PROFESSIONAL EDUCATION BROADCAST NETWORK. Speaker Contact Information TRUSTS & DISTRIBUTIONS: ALL ABOUT NON-PRO-RATA DISTRIBUTIONS

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1 PROFESSIONAL EDUCATION BROADCAST NETWORK Speaker Contact Information TRUSTS & DISTRIBUTIONS: ALL ABOUT NON-PRO-RATA DISTRIBUTIONS Blanche Lark Christerson Deutsche Bank Wealth Management - New York City (o) (212) blanche.christerson@db.com David T. Leibell UBS Private Wealth Management New York City (o) (212) david.leibell@ubs.com

2 VT Bar Association Continuing Legal Education Registration Form Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT Fax: (802) PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name Middle Initial Last Name Firm/Organization Address City State ZIP Code Phone # Fax # Address Trusts & Distributions: All About Non-Pro-Rata Distributions Teleseminar March 1, :00PM 2:00PM 1.0 MCLE GENERAL CREDITS VBA Members $75 Non-VBA Members $115 NO REFUNDS AFTER February 22, 2017 PAYMENT METHOD: Check enclosed (made payable to Vermont Bar Association) Amount: Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # Exp. Date Cardholder:

3 Vermont Bar Association CERTIFICATE OF ATTENDANCE Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: March 1, 2017 Seminar Title: Location: Credits: Program Minutes: Trusts & Distributions: All About Non-Pro-Rata Distributions Teleseminar - LIVE 1.0 MCLE General Credit 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

4 Blanche Lark Christerson Managing Director, Senior Wealth Planning Strategist Tax Topics /30/15 Trusts and divorce Trusts can offer creditor protection to beneficiaries. Yet the extent of that protection can depend on various factors, including the terms of the trust, where the beneficiary lives and the nature of the action against the beneficiary. Pfannenstiehl v. Pfannenstiehl, a recent decision from the Appeals Court of Massachusetts dealing with the division of property in divorce, is a case in point (88 Mass. App. Ct. 121, August 27, 2015). The facts. H and W married in early They had two children, both with special needs (one child was dyslexic and had attention-deficit disorder, and the other had Down syndrome); W was the primary homemaker and caretaker of the children. Dad, H s father, and B, H s twin brother, ran very successful forprofit colleges through several closely held corporations (H worked as an assistant bookstore manager at one of the colleges, earning $170,000 a year). In 2004, Dad created a trust to benefit his descendants a class that would grow as more descendants were born (at the time in question, Dad had three children (including H) and eight grandchildren, or 11 descendants in all). Dad funded the trust chiefly with shares from the companies, which generated substantial income through tuition payments. B and the lawyer who had represented Dad and the companies for 30+ years were the trustees. The trustees could make discretionary distributions of income or principal to a beneficiary, in equal or unequal shares, for a beneficiary s comfortable support, health, maintenance, welfare and education, and could consider a beneficiary s other sources of funds in determining whether to make a distribution; distributions were income-tax free since Dad was responsible for paying the trust s income taxes (yes, this was a defective grantor trust). The trust had a spendthrift provision that was designed to preclude a beneficiary from assigning or pledging trust property, as well as shield the property from attachment, execution, garnishment or other seizure under any legal, equitable or other process. The trustees only made distributions to Dad s three children: from May 2009 through March 2012, H s brother and sister received varying amounts, generally monthly, totaling $1.13 million and $1.18 million, respectively; in 2008, H received a single distribution of $300,000, and from May 2009 through August 2010,

