be used together for the same marital deduction trust. They are mutually exclusive. Therefore, use one or the other, but not both for the same marital deduction trust. (D) Postmortem Flexibility. The Clayton contingent QTIP election provides tremendous postmortem flexibility. This is because the executor has at least fifteen (15) months (nine (9) month due date for filing the decedent s 706 plus a six (6) month extension) after the death of the decedent to assess the current situation and determine the appropriate response. Reg. section (b)-7(b)(4)(i). No other form of marital deduction provides this amount of flexibility. (1) Because of the fifteen (15) month post death window period available to the executor to determine how much trust property should be elected for the QTIP marital deduction, there is no need for a six (6) month spousal survival requirement clause in the decedent s governing instrument. Similarly there is also no need for a marital deduction equalization clause in the decedent s governing instrument. (2) The Clayton contingent QTIP election not only permits the executor of the decedent s estate to determine the optimum amount of the marital deduction for equalization purposes if the surviving spouse dies within fifteen (15) months of the decedent, but it also permits the executor to give consideration to the possible use of the previously taxed property ( PTP ) credit under IRC section 2013 as concerns a surviving spouse who has died within the fifteen (15) months or has a short life expectancy.

11 (a) A considerable overall estate tax savings can result if a Clayton contingent QTIP election is made by the decedent s executor and the estate pays some estate tax. A portion of the estate tax paid will be allowed as a credit against the estate tax otherwise payable on the death of the surviving spouse. A credit is allowable under IRC section 2013 for the portion of the tax attributable to the actuarially determined value of the income interest in the portion of the trust that is not elected for QTIP treatment (or for that matter, any other non marital trust) in which the surviving spouse has an income interest capable of valuation, under IRC section 7520 and Reg. section (b)(3), (which prohibits use of the tables when death is clearly imminent) even though none of the trust corpus is includable in the surviving spouse s gross estate. Examples of a surviving spouse s trust interest that might provide a PTP credit are the non-elected QTIP portion and a credit shelter trust that provide mandatory income to the surviving spouse for life or a term of years. (b) The full amount of the PTP credit is allowed if the surviving spouse dies within two (2) years of the decedent. Thereafter the amount of the credit diminishes by twenty (20%) percent every two (2) years. At the end of ten (10) years no credit is allowable. (E) Death Tax Apportionment Issues. Whenever a Clayton contingent QTIP marital deduction trust is utilized, provision needs to be made concerning the apportionment of estate taxes attributable to the property that is not elected for the marital deduction. Since the QTIP marital deduction trust constitutes the residue of the grantor s estate, care must be taken to ensure that estate taxes attributable to the non-elected portion (i.e., the portion that is distributed to the credit shelter trust) are not apportioned against the QTIP marital deduction trust. Many estate tax apportionment clauses routinely apportion taxes to the residue of the grantor s estate. Such a provision could impair the marital deduction (to the extent of the estate taxes apportioned against it). It may be appropriate to specifically apportion to the non-elected property any federal estate taxes attributable to that property.

12 (1) Drafting example: Estate Taxes to be Paid from and Charged to Estate. Except as provided in the below sub-paragraph entitled, "Payment of Death Taxes From Property," I direct that all federal estate taxes, which shall become payable with respect to any property, or interest therein, whether such property or interest passes under this will, my revocable living trust agreement or otherwise, and which is properly includable in my estate for any such taxation purposes by any domestic or foreign taxing authority, shall be charged to and paid out of that portion of my estate which is not included in a gift qualifying for the marital or charitable deduction. Generation skipping transfer taxes, including interest and penalty shall be borne by and be paid out of the property generating the tax (notwithstanding the provisions of IRC section 2602(a)(3)). Except as provided in the below sub-paragraph entitled, "Payment of Death Taxes From Property," my personal representative shall not seek recovery or reimbursement from, or apportionment between or among the recipients of any such property or interest. Subject to the foregoing, federal estate taxes shall be paid from the residue of my estate and not from any trust that qualifies for the federal estate tax marital or charitable deduction. (A) Payment of Death Taxes From Property. Federal estate taxes (computed on a marginal basis) including interest and penalty thereon, shall be borne by and paid out of the property to which the tax is attributable, to wit: (1) Any disclaimer by a beneficiary (to the extent the disclaimed property does not otherwise qualify for the marital or charitable deduction), or (2) The failure of my fiduciary to elect the marital deduction as to any property as to which such an election could be made under the qualified terminable interest property provisions of the tax law (but only to the extent that the non elected portion of said property is considered to be held in separate trust vis-a-vis the elected portion of said property),

