Reporting GRATS, GRUTS, ILITS and IDGTs on Form 709: GST Exemption Allocation Calculations and Strategies

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1 FOR LIVE PROGRAM ONLY Reporting GRATS, GRUTS, ILITS and IDGTs on Form 709: GST Exemption Allocation Calculations and Strategies WEDNESDAY, JULY 13, 2016, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. You will have to write down only the final verification code on the attestation form, which will be ed to registered attendees. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 Tips for Optimal Quality FOR LIVE PROGRAM ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem.

3 Reporting GRATS, GRUTS, ILITS and IDGTs on Form 709 July 13, 2016 Tracy M. Child, J.D., LLM., Partner Joy Matak, J.D., LLM., Director Sherman Wells Sylvester & Stamelman CohnReznick

4 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

5 Gift Tax Returns What is gift tax return? If a Donor makes a gift worth more than the annual tax exclusion amount ($14,000 in 2015 and 2016), the Donor must file a gift tax return (Form 709). Who is responsible for filing gift tax return? All individuals who make a gift to another individual or entity that exceeds the annual exclusion amount must file a gift tax return. The Donor is responsible for paying the gift tax, except in certain circumstances in which IRS allows the gift recipient to pay the gift tax. What is the benefit of filing gift tax return? By filling the gift tax return, the government is formally advised of the transfer and less likely to challenge that transaction in the future. 5

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8 WHO IS A Donee? Each individual, trust or charity listed on Schedule A equals one donee. However, if the beneficiaries of a trust have a present interest in the gift (e.g., Crummey withdrawal rights), then each beneficiary of the trust is a donee. 8

9 Bea Generous Donees Forgiveness of indebtedness owed by Marion Money Gift to Juana B. Generous Gift to Community Foundation Charitable Organization Gift to Easy Living Qualified Personal Residence Trust Gift to Bea Generous 2013 GRAT Gift to Ivan Money 2013 Trust 529 Plan Gift to Xavier Money Non-gift disclosure of sale to Grandchildren s Generous Trust Gift to Bea Generous GST Trust for Robin Money Robin Money has a right of withdrawal Gift to Collette A. Day Gift to Generous Giving Family Trust The following three beneficiaries each have a right of withdrawal: Ben Generous Marion Money (already counted above) Owen Money Gift to Generous Dynasty Trust Gift to Ben Generous Spousal Access Trust GST Allocation to Ben Generous 2011 GRAT upon termination TOTAL: = = = = = = = = = 1 donee 1 donee 1 donee 1 donee 1 donee 1 donee 1 donee 1 donee 1 donee = = 1 donee 2 donees = = = 1 donee 1 donee 1 donee 15 donees 9

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11 Basics A spouse of a donor may elect to be treated as the donor of one-half the value of the of the gifts made by the donor from the donor s separate funds. The spouse must sign the donor s gift tax return consenting to the election. If spouses choose to split gifts, they must split all eligible gifts. Spouses cannot split gifts made to a trust in which the other spouse has a beneficial interest, unless the other spouse s interest is ascertainable. 11

12 Example One Bea Generous creates a trust for the benefit of her husband, Ben Generous, and her descendants. The trustee has complete discretion to make distributions to the beneficiaries. The portion of the gift allocable to Ben is not ascertainable, so the election to split gifts to this trust would not be effective. 12

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14 Example Two Bea Generous gifts $78,000 to a Crummey trust. Ben and two of Bea s children each have the right to withdraw $26,000. Because Ben s interest in the gift is ascertainable (i.e., $26,000), they may split all but $26,000 of the gift. 14

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16 amount of gi split gst exemption allocation If spouses elect to split gifts and a portion of the gift cannot be split, as in the example above, the gift can still be fully split for GST exemption allocation purposes. In the example above, Ben is only reporting gifts of $28,000 to the trust beneficiaries, but he may allocate up to $42,000 of his GST exemption to the trust. 16