5 received varying amounts, generally monthly, totaling $500,000. When H filed for divorce in September 2010, he received nothing further from the trust. Divorce proceedings lower court. H s divorce trial lasted eight days in early The proceedings were complicated, and intensely litigated. A key question was whether the trust was part of the marital estate. Under Massachusetts law, the Probate and Family Court judge had considerable latitude in ascertaining that estate and its division. She concluded that the trust, which she valued at nearly $25 million, was part of the marital estate, and that H, as one of 11 possible beneficiaries, had a 1/11 interest in the trust. The judge valued the entire marital estate at $4.3 million, and allocated 60% to W and 40% to H (in the final calculation, W received $2.33 million and H received $1.97 million). To effect the transfers to W, the judge ordered H to pay W nearly $50,000 per month for 24 months. Thanks to loans from Dad, H was able to make about five payments; when those loans ceased, H wrote to the trustees requesting distributions from the trust so that he could comply with the judgment. The trustees denied his request, and W filed a contempt proceeding: H had not paid her from January through April H was found guilty, and ordered to jail for 60 days unless he paid what was owed (over $200,000, with interest). H appealed the contempt judgment, stating that he had no independent ability to make the payments and therefore could not be held in contempt; he also appealed the holding the trust was part of the marital estate. Appeals Court. The Appeals Court vacated the contempt judgment, noting that H had tried to satisfy the monthly payments by borrowing from his father, and by asking the trustees for distributions after the loans ceased. Although one could question the genuineness of all these machinations given the bias of the two trustees and the husband s father, it was not proved by clear and convincing evidence that H willfully and intentionally violated a clear and unequivocal order. The Appeals Court affirmed that the trust was part of the marital estate. Some of the factors the court looked at included the following: The spendthrift provision was being invoked as a subterfuge to mask the husband s income stream and thwart the division of the marital estate in the divorce. The cutoff of distributions to H on the eve of divorce was a deliberate manipulation to erase a major component of the husband s annual income and to silence his interest in the trust. The trust s standard for distributions to beneficiaries comfortable support, health, maintenance, welfare and education was ascertainable; H s income stream was therefore not too remote or speculative for inclusion in the marital estate. H had an enforceable right to trust distributions to support his lifestyle, his interest in the trust was vested in possession, and he was likely to receive distributions once the divorce was over. The 60/40 split between W and H was also appropriate, given that W was the primary homemaker and caretaker of the two children and spent extraordinary amounts of time addressing their needs; H s substantial income distributions from the trust for support, maintenance and welfare were woven into the fabric of the marriage. A dissenting judge (with whom another judge joined) said that H s interest was too remote and speculative, too dependent on trustee discretion, and too elusive of valuation to have been included in the Tax Topics 11/30/15 2

6 marital estate for purposes of division. Here, the trust was not solely for H, but had an open class and multiple beneficiaries, in different generations, to whom the trustees owe fiduciary duties. In addition, the trust s ascertainable standard could not be read in isolation. The trustees had discretion regarding the amounts and timing of distributions, and could take into account a beneficiary s funds from other sources in determining whether to make a distribution; indeed, the trustees made distributions in some years, and not in others. In short, the husband s interest in the trust stands on different footing from a party s interest in cases where interests are more clearly fixed and certain. The fractional share methodology used by the judge in the lower court produced an arbitrary result. Although the majority of the court noted what it considered machinations on the part of the trustees to discontinue payments to H on the eve of his divorce filing so as to paint his interest as remote and speculative where it never had been previously the primary focus should be the terms of the trust instrument itself, not how those terms may be or have been manipulated. In other words, consideration of such manipulation must be secondary to the terms of the trust instrument itself. Comments. H has appealed to the Supreme Judicial Court of Massachusetts (the highest court in the state). In the meantime, what to make of this case? Several thoughts come to mind. First, in the words of the majority opinion, Massachusetts divorce law takes an expansive view of the marital estate, which can include a beneficial interest in trust; in determining that marital estate and its division, a judge is allowed to weigh many factors, including the length of the marriage, the conduct of the parties during the marriage, the age, health, station, occupation, amount and sources of income, vocational skills, employability and needs of each of the parties. Other jurisdictions, however, may have less expansive views. Accordingly, the divorce law to which the beneficiary is subject (typically, where the beneficiary lives) will affect which of the beneficiary s property interests are available for purposes of dividing the marital estate notwithstanding language in the trust that attempts to limit a creditor s access to the trust property. Second, because the trust had an ascertainable standard for distributions ( comfortable support, health, maintenance, welfare and education ), the trust property was more accessible than it would have been if the trustees had full discretion for distributions, and no ascertainable standard. In this case, however, full discretion would have been problematic since H s brother was a trustee/beneficiary: for him to be able to participate in decisions regarding trust distributions and avoid adverse tax consequences (such as the trust property being includible in his estate), the ascertainable standard was necessary. (Note that when family members are trustees and beneficiaries, there are often trade-offs in terms of the flexibility and potential creditor protection the trust can provide; as with so much in the planning area, it is a balancing act.) Third, it was clear that the court s sympathies lay with W, and not H (W had made significant employment sacrifices to take care of their children, in particular, their Down-syndrome daughter). To illustrate, the court commented unfavorably on for-profit colleges, and repeated many of the probate judge s tart observations regarding H and his family, including how the proverbial family wagons circled the family money when H s divorce began, describing H s $170,000 salary as an assistant bookstore manager as inflated and flowing from familial relations (the court said that a normal incumbent in this position would earn $50,000-$60,000 a year), and noting the machinations that were designed to silence H s interest in the trust. As the old saying goes, however, bad facts make bad law. That is, putting the human factor to one side, it seems surprising that the court concluded that H had a fixed right to distributions, given that distributions were discretionary (albeit subject to an ascertainable standard); it also seems surprising that the court agreed that as one of 11 current beneficiaries, H had a 1/11 interest in the trust: this fractional approach overstates H s interest assuming more descendants are born, and understates his interest if the class suddenly contracts because beneficiaries die. Tax Topics 11/30/15 3