13 (i.e., the amount by which my federal estate tax exceeds the amount such taxes would have been had such disclaimed or non-elected property not been subject to such taxes) shall be borne by and paid out of the disclaimed or non-elected but otherwise eligible qualified terminable interest property, as the case may be. 1.5 Outright to Surviving Spouse with Right to Disclaim to Credit Shelter Trust. In instances where the combined estates of the husband and wife are less than the current estate tax applicable exclusion amount, an alternative to the Clayton contingent QTIP election is for the grantor to leave the residue of his or her estate outright to the surviving spouse. The surviving spouse can then disclaim whatever interests or amounts that the spouse determines to be appropriate. Unlike the Clayton contingent QTIP election, which provides the fiduciary with at least fifteen (15) months (based on a six (6) month extension to file the decedent s federal estate tax return) to determine the appropriateness and amount of the marital deduction, the qualified disclaimer rules under IRC section 2518 provide the surviving spouse with only nine (9) months to determine the appropriateness and the amount to be disclaimed. Furthermore, the surviving spouse cannot disclaim property if he or she has accepted any benefits from that property a potential trap. Property disclaimed by the surviving spouse under IRC section 2518 may be held in further trust for the surviving spouse, such as a QTIP marital deduction trust or a credit shelter trust, or may be distributed to other beneficiaries (either outright or in trust), as predetermined by the deceased grantor and as specified in the deceased grantor s trust instrument. Because the surviving spouse cannot have any discretion as to who receives the disclaimed property, the surviving spouse cannot hold a power of appointment, either as a beneficiary or as a trustee over the disclaimed property, other than a 5x5 right of withdrawal (Reg. section (e)(5), Example 7) or a power limited by an ascertainable standard (Reg. section (e)(2). (A) Federal Law Authorizing Disclaimers. Federal law concerning the estate and gift tax consequences of qualified disclaimers is contained in IRC section 2518, which sets forth the rules that must be followed for a disclaimer to be qualified and gift tax-free by the disclaimant. IRC section 2518 applies to taxable transfers made after December 31, 1976 that create an interest in the person attempting to disclaim the interest. Reg. section (a).

14 IRC section (a) General rule. For purposes of this subtitle, if a person makes a qualified disclaimer with respect to any interest in property, this subtitle shall apply with respect to such interest as if the interest had never been transferred to such person. (b) Qualified disclaimer defined. For purposes of subsection (a), the term "qualified disclaimer" means an irrevocable and unqualified refusal by a person to accept an interest in property but only if (1) such refusal is in writing, (2) such writing is received by the transferor of the interest, his legal representative, or the holder of the legal title to the property to which the interest relates not later than the date which is 9 months after the later of (A) the day on which the transfer creating the interest in such person is made, or (B) the day on which such person attains age 21, (3) such person has not accepted the interest or any of its benefits, and (4) as a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either (A) to the spouse of the decedent, or (B) to a person other than the person making the disclaimer.