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18 Deceased Spousal Unused Exclusion or Portability If a first-to-die spouse has not fully used the lifetime exclusion, the unused portion can be transferred or ported to the surviving spouse. Thereafter, for both gift and estate tax purposes, the surviving spouse s exclusion is the sum of his/her own exclusion (as such amount is inflation adjusted), plus the first-to-die s ported Deceased Spousal Unused Exclusion (DSUE) amount. Example: Ben and Bea Generous (U.S. citizens) have only been married to each other. Bea owns assets worth $5.43 million and Ben owns assets worth $5.43 million. Ben Generous dies in 2015 leaving his entire estate to Bea, using none of his lifetime exclusion. Ben s DSUE amount is $5.43 million (his exclusion of $5.43 million less the $0 used, because all of his assets were transferred to Bea, his spouse). Bea s exclusion in 2015, for gift and/or estate tax purposes, is $10.86 million (her own $5.43 million plus the $5.43 million ported DSUE amount). Bea could make gifts of $10.86 million in 2015 and fully shield those gifts from transfer. If Bea did not make gifts but died in 2015 with a $10.86 million estate, she could fully shield her estate from estate taxes. The general rule is that surviving spouse can use the DSUE amount of his/her last deceased spouse. This will be an issue only if the survivor marries again. 18

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20 Schedule C Calculation of DSUE Amount 20

21 Applicable Credit Amount 21

22 Notes about DSUE Unused Generation Skipping Transfer Tax exemption cannot be used by a surviving spouse The DSUE may be affected on audit of a deceased spouse s prior gift tax returns or estate tax return, particularly in the case where closely held business interests were transferred. A surviving spouse may want to consider incorporating DSUE usage with formula gifting. 22

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24 The IDGT: A Highly Effective Defective Trust Defective for Income Tax Purposes Effective for Estate Tax Purposes Income is taxable to the grantor or the beneficiaries Trust Corpus is excluded from Grantor s estate for estate tax purposes Sale to trust is a nontaxable event Taxes paid on income earned by the trust further reduces estate 24

25 IDGT: Best Ways to Break the Rules 674(a)- power to control beneficial enjoyment 675(1) power to deal with trust assets for less than full & adequate consideration 675(2) specific power of grantor to borrow trust assets without adequate security or adequate interest 675(3) actual borrowing of trust assets by the Grantor 675(4)(C) - power to substitute assets (exercisable in Non-Fiduciary capacity) 25

26 Sale to IDGT 1. Grantor makes seed gift of at least 10% (as a rule of thumb) of the purchase price to be paid by the IDGT 2. Grantor sells asset with expected future appreciation to IDGT 3. IDGT pays for asset with a Promissory Note, using the current applicable federal rate 4. No income tax on sale of asset to IDGT 5. Adequately disclose non-sale transaction on timely filed gift tax return 26

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28 Statute of Limitations Generally, the IRS must assess tax within three years after a return is filed. If the value of omitted gifts exceeds 25% of the total amount of gifts reported on the return, the statute of limitations is six years. There is no statute of limitations barring assessment if no return is filed or if the return is false or fraudulent. The statute of limitations does not apply to gifts that are not adequately disclosed. 28

29 Adequate Disclosure Safe Harbor For Gifts A gift will generally be adequately disclosed if the return is full and complete and the return or an attached statement includes the following: A description of the transferred property and any consideration received by the donor; The identity of, and relationship between the donor and each donee; If the property is transferred to a trust, the trust s employer identification number and a brief description of the terms of the trust or a copy of the trust; and Either a qualified appraisal or detailed description of the method used to determine the fair market value of the gift. A statement describing any position taken that is contrary to any proposed, temporary or final Treasury regulations or revenue rulings published at the time of the transfer. 29

