RECIPES FOR INCOME AND ESTATE TAX PLANNING IN Presented by: LORA G. DAVIS, Dallas The Blum Firm. STEPHANIE E. DONAHO, Houston Locke Lord LLP

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1 RECIPES FOR INCOME AND ESTATE TAX PLANNING IN 2014 Presented by: LORA G. DAVIS, Dallas The Blum Firm STEPHANIE E. DONAHO, Houston Locke Lord LLP ALVIN J. GOLDEN, Austin Ikard Golden Jones, P.C. Moderated by: MICKEY R. DAVIS, Houston Davis & Willms, PLLC State Bar of Texas 20 TH ANNUAL ADVANCED ESTATE PLANNING STRATEGIES COURSE April 24-25, 2014 Denver, CO CHAPTER 1

2 MICKEY R. DAVIS Moderator Davis & Willms, PLLC 3555 Timmons Lane, Suite 1250 Houston, Texas Fax LORA G. DAVIS Panelist The Blum Firm, P.C. 300 Crescent Court, Suite 1350 Dallas, Texas Fax STEPHANIE E. DONAHO Panelist 2800 JPMorgan Chase Tower 600 Travis Houston, Texas ALVIN J. GOLDEN Panelist Ikard Golden Jones, P.C. 400 W. 15 th Street, Suite 975 Austin, Texas Fax

3 Papers Included in the Written Materials: PART 1 Recipes for Income and Estate Tax Planning in 2014 By Mickey R. Davis PART 2 The Optimal Basis Increase and Income Tax Efficiency Trust By Edwin P. Morrow III PART 3 Portability + QTIP = A Happy Couple or a Recipe for Family Discord? By Charles A. Granstaff PART 4 "Constrained" General Powers of Appointment Matrix and Sample Language By Terence Nunan

4 RECIPES FOR INCOME AND ESTATE PLANNING IN 2014 Presented and Written by: MICKEY R. DAVIS Co-written by: MELISSA J. WILLMS Davis & Willms, PLLC 3555 Timmons Lane, Suite 1250 Houston, Texas Ph: Fax: State Bar of Texas 20 TH ANNUAL ADVANCED ESTATE PLANNING STRATEGIES COURSE April 24-25, 2014 Denver, CO CHAPTER , Mickey R. Davis and Melissa J. Willms, All Rights Reserved.

5 Recipes for Income and Estate Tax Planning in 2014 Chapter 1 TABLE OF CONTENTS I. Introduction... 1 II. Federal Estate, Gift and GST Tax Laws... 1 A. Permanent, Unified Tax System Historical Perspective American Taxpayer Relief Act of 2012, P.L Permanency Clawback... 2 B. Portability Disadvantages of Portability vs. Bypass Trusts Use with Bypass Trusts It's Not "Either/Or" Estate Administration Musts Temporary and Proposed Regulations Overview of Regulatory Provisions and Observations Inclusion in Marital Property Agreements... 9 III. Additional Income Tax on Estates and Trusts... 9 A. Health Care and Education Reconciliation Act of 2010, P.L B. IRC C. Regulations Proposed Regulations Final Regulations D. Net Investment Income vs. Undistributed Net Investment Income E. Trade or Business F. Trusts G. Grantor Trusts H. Special Problem Areas Capital Gains Passive Activities, Passive Income, and the Passive Loss Rules Qualified Subchapter S Trusts ("QSSTs") Electing Small Business Trusts ("ESBTs") Charitable Remainder Trusts Allowable Losses and Properly Allocable Deductions I. Special Notes. A few additional items of note: Tax Does Not Apply to Distributions from Qualified Plans Nonresident Aliens J. Planning for the Tax IV. What Works Now? A. Intra-Family Loans Term Loans Demand Loans Note Terms Impact of Interest Rates Income Tax Issues Death During Term Use with Grantor Trusts Rates and Yield Curves Current Rates Using A Balloon Note i

6 Recipes for Income and Estate Tax Planning in 2014 Chapter Payment at Maturity B. Sale to an Intentionally Defective Grantor Trust Structure of the IDGT Seeding of Trust Impact of Interest Rates Servicing the Debt Grantor Trust Implications Death of Note Holder Benefit to Heirs GST Issues Selling Discounted Assets Lack of Certainty C. Grantor Retained Annuity Trusts Structure Setting the Annuity Gift on Formation Impact of Interest Rates Zeroed-Out GRATs Death During GRAT Term Payments in Kind Benefit to Heirs GST Issues Short-term v. Long-term GRATs Insuring the GRAT D. Charitable Lead Annuity Trusts Basic Structure Gift on Formation Setting the Interest Rate Income Tax Issues Death During Term) Benefit to Heirs GSTT Issues CLATs and Business Interests E. Outright Gifting What to Give Gift Tax and the Three Year Rule Carry-Over Basis Income Tax Issues Giving Discounted Assets F. Self-Cancelling Installment Notes SCIN Terms Risk Premiums Death Before Maturity Impact of Life Expectancy Impact of Interest Rates G. Private Annuities Private Annuities Income Taxation of Annuity Payments The Exhaustion Test Estate Tax Exposure ii