15 (c) Other rules. For purposes of subsection (a) (1) Disclaimer of undivided portion of interest. A disclaimer with respect to an undivided portion of an interest which meets the requirements of the preceding sentence shall be treated as a qualified disclaimer of such portion of the interest. (2) Powers. A power with respect to property shall be treated as an interest in such property. (3) Certain transfers treated as disclaimers. A written transfer of the transferor's entire interest in the property (A) which meets requirements similar to the requirements of paragraphs (2) and (3) of subsection (b), and (B) which is to a person or persons who would have received the property had the transferor made a qualified disclaimer (within the meaning of subsection (b)), shall be treated as a qualified disclaimer. (Emphasis added.) (B) Michigan Law Authorizing Disclaimers. With the exception of the rule described in IRC section 2518(c)(3) concerning certain transfers being treated as if they were qualified disclaimers, a disclaimer must be valid under applicable state law in order to be valid under IRC section Michigan s statutory law governing disclaimers is contained in EPIC sections (MCLA , MSA ). The common law right of disclaimer has been abolished in Michigan. EPIC section (1) For additional information concerning disclaimers under Michigan law, see Zack, Clients with Estates of less than $2 million: Disclaimer Planning and Drafting, 11 th Annual Drafting Estate Planning Documents Seminar, ICLE (January2002), course materials # ICLE may be reached at , or

16 (C) Drafting example of disclaimable bequest to spouse: Marital Bequest to Surviving Spouse with Right to Disclaim. After first satisfying all of my just debts and approved claims against my estate, the expenses of the administration of my estate, and the payment of any specific devises contained in this trust agreement or under my will, if I am survived by my spouse, Trustee shall distribute the remaining trust property to my spouse, outright and free of trust; provided however, my spouse, or my spouse's agent under a power of attorney, or my spouse's conservator, or the executor of my spouse's estate, or, if my spouse has no probate estate, the trustee of any trust created by my spouse containing one-third or more in value of my spouse's assets, or any other person permitted by law, shall have the right, to the extent permitted by law, to disclaim all or any part of this marital bequest. Any property or amount of this marital bequest that is disclaimed shall become part of the Family Trust [i.e., credit shelter trust]. To the extent permitted by law, disclaimers under this paragraph may be either qualified disclaimers or non-qualified disclaimers under federal tax law, provided, however, if the disclaimer is not a qualified disclaimer under IRC section 2518, then and in that event, any property (or interest therein) disclaimed by my Spouse in the first instance shall instead be distributed to the Children s Trust, [i.e., descendants trust], which shall be administered in all regards as if my spouse had predeceased me. A disclaimer shall become effective upon the first to occur: (i) as provided by law, or (ii) upon written notice to Trustee.. If the Family Trust contains a power of appointment, excercisable by my Spouse, either as a beneficiary or as a trustee over the disclaimed property (other than those powers permitted by IRC section 2518, to wit, an inter vivos "5x5" withdrawal right limited to the dollar and percentage amounts set forth in IRC sections'' 2041(b)(2)(A) and (B) and 2514(e)(1) and (2)) (as is permitted by Reg. section (e)(5), Example 7) and powers limited by an ascertainable standard (as is permitted by Reg. section (e)(2))), then and in that event, any interest in the marital bequest that is disclaimed, shall not be allocated to the Family Trust, but shall instead be allocated to a new, separate trust to be known as the "Disclaimer Trust," the provisions of which are identical to those of the Family Trust, including trusteeship, except that my Spouse shall neither possess nor exercise any powers prohibited by IRC section 2518 or applicable Treasury Regulations, either as beneficiary or as a trustee over the Disclaimer Trust, either during lifetime or on death.