30 Qualified Appraiser Treas. Reg. Sect (c)(5)(iv) Qualified Appraiser CANNOT be: Transferor or Member of Transferor s/transferee s Family Party to the transaction Persons or business entities receiving or purchasing the transferred property Employee of a person or organization listed above Related Party as defined in IRC Sect. 267(c) Appraiser regularly used by excluded person who does not perform majority of appraisals for others 30

31 Disclosure of Non-Gift Transactions Non-gift transactions may be reported on a gift tax return to start the statute of limitations in which the IRS must determine if a taxable gift was in fact made. In order for a non-gift transaction to be considered adequately disclosed, it must meet all of the disclosure requirements for gifts listed above, plus an explanation as to why the transfer is not a transfer by gift under the Internal Revenue Code must be included. 31

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33 Sample Statement of Disclosure 33

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35 Generation Skipping Tax & Skip Person What is the Generation Skipping Tax? Generation-skipping transfer tax imposes a tax on both outright gifts and transfers in trust to or for the benefit of skip person. Who is a Skip Person? A skip person is a natural person assigned to a generation which is 2 or more generations below the generation assignment of the transferor (donor), or A trust, if all interests in such trust are held by skip person, or No person holds an interest in the trust, and at no time after the transfer to the trust, may a distribution be made to a non skip person. 35

36 Generation Assignment Unrelated Beneficiaries Related Beneficiaries Grantor's Parent Grantor's Uncles/Aunts Grantor Grantor's Brother/Sister Grantor's Cousin Grantor's Child Grantor's Nephew/Niece Cousin's Child Grantor's Grandchild Grantor's Grand Nephew/Niece Cousin's Grand Child 36

37 Direct skip vs. Indirect skip A direct skip is a property transfer made to a skip person that is subject to an estate of gift tax. An example of a direct skip would b a grandmother gifting property to a grandchild. The transferor, or his or her estate, is responsible for paying the GST tax for direct skips. Indirect skips involve transfers that have intermediate steps before reaching a skip person. There are two types of indirect skips, the taxable termination and the taxable distribution. Grandparent Grand Child Upon the death of child Trust with income beneficiary as child 37

38 What is GST Exemption (IRC Section 2632)? Under section 2631(a) each individual is allowed to give away during his or her lifetime up to $5,430,000 (for year 2015) without any federal gift or estate taxes due to the historically high exemption for federal transfer tax purposes. The same exemption amount applies for generation-skipping transfer (GST) tax purposes this year. Under section 2632(a), an allocation of an individual s GST exemption may be made at any time on or before the date prescribed for filing the estate tax return for the individual s estate (determined with regard to extensions). 38

39 Deemed Allocation IRC Sect. 2632(b) Section 2632 also provides deemed allocation rules pursuant to which an individual s available GST exemption is automatically allocated to certain kinds of transfers, without any action on the part of the transferor. Under section 2632(b), an individual s unused GST exemption is automatically allocated to transfers made during that individual s lifetime that are direct skips as defined in section 2612(c), to the extent necessary to make the inclusion ratio zero for the property transferred. The unused portion of an individual s GST exemption is that portion of such exemption which has not previously been allocated by such individual 39

40 GST Annual Exclusion Currently $14,000 Available to direct skips Available to trust if: During the life of the beneficiary, no distributions may be made to anyone but the beneficiary; and At the beneficiary's death, the trust assets will be included in the beneficiary s gross estate. 40

41 GST Annual Exclusion 41

42 Automatic Allocation IRC Sect. 2632(c) Under section 2632(c), in the case of a lifetime transfer made after December 31, 2000, that is an indirect skip, the transferor s available GST exemption is automatically allocated to the transfer to the extent necessary to make the inclusion ratio zero for the property transferred. Under section 2632(c)(5)(A)(i)(I), an individual may elect out of the deemed allocation rules so that GST exemption will not be allocated automatically to a particular transfer that is an indirect skip. Under section 2632(c)(5)(B)(i), this election out with regard to a particular indirect skip shall be deemed timely if made on a timely filed gift tax return for the calendar year in which the transfer was made, or deemed to have been made under section 2632(c)(4) with regard to trusts subject to an estate tax inclusion period, or on such later dates as may be prescribed in regulations. 42