7 In addition, notwithstanding the court s dim view of how the trust was administered and the perceived manipulations of H s family, the trustees had a fiduciary obligation to the other trust beneficiaries. If they had agreed to H s request for distributions so that he could fulfill the court-ordered 24 monthly settlement payments to W, those distributions arguably would have fallen outside of the scope of the trust s ascertainable standard for distributions (again, "comfortable support, health, maintenance, welfare and education ). Furthermore, whether a trustee is an independent third-party or a family member or friend, that trustee is no less vulnerable to a potential suit from a disgruntled beneficiary. Here are a few takeaways from this case: 1) full discretion on the part of trustees (as opposed to discretion that is subject to an ascertainable standard) offers more potential creditor protection to beneficiaries; 2) depending on the jurisdiction, a divorce court may be more willing to consider a beneficiary s discretionary trust interest as a divisible part of the marital estate; and 3) before they wed, beneficiaries of means may want to consider having a pre-nuptial agreement, as unromantic as such agreements can be. No more $100,000,000 checks! On September 7, 2015, the IRS issued Announcement IRS personnel were told that effective January 1, 2016, the IRS cannot accept checks over $99,999,999, as checks in excess of that amount must be processed by hand, which can lead to errors. If a taxpayer owes more than that amount, the taxpayer must use two or more checks or pay by Fed Wire. Good to know. December 7520 rate The IRS has issued the December 2015 applicable federal rates: the December 7520 rate remains at 2.0%, where it was in November. The December mid-term rates are: 1.68% (annual), 1.67% (semiannual and quarterly) and 1.66% (monthly). The November mid-term rates were: 1.59% (annual), 1.58% (semiannual and quarterly) and 1.57% (monthly). Blanche Lark Christerson is a managing director at Deutsche Asset & Wealth Management in New York City, and can be reached at blanche.christerson@db.com. The opinions and analyses expressed herein are those of the author and do not necessarily reflect those of Deutsche Bank AG or any affiliate thereof (collectively, the Bank ). Any suggestions contained herein are general, and do not take into account an individual s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. No warranty or representation, express or implied, is made by the Bank, nor does the Bank accept any liability with respect to the information and data set forth herein. The information contained herein is not intended to be, and does not constitute, legal, tax, accounting or other professional advice; it is also not intended to offer penalty protection or to promote, market or recommend any transaction or matter addressed herein. Recipients should consult their applicable professional advisors prior to acting on the information set forth herein. This material may not be reproduced without the express permission of the author. "Deutsche Bank" means Deutsche Bank AG and its affiliated companies. Deutsche Asset & Wealth Management represents the asset management and wealth management activities conducted by Deutsche Bank AG or its subsidiaries. Clients are provided Deutsche Asset & Wealth Management products or services by one or more legal entities that are identified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services. Trust and estate and wealth planning services are provided through Deutsche Bank Trust Company, N.A., Deutsche Bank Trust Company Delaware and Deutsche Bank National Trust Company Deutsche Asset & Wealth Management. All rights reserved Tax Topics 11/30/15 4

8 Blanche Lark Christerson Managing Director, Senior Wealth Planning Strategist Tax Topics /28/15 Revised discussion on basis consistency and basis reporting The prior edition of Tax Topics (8/31/15) addressed some of the tax provisions in the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (Public Law No ). This short-term patch for the Highway Trust Fund, which was about to run out of money, was enacted on July 31 st. Last month s discussion chiefly addressed the new rules regarding: a) consistent basis reporting between an estate and property recipients, and b) basis reporting requirements for estate executors. We noted that these new rules applied to estates over the current $5.43 million estate tax return filing threshold and queried whether they also applied to portability returns, where the estate is under the filing threshold, but a return is filed anyway so that the surviving spouse can receive the deceased spouse s leftover exclusion (see below). We have since realized that because the portability regulations treat a portability return as being over the filing threshold, the new rules presumably apply to all estate tax returns filed after July 31, With that in mind, here is a revised discussion of the prior material: Consistent basis reporting between an estate and property recipients. In general, the basis of property that a person receives from a decedent is the property s fair market value at the decedent s death; nothing, however, has required a beneficiary to use this same basis for subsequent transactions with the property until now. For estate tax returns filed on or after August 1, 2015, the basis of estate property cannot exceed the property s finally determined estate tax value or, if none, the value reported by the executor to both the IRS and the beneficiary within the earlier of 30 days from: a) filing the estate tax return, or b) the return s required due date. Penalties apply if the executor fails to report the property s basis or if beneficiaries later overstate it. The Treasury Department will issue regulations as necessary to implement basis reporting, and to address: a) how the new rules apply to a decedent s property if no estate tax return is necessary, and b) situations where a surviving joint tenant or other property recipient has better information than the executor regarding the property s basis or fair market value.