17 (D) Durable Powers of Attorney and Disclaimers. When utilizing a spousal disclaimer approach, it may be helpful to grant the surviving spouse s agent under a durable power of attorney the authority to execute qualified disclaimers on behalf of the surviving spouse. State law should be consulted to determine if an agent can exercise a disclaimer on behalf of a principal, and the procedures that must be followed. (1) Drafting example of power of attorney s authority to disclaim: Disclaim Property. My attorney-in-fact acting under this durable power of attorney is authorized and empowered to execute and deliver disclaimers, either partial or complete, of any rights or interest I now or hereafter may have, if my attorney-in-fact deems it probable that no gift taxes will be imposed on me on account of such disclaimer; provided however, my attorney-in-fact may not disclaim assets to which I would otherwise be entitled if such disclaimer would result in such assets passing directly to my attorney-in-fact or his or her estate. (E) Disclaimers and Apportionment of Death Taxes. Whenever a spousal disclaimer approach is utilized, provision needs to be made concerning the apportionment of estate taxes attributable to the disclaimed property that does not qualify for the marital deduction. Since the outright bequest to the surviving spouse constitutes the residue of the grantor s estate, care must be taken to ensure that any estate taxes attributable to the disclaimed property are generally not apportioned against the residue. Many estate tax apportionment clauses routinely apportion taxes to the residue of the grantor s estate. Such a provision could impair the marital deduction (to the extent of the estate taxes apportioned against it). It may be appropriate to specifically apportion to the disclaimed property any federal estate taxes attributable to that property. (1) Drafting example: Estate Taxes to be Paid from and Charged to Estate. Except as provided in the below sub-paragraph entitled, "Payment of Death Taxes From Property," I direct that all federal estate taxes (including

18 interest and penalty thereon), which shall become payable with respect to any property, or interest therein, whether such property or interest passes under this will, my revocable living trust agreement or otherwise, and which is properly includable in my estate for any such taxation purposes by any domestic or foreign taxing authority, shall be charged to and paid out of that portion of my estate which is not included in a gift qualifying for the marital or charitable deduction. Generation skipping transfer taxes, including interest and penalty shall be borne by and be paid out of the property generating the tax (notwithstanding the provisions of IRC section 2602(a)(3)). Except as provided in the below sub-paragraph entitled, "Payment of Death Taxes From Property," my personal representative shall not seek recovery or reimbursement from, or apportionment between or among the recipients of any such property or interest. Subject to the foregoing, federal estate taxes shall be paid from the residue of my estate and not from any trust that qualifies for the federal estate tax marital or charitable deduction. (1) Payment of Death Taxes From Property. Federal estate taxes (computed on an incremental/marginal basis) and interest and penalty thereon, shall be borne by and paid out of the property to which the tax is attributable, to any disclaimer by a beneficiary (to the extent the disclaimed property does not otherwise qualify for the marital or charitable deduction. (F) Surviving Spouse as Trustee of Credit Shelter (Disclaimer) Trust. The surviving spouse may serve as trustee of a trust that contains property that the surviving spouse disclaimed pursuant to IRC section Because IRC section 2518 prohibits the surviving spouse from holding a power to direct the disposition of the disclaimed property, the surviving spouse must not be granted any powers over the disclaimed trust property, either as a trust beneficiary or as a trustee of the trust, that violate IRC section In this regard, Treasury Regulations permit the surviving spouse to serve as trustee of the trust that contains the disclaimed property provided the surviving spouse holds no powers of appointment or discretion over the trust property. Reg. section (e)(1)(i). Thus, the surviving spouse can serve as sole trustee over the credit shelter trust, which is the repository for the disclaimed property, if the credit shelter trust contains mandatory distributions (i.e., no discretion on the part of the trustee) or ascertainable standards for distributions of principal and/or income. Reg. section (e)(2) and Reg. section (e)(2) examples (11) and (12).