7 Recipes for Income and Estate Tax Planning in 2014 Chapter 1 5. Outliving the Tables Best Time for Private Annuities H. Sale to "Accidentally Perfect Grantor Trusts" Structure of the APGT Basis Issues Impact of Interest Rates Benefit to Heirs Income Tax Issues Estate Tax Issues GST Issues Selling Discounted Assets I. The Preferred Partnership "Freeze" Structure of the Preferred Partnership Structuring the Preferred Payment Rights Valuing the Preferred Interest Giving Away the Preferred Partnership Interest Giving Away the Common Partnership Interest Where to Give V. A New Estate Planning Paradigm A. New Prominence for QTIP Trusts? Bypass Trust Benefits Bypass Trust Costs Contrast the QTIPable Trust B. QTIP Trust Disadvantages: No "Sprinkle" Power Estate Tax Exposure Income Tax Exposure C. Building in Flexibility Disclaimer Bypass Trusts Is a QTIP Election Available? Clayton QTIP Trusts The Three-Choice Option D. The QTIP Tax Apportionment Trap E. What to Do with Old Bypass Trusts Strategies for Income Tax Rates Strategies for Basis Adjustment VI. Conclusion EXHIBIT A: Sample Letter Regarding Portability EXHIBIT B: IRC 1411 Net Investment Income (Preliminary) iii

8 THE OPTIMAL BASIS INCREASE AND INCOME TAX EFFICIENCY TRUST Written by: EDWIN P. MORROW, III Senior Wealth Specialist Key Private Bank State Bar of Texas 20 TH ANNUAL ADVANCED ESTATE PLANNING STRATEGIES COURSE April 24-25, 2014 Denver, CO CHAPTER 1.2

9 The Optimal Basis Increase and Income Tax Efficiency Trust Chapter 1.2 The Optimal Basis Increase and Income Tax Efficiency Trust Exploiting Opportunities to Maximize Basis, Lessen Income Taxes and Improve Asset Protection for Married Couples after ATRA (or: why you ll learn to love the Delaware Tax Trap) 1 (this version updated January 2014) By Edwin P. Morrow III, J.D., LL.M. (tax) edwin_p_morrow@keybank.com, edwin.morrow3@gmail.com I. Problems with Traditional AB Trust Design & the Lure of Portability 1 II. Marital Trusts not as simple a solution as you think 9 a. Clayton QTIP advantages over disclaimer planning b. Advantages of GPOA marital over QTIP? Drawbacks to both c. Techniques to adapt ordinary bypass trusts to increase basis III. Why Optimal Basis Increase Trusts (OBITs) are Superior to AB Trusts 17 a. Formula General Powers of Appointment b. Application to States with Separate Estate Tax c. Drafting GPOAs to Keep Fidelity to Plan and Asset Protection d. Exploiting the Delaware Tax Trap e. Comparing LPOAs & Delaware Tax Trap to Using Formula GPOAs IV. Busting Disclaimer Myths Using OBITs w/ Disclaimer Based Planning 46 a. How a spouse can retain LPOAs/GPOAs in trusts post-disclaimer V. Doubling or Increasing the Basis Step Up at First or Other Deaths 48 a. Transmutation Agreements and Alaska/TN Community Property Trusts b. Joint GPOA or Joint Exemption Step up Trusts ( JESTs ) c. Naked GPOAs and the Promise and Limits of Upstream Basis Planning 60 VI. Asset Protection Strategies Opened Up by Increased Exclusion 61 a. SLATs and ILITs with OBIT Clauses and de facto reversions VII. Application of OBIT Techniques to Existing Irrevocable Trusts 64 a. Using existing LPOAs to trigger 2041(a)(3) for basis increase b. Non-Judicial Settlement Agreements, Reformations, Decantings, etc VIII. Ongoing Income Tax Planning for Irrevocable Non-Grantor Trusts 72 a. IRC 678(a) Using Mallinckrodt/Beneficiary-Defective Grantor Trusts b. Using Exceptions that Permit Capital Gains to Pass Out w/dni on K-1 c. Using Lifetime Limited Powers of Appointment to Spray Income d. IRC 642(c) Seizing Above the Line Charitable Deductions in Trust IX. Summary also see attached Comparison Chart 91 Appendix frequently cited statutes, glossary of acronyms, author bio, sample clauses, proposed statutory amendment to state rule against perpetuities law 1 Portions of this outline were presented at other CLEs and were published in Trusts and Estates (Dec. 2012) and Leimberg LISI Estate Planning Newsletter #2080 (March 20, 2013) Edwin P. Morrow III and KeyBank, NA Contact author for later updates. Constructive criticism appreciated.

10 PORTABILITY + QTIP = A HAPPY COUPLE OR A RECIPE FOR FAMILY DISCORD? Written by: CHARLES A. GRANSTAFF State Bar of Texas 20 TH ANNUAL ADVANCED ESTATE PLANNING STRATEGIES COURSE April 24-25, 2014 Denver, CO CHAPTER 1.3

11 CONSTRAINED GENERAL POWERS OF APPOINTMENT (MATRIX AND SAMPLE LANGUAGE) Written by: TERENCE NUNAN State Bar of Texas 20 TH ANNUAL ADVANCED ESTATE PLANNING STRATEGIES COURSE April 24-25, 2014 Denver, CO CHAPTER 1.4