43 Automatic Allocation Rules Direct skips Indirect: GST trusts A GST trust is a trust that could have a taxable termination or taxable distribution unless certain exceptions apply. Note: A conventional insurance trust where the spouse is a beneficiary and that provides for the possibility of trusts for descendents after the spouse s death is a GST trust. 43

44 IRC 2632(c)(3)(B) Definition of a GST Trust A Trust is a GST Trust unless: More than 25% of corpus distributable to non-skip person before such person attains the age of 46 More than 25% of corpus distributable to non-skip persons living on date of death of another person who is more than 10 years old than such non-skip persons More than 25% of corpus subject to general power of appointment held by non-skip persons Any portion of trust includable in estate of non-skip person if such person died immediately after transfer Certain types of charitable trusts (i.e. CLATs) 44

45 Sample Gift to Dynasty Trust 45

46 Opt Out / Opt In of Automatic Allocation The method for opting in or out of automatic allocation is the same. Check the 2632 election box. Attach a statement to the return that includes a description of the transfer and the extent to which the automatic allocation is to apply (or not apply). An election can be made for all future transfers to a particular trust (you can subsequently elect to have the allocation rules apply). Once an election is made, it is irrevocable after the due date of the return. 46

47 Timely vs. Late GST Allocations For timely allocations, the date-of-gift value is used. For late allocations, the value as of the first of the month when the return is filed is used. 47

48 Example Bea Generous makes a $150,000 gift to the Generous Dynasty Trust in 2009 but did not allocate GST Exemption on the gift tax return. Bea files a gift tax return in February 2014 in order to allocate GST exemption to the trust. Bea must use the value of the trust assets on February 1, 2014 to fully allocate GST exemption to the trust. 48

49 Late Allocations of GST Exemption Procedural Requirements File a Form 709 for the year of the transfer to the trust, regardless of whether a Form 709 had been previously filed for that year. State at the top of the Form 709 that the return is FILED PURSUANT TO REV. PROC Report on the Form 709 the value of the transferred property as of the date of the transfer. Allocate GST exemption to the trust by attaching a statement to the Form 709 entitled Notice of Allocation. The notice of allocation must contain the following information: clear identification of the trust, including the trust s identifying number, as defined in 6109 and the regulations thereunder, when applicable; the value of the property transferred as of the date of the transfer (adjusted to account for split gifts, if any); the amount of taxpayer s unused GST exemption at the time this Notice of Allocation is filed (taxpayers are reminded that they must have unused GST exemption at the time this Notice of Allocation is filed); the amount of GST exemption allocated to the transfer; the inclusion ratio of the trust after the allocation; and a statement that all of the requirements of section 3.01 of this revenue procedure have been met. 49

50 Important Remember to adjust the amount of GST exemption used in prior periods in which a gift tax return was not filed. 50

51 Example On her 2008 gift tax return, Bea Generous opted to have GST exemption allocated to all future gifts made to a Crummey trust. During 2009, 2010, 2011 and 2012, Bea only made annual exclusion gifts to the trust in the amount of $120,000, so she did not file gift tax returns for these years. When Bea files her 2013 return, the amount of GST exemption used for prior years should be increased by $480,000 (4 years x $120,000 per year), the amount automatically allocated during 2009, 2010, 2011 and

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53 Overview of GRAT Under the terms of a grantor retained annuity trust ( GRAT ), a grantor transfers property to an irrevocable trust. Every year for a specified number of years (the annuity term ), the trustee pays the grantor a fixed annuity amount. The Annuity Amount which is expressed as a percentage of the initial fair market value of the property transferred to the GRAT is set so that the present value of the amount to be paid to the grantor over the annuity term equals the amount transferred to the GRAT, plus an assumed rate of return. At the end of the annuity term, the GRAT may continue to hold in trust property remaining in the GRAT (if any) for the benefit of persons other than the grantor (e.g., the grantor s children) on such terms as the grantor specifies in the trust instrument. The GRAT may distribute any remaining trust property outright to persons named in the trust instrument. 53