19 (1) Drafting example: Credit Shelter Trust. Trustee shall hold the Credit Shelter Trust for the following purposes: (a) Income. Trustee shall pay all the net income to or for the benefit of my Spouse until death, at least annually. (b) Principal. If the trust s net income and other assets reasonably and readily available to my Spouse are insufficient to maintain the health, education, support and maintenance of my Spouse in my Spouse s accustomed manner of living at the time of my death, Trustee shall use that portion of principal necessary to enable my Spouse to maintain that standard of living. Furthermore, an Independent Trustee may, in its sole and absolute discretion, distribute such amounts of principal to or for the benefit of my Spouse and my then living descendants, in such amounts and proportions (with no requirement as to equality or any pro rata scheme of distribution) as the Independent Trustee shall determine (including the terms and conditions thereof), after giving due consideration to the needs of my Spouse, who is the primary and preferred beneficiary of the Credit Shelter Trust. If possible, the Independent Trustee shall consult with my Spouse concerning any proposed distributions. (c) Residue. At my Spouse's death, the remaining Credit Shelter Trust property, together with any income of the Credit Shelter Trust not distributed during my Spouse's lifetime, shall be distributed to, and be administered under the provisions of the Paragraph entitled, "Descendants Trust." (d) Trustees. The following persons shall serve, in priority of the order listed, as the Trustee of the Credit Shelter Trust:

20 my Spouse, provided however, if any property has passed to the Credit Shelter Trust as a result of my Spouse having made a disclaimer and such Trust either (a) permits my Spouse as a Trustee to make discretionary distributions of income and/or principal not limited by an ascertainable standard or (b) contains a power exercisable by my Spouse as a Trustee that is not permitted under IRC section 2518 or applicable Treasury Regulations, then and in that event, my Spouse shall not be permitted to serve as a Trustee or co-trustee of the trust in question. «AltTrustee2» of «AltTrst2Address» «AltTrustee3» of «AltTrst3Address» «AltTrustee4» of «AltTrst4Address» (G) Drafting point: In the absence of state law to the contrary, a spendthrift provision in a trust will generally be construed to prohibit a disclaimer. Therefore, include in the spendthrift clause the following language: This spendthrift provision shall not restrict the exercise of a disclaimer. (H) Closing Letter to Client Regarding Disclaimer Trust. Because of the nine (9) month time limit on qualified disclaimers and the prohibition of the surviving spouse s acceptance of benefits from the disclaimable property, it may be appropriate to include a reminder in your closing letter to the clients of the need to be vigilant about this form of marital deduction planning. (1) Drafting example: Dear Mr. and Ms. Client:

21 As I mentioned in our initial conference and at the execution of your estate plan, the living trust plan that you have chosen leaves all of your estate outright to your surviving spouse and does not provide any self-initiating estate tax or generation skipping transfer tax benefits or savings. Your trust does, however, permit your surviving spouse to make qualified disclaimers that may result in estate tax benefits or savings; however, qualified disclaimers must be made within a short period of time after your demise and the surviving spouse must not have accepted any benefits from the property that he or she desires to disclaim. Disclaimers should only be done after consultation with competent tax counsel. At a later date, you may want to consider revising your living trust so as to automatically provide for self-initiating estate tax benefits or savings (rather than relying on your surviving spouse to affirmatively make qualified disclaimers). (I) Additional Information on Marital Deduction Disclaimer Trusts. For additional information concerning marital deduction disclaimer trusts, including a complete sample trust form, see Grassi, Drafting the Marital Deduction Disclaimer Trust After EPIC and The 2001 Tax Act, 11 th Annual Drafting Estate Planning Documents Seminar, ICLE (January 2002) course materials # ICLE may be reached at or Disclaimer Based GST Planning. With the increasing GST exemption and its tentative repeal in 2010, GST formula clauses may, in the absence of a dollar amount cap, allocate more to a dynasty trust for the benefit of the grantor s grandchildren and less to the grantor s children. This unintended result and potential detriment to the grantor s children can be dealt with by not establishing a testamentary dynasty trust for the grandchildren, and instead having the grantor devise his or her estate to the children. The children can then disclaim the amount that they determine to be appropriate, with the disclaimed amount being distributed to a dynasty trust for the disclaimant s descendants, i.e., the grantor s grandchildren and more remote descendants. The children s qualified disclaimers under IRC section 2518 will not result in the children being treated as the transferor for GST purposes, and thus will preserve the use of the deceased grantor s unused GST exemption which can then be allocated to the disclaimed amount. The children s qualified disclaimers will not, however, invoke the so called predeceased parent rule under IRC section 2651(e), which for GST purposes permits a grandchild to move up a generation assignment (into that of his or her