9 Because of the law s immediate effective date, the first basis reports would have been due by the end of August a challenging deadline, given that no guidance or forms were available. Aware of this problem, the IRS granted executors a reprieve on August 21 st : IRS Notice instructs executors to wait until February 29, 2016 before filing ANY basis reports that would otherwise be due (yes, 2016 is a leap year). A Treasury Department official has since stated that draft forms and guidance likely will be issued in the first or second week of January. Here are some additional details: For purposes of the consistency rules, a property s basis and estate tax value has been finally determined if the IRS does not contest the value before the statute of limitations has expired with respect to the estate tax return (generally three years from filing); if the IRS does contest the property s value, the redetermined value becomes the basis if: a) the estate does not timely disagree with the IRS, b) the estate settles with the IRS, or c) a court determines the property s value. The consistency rule only applies to property that increased the decedent s estate tax liability (reduced by any allowable credits); the Treasury Department is allowed to provide regulatory exceptions to the consistency rule. If the executor has already reported the property s basis to the IRS and the beneficiary and the property s value (and therefore basis) is later adjusted, the executor must file a supplemental basis statement within 30 days of the adjustment. Comments. The promised guidance will be welcome, as there are a number of unanswered questions regarding the new rules and their implementation, including the following: The consistency rule only applies to property that increases a decedent s estate tax liability (reduced by any allowable credits). What does this mean in the following situations? 1. Dad dies with a $6 million estate that he leaves entirely to a trust for Mom that qualifies for the marital deduction and therefore postpones estate tax until Mom s death. Since the trust does not increase Dad s estate tax liability, is it exempt from the consistency rule? 2. Dad dies with a $20 million non-taxable estate: part of it passes to a credit shelter trust for Mom and the kids and the balance passes to Mom outright and qualifies for the marital deduction. Although the credit shelter trust is a taxable disposition, it does not increase Dad s estate tax liability because the credit for his exclusion amount offsets the liability, and reduces it to zero. Since both dispositions are effectively non-taxable, is the consistency rule inapplicable? 3. Dad makes no taxable gifts during his life, and dies with a $5 million estate. He gives Son property worth $1 million, and the balance of his estate to Mom, who is also Dad s executor. Although Dad s estate is under the $5.43 million filing threshold, Mom files an estate tax return for his estate so that she can receive Dad s $4.43 million unused exclusion and add it to hers (a portability return). Son s gift is taxable, but does not increase Dad s estate tax liability, because the credit for Dad s exclusion amount offsets the liability; the gift to Mom qualifies for the marital deduction. Again, is the consistency rule inapplicable? Tax Topics 09/28/15 2