54 Zero-ing Out The GRAT A GRAT is zeroes out for gift tax purposes when the annuity amount paid by the trustee to the grantor is equal to the amount transferred to the GRAT. The result of such a zeroed-out GRAT is that any appreciation in the value of the property contributed to the GRAT in excess of an assumed rate of return can be distributed to the named beneficiaries at the end of the annuity term without any gift tax. If the property placed in the GRAT does not appreciate, or appreciates at a rate lower than the assumed rate of return, all of the property placed in the GRAT will be paid back to the grantor during the annuity term and nothing will be left for the intended beneficiaries. 54

55 Grantor Retained Annuity Trust Reporting on Schedule A part 1 55

56 Grantor Retained Annuity Trust Reporting on Schedule A part 3 56

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58 Overview of ETIP An ETIP is the period during which, should death occur, the value of transferred property would be includible (other than by reason of section 2035) in the gross estate of (A) The transferor; or (B) The spouse of the transferor. The value of transferred property is not considered as being subject to inclusion in the gross estate of the transferor or the spouse of the transferor: If the possibility that the property will be included is so remote as to be negligible. A possibility is so remote as to be negligible if it can be ascertained by actuarial standards that there is less than a 5 percent probability that the property will be included in the gross estate. If the spouse possesses with respect to any transfer to the trust, a right to withdraw no more than the greater of $5,000 or 5 percent of the trust corpus, and such withdrawal right terminates no later than 60 days after the transfer to the trust. 58

59 Termination of an ETIP An ETIP terminates on the first to occur of: The death of the transferor The time at which no portion of the property is includible in the transferor's gross estate (other than by reason of section 2035) or, in the case of an individual who is a transferor solely by reason of an election under section 2513, the time at which no portion would be includible in the gross estate of the individual's spouse (other than by reason of section 2035) The time of a GST, but only with respect to the property involved in the GST; or In the case of an ETIP arising by reason of an interest or power held by the transferor's spouse and at the first to occur of (A) The death of the spouse; or (B) The time at which no portion of the property would be includible in the spouse's gross estate (other than by reason of section 2035). 59

60 Thank You For Attending! This presentation was not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties under U.S. federal tax law. 60

61 Tracy M. Child, JD, LLM Sherman Wells Sylvester & Stamelman LLP 54 West 40th Street New York, NY Tracy Child is a partner at the law firm of Sherman Wells Sylvester & Stamelman, a New Jersey based full service firm. She is a member of the Firm s Trusts & Estates Group, where she assists individuals and families with a broad range of estate planning, estate administration, family business succession planning and related tax work. In the course of doing so, Tracy counsels clients on establishing an estate plan that meets their needs and objectives as tax-efficiently as possible. Prior to attending law school, Tracy was a senior tax associate with Deloitte and Touche LLP and at Arthur Andersen LLP. Tracy also serves as the partner-in-charge of the Firm s New York office. 61

62 Joy Matak, JD, LLM CohnReznick LLP 4 Becker Farm Road P.O. Box 954 Roseland, NJ joy.matak@cohnreznick.com Joy Matak, JD, LLM, is a tax director at CohnReznick and a member of the Firm s National Trusts and Estates Practice. Joy has more than 18 years of diversified experience with an extensive background in providing tax services to multigenerational wealth families, owners of closely-held businesses, and high-net-worth individuals and their trusts and estates. Joy has significant expertise providing her clients with diverse wealth transfer strategy planning to accomplish estate planning and business succession goals. She also performs tax compliance, including gift tax, estate tax, and income tax returns for trusts and estates, as well as consulting services related to generation skipping, including transfer tax planning, asset protection, life insurance structuring, and post-mortem planning. 62