22 parent s generation assignment) if the parent dies within ninety (90) days after the death of the grantor-transferor. Although state law may treat a disclaimant-child as having predeceased the grantor-transferor, Treasury Regulations specifically deny the applicability of IRC section 2651(e) to such disclaimers. Reg. section (a)(2)(i). Since the disclaimant children cannot have a power of appointment over the disclaimed property, it is best to prohibit a disclaimant child from serving as trustee of the dynasty trust, which is typically a discretionary trust. (A) Drafting example: Distribution to Children with Right to Disclaim. When my spouse dies or when I die, whichever is later, Trustee shall divide the remaining trust property, including additions from any sources, into separate shares, equal in value, one for each child of mine who survives me and my spouse and one for each child of mine who does not survive me and my spouse but is survived by then living descendants, such descendants to take by right of representation. Trustee shall then distribute each share, outright and free of trust; provide however, a beneficiary, or a beneficiary s agent under a power of attorney, or a beneficiary s court appointed legal representative, or any other person permitted by law, shall have the right to disclaim all or any part of that beneficiary s devise. Any property or amount of a beneficiary s devise that is disclaimed shall be held in a continuing ( pot ) trust by the Independent Trustee for the benefit of the beneficiary-disclaimant s descendants, who are then living from time to time. The Independent Trustee, in its sole and absolute discretion may pay such amounts of the continuing trust s net income and principal to or for the benefit of such descendants and in such proportions (equal or unequal) as the Independent Trustee determines. Unless earlier terminated, the continuing trust for such descendants shall terminate one day before the expiration of the applicable rule against perpetuities (or similar applicable rule concerning alienation and vesting of trust interests) and the Independent Trustee shall distribute the assets of the continuing trust pro-rata among the trust s then living beneficiaries, outright and free of trust. My fiduciary is authorized to allocate the unused portion of my generation skipping tax exemption to any such continuing trust so that the trust has an inclusion ratio of zero (0) for generation skipping transfer tax purposes.

23 (B) Trustee Powers. Whenever a trust has the possibility of having a GST issue arise, it is appropriate to include comprehensive trustee powers in that regard. The below trustee powers concerning GST issues track the current Treasury Regulations and include trustee authority to under take a qualified severance of a single trust, as is permitted under IRC section 2642(a)(3) as added by the 2001 Tax Act. (1) Drafting example: Trustee Powers Concerning Generation-Skipping Tax Matters. In order to minimize the impact of any generation-skipping transfer tax that may be applied to any of the trusts created by this Agreement or their beneficiaries, Trustee shall take the following actions, where applicable: (1) If any trust under this trust agreement would otherwise by reason of an allocation of generation-skipping transfer tax exemption to it, have an inclusion ratio, as defined in IRC section 2642(a) of neither one (1) nor zero (0), then prior to such allocation Trustee shall divide, on a fractional basis, the total trust assets into two (2) separate trusts of equal or unequal value, to permit allocation of the exemption solely to one trust (the "exempt trust") so that the exempt trust will have an inclusion ratio of zero (0); any such division shall be accomplished by allocating to the other trust (the non-exempt trust which will have an inclusion ratio of one (1)) the minimum fractional share necessary to leave the exempt trust with a corpus of the desired value and an inclusion ratio of zero (0), so as to be entirely exempt from generation-skipping tax. Trustee is also authorized to sever a single trust into multiple trusts under the qualified severance rules of IRC section 2642(a)(3). References hereunder to "trust" or "trusts" refer also to arrangements that are treated as trusts for generationskipping purposes and to separate shares of a trust, when appropriate to the context, if the shares are, as "substantially separate and independent shares of different beneficiaries" or otherwise, entitled to be treated as separate trusts for generation-skipping tax purposes.