10 Given that certain property is exempt from the consistency rule (see above), why must the executor nevertheless report basis to each person acquiring any interest in property included in the decedent s gross estate? The basis statement must identify the value of each interest in the property as reported on the estate tax return. If the person receiving the interest is an entity, does the reporting stop at the entity level? For example, if property passes to a trust, does the executor only report to the trustee, or must the executor also report to beneficiaries? Suppose that 30 days after filing a timely estate tax return (it s due 9 months after date of death unless the executor filed for an automatic 6-month extension), the executor is still undecided as to how to distribute the decedent s residuary estate (what s left over after taxes and expenses) to the residuary beneficiaries. Besides the IRS, to whom should the executor be reporting basis, when it is currently unclear who receives what? In this circumstance, will the executor still be liable for a penalty for a failure to report, or will an extension be available for this reporting? Suppose that divorced Mom dies with a $10 million estate, and leaves her vacation home to Daughter; Daughter (Mom s executor) files a timely estate tax return for Mom s estate. 30 days later, Daughter files a basis report with the IRS and herself setting forth the property s value as of Mom s date of death. Daughter later remodels the kitchen and the bathrooms, thereby incurring capital expenses that increase her basis in the property. If Daughter sells the home and uses this increased basis to calculate her gain, will she be liable for a basis overstatement penalty? And so forth. The more practitioners look at this new law, the more issues they are likely to find. Treasury and the IRS have their work cut out for them to craft guidance and basis reporting forms prior to the delayed basis reporting date of February 29, Although Congress is keen to put more mechanisms in place to verify that taxpayers don t overstate tax basis (or other items that could reduce their taxes), that is easier said than done. p.s. What is the filing threshold? A decedent s estate is over the filing threshold for filing an estate tax return if the decedent s gross estate plus adjusted taxable gifts exceeds the basic exclusion amount in effect at the decedent s death. This translates as follows: The gross estate refers to everything the decedent owned at death (such as real estate, brokerage and bank accounts, life insurance, retirement accounts and the decedent s share of jointly owned property). Adjusted taxable gifts are lifetime gifts that reduce the decedent s applicable exclusion amount; in general, these are gifts other than: a) direct payments for tuition, medical expenses and health insurance premiums, and b) the $14,000 annual gifts that donors can give to as many people as they wish ($28,000 if the donor s spouse consents to the gift). The applicable exclusion amount consists of the basic exclusion amount ($5 million annually indexed for inflation, or $5.43 million in 2015) plus, if applicable, the deceased spousal unused exclusion amount (DSUE) loosely known as portability. If there is no DSUE, the applicable exclusion amount and basic exclusion amount are the same. So: if divorced Dad, who has made no prior taxable gifts, gives Daughter $500,000 to help her buy a house, $14,000 of that gift qualifies for the annual exclusion, and the balance ($486,000) is an adjusted Tax Topics 09/28/15 3

11 taxable gift that reduces Dad s applicable exclusion amount. If Dad dies in late 2015 and leaves his entire $5 million gross estate to Daughter, who is also his executor, she still must file an estate tax return for Dad s estate since his gross estate plus adjustable taxable gifts exceeds the $5.43 million threshold by $56,000 ($5 million + $486,000 = $5.486 million). 30 days after filing the return, Daughter must also file a basis statement with the IRS and herself. what if an estate is under the filing threshold? If an estate is under the filing threshold, an estate tax return is not required unless there is a surviving spouse and the deceased spouse s executor wants to elect portability. In other words, suppose Dad made no taxable lifetime gifts and dies in 2015, leaving his entire $4 million estate to Mom (also his executor). For Mom to receive Dad s $5.43 million unused exclusion so that she can add it to her own, she must file a timely return for Dad s estate (yes, Dad s DSUE can exceed the size of his actual estate). By merely filing this return, Mom is deemed to elect portability for Dad s estate. October 7520 rate The IRS has issued the October 2015 applicable federal rates: the October 7520 rate is 2.0%, a drop of 0.20% (20 basis points) from the 2.2% rate in September, August and July. The October mid-term rates are: 1.67% (annual), 1.66% (semiannual and quarterly) and 1.65% (monthly). The September mid-term rates were: 1.77% (annual), 1.76% (semiannual and quarterly) and 1.75% (monthly). Blanche Lark Christerson is a managing director at Deutsche Asset & Wealth Management in New York City, and can be reached at blanche.christerson@db.com. The opinions and analyses expressed herein are those of the author and do not necessarily reflect those of Deutsche Bank AG or any affiliate thereof (collectively, the Bank ). Any suggestions contained herein are general, and do not take into account an individual s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. No warranty or representation, express or implied, is made by the Bank, nor does the Bank accept any liability with respect to the information and data set forth herein. The information contained herein is not intended to be, and does not constitute, legal, tax, accounting or other professional advice; it is also not intended to offer penalty protection or to promote, market or recommend any transaction or matter addressed herein. Recipients should consult their applicable professional advisors prior to acting on the information set forth herein. This material may not be reproduced without the express permission of the author. "Deutsche Bank" means Deutsche Bank AG and its affiliated companies. Deutsche Asset & Wealth Management represents the asset management and wealth management activities conducted by Deutsche Bank AG or its subsidiaries. Clients are provided Deutsche Asset & Wealth Management products or services by one or more legal entities that are identified to clients pursuant to the contracts, agreements, offering materials or other documentation relevant to such products or services. Trust and estate and wealth planning services are provided through Deutsche Bank Trust Company, N.A., Deutsche Bank Trust Company Delaware and Deutsche Bank National Trust Company Deutsche Asset & Wealth Management. All rights reserved Tax Topics 09/28/